-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DwDAbXi7vXpxwkvsm/gGoc/bKz8pDOTH0h4obccqeFJXD2pc6BMNyIOGONS7mHwt 6T2H7+30BgrZoZLqzQtOlg== 0000950146-96-002117.txt : 19961121 0000950146-96-002117.hdr.sgml : 19961121 ACCESSION NUMBER: 0000950146-96-002117 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19961120 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PEGASYSTEMS INC CENTRAL INDEX KEY: 0001013857 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-16475 FILM NUMBER: 96669869 BUSINESS ADDRESS: STREET 1: 101 MAIN ST CITY: CAMBRIDGE STATE: MA ZIP: 02142-1590 BUSINESS PHONE: 6173749600 MAIL ADDRESS: STREET 1: 101 MAIN ST CITY: CAMBRIDGE STATE: MA ZIP: 02142-1590 S-1 1 REGISTRATION STATEMENT As filed with the Securities and Exchange Commission on November 20, 1996 Registration No. 333- ----------------------------------------------------------------------------- ----------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------- FORM S-1 REGISTRATION STATEMENT Under THE SECURITIES ACT OF 1933 ------------- PEGASYSTEMS INC. (Exact name of Registrant as specified in its charter)
Massachusetts 7389 04-2787865 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification Number) incorporation or organization) Classification Code Number)
101 Main Street, Cambridge, Massachusetts 02142 (617) 374-9600 (Address and Telephone Number of Registrant's Principal Executive Offices) ------------- ALAN TREFLER President PEGASYSTEMS INC. 101 Main Street Cambridge, Massachusetts 02142 (617) 374-9600 (Name, Address and Telephone Number of Agent for Service) ------------- Copies to: ROBERT V. JAHRLING III, ESQ. MARK G. BORDEN, ESQ. Choate, Hall & Stewart JEFFREY A. STEIN, ESQ. Exchange Place Hale and Dorr 53 State Street 60 State Street Boston, Massachusetts 02109-2891 Boston, Massachusetts 02109-1816 (617) 248-5000 (617) 526-6000 ------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this form are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [ ]
CALCULATION OF REGISTRATION FEE - -------------------------------------------------------------------------------- Proposed Maximum Proposed Maximum Title of Each Class of Amount to be Offering Price Per Aggregate Offering Amount of Securities to be Registered Registered (1) Share (2) Price (2) Registration Fee ------------------------------ --------------- ------------------ ------------------ ----------------- Common Stock, $.01 par value 2,581,750 $33.00 $85,197,750 $25,818
(1) Includes 336,750 shares which may be sold if the over-allotment option granted to the Underwriters is exercised. (2) Calculated pursuant to Rule 457(c) under the Securities Act of 1933 based on the average high and low sale prices of the Registrant's Common Stock as reported by Nasdaq on November 13, 1996. ------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. ================================================================================ Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION, DATED NOVEMBER 20, 1996 2,245,000 Shares [Pegasystems Logo] Pegasystems Inc. Common Stock (par value $.01 per share) ------------- Of the 2,245,000 shares of Common Stock offered hereby, 1,500,000 are being sold by Pegasystems Inc. ("Pegasystems" or the "Company") and 745,000 shares are being sold by the Selling Stockholders. See "Principal and Selling Stockholders." The Company will not receive any of the proceeds from the sale of shares by the Selling Stockholders. See "Risk Factors" beginning on page 5 for certain considerations relevant to an investment in the Common Stock. The last reported sale price of the Common Stock, which is quoted under the symbol "PEGA" on the Nasdaq National Market, was $32.625 per share on November 19, 1996. See "Price Range of Common Stock." ------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. -------------
Initial Public Underwriting Proceeds to Proceeds to Selling Offering Price Discount (1) Company (2) Stockholders Per Share $ $ $ $ Total (3) $ $ $ $
- ------------- (1) The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933. See "Underwriting." (2) Before deducting expenses of the offering payable by the Company, estimated to be $300,000. (3) The Company has granted to the Underwriters an option for 30 days to purchase up to an additional 336,750 shares at the initial offering price per share, less the underwriting discount, solely to cover over-allotments, if any. If such option is exercised in full, the total initial public offering price, underwriting discount and proceeds to Company will be $ , $ and $ , respectively. See "Underwriting." ------------- The shares offered hereby are offered severally by the Underwriters, as specified herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that certificates for the shares will be ready for delivery in New York, New York, on or about , 1996, against payment therefor in immediately available funds. Goldman, Sachs & Co. Cowen & Company Montgomery Securities ------------- The date of this Prospectus is , 1996. IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 10b-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE "UNDERWRITING." Illustration, set over a map of the world, of the Company's three-tier, client/server environment. A central server is connected to three satellite servers, with rules and code replicated on all servers. Foldout: Illustration omitted: Illustration of the Pegasystems' "service backbone." A circle, revolving around customers, is divided into six segments corresponding to the customer service management functions supported by the Company's products, each segment containing labeled icons representing examples of such functions. In the "receiving" segment are icons representing computer inbound faxes, PegaView-ACE and Internet connections, high speed computer network links and shows computer screens demonstrating PegaView-ACE and Internet access; in the "reporting" segment, icons representing productivity, service and quality management, relational database interfaces and opportunity analysis; in the "resolving" segment, icons representing advisor checklists, system-driven processing and multi-currency accounting; in the "responding" icon, outbound faxes, internet electronic mail and personalized letters and automated followups; in the "researching" segment, icons representing on-line disks, micrographics and virtual archive opticals and tapes; and in the "routing" segment, prioritization and queuing, rule-driven workflow, electronic baskets and clustered work. Inside cover: Illustration omitted: Illustration of dispersed departments of an organization interacting with customers contacting the organization through various means, each such department connected to the organization's integrated service backbone, which is represented by a circle divided into six segments corresponding to the customer management functions supported by the Company's products support (receiving, reporting, resolving, responding, researching and routing). PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus. Investors should carefully consider the information set forth under the heading "Risk Factors." The Company Pegasystems develops customer service management software to automate customer interactions across transaction-intensive enterprises. Many of the world's largest banks, mutual funds and credit card organizations use the Company's solutions to integrate, automate, standardize and manage a broad array of mission-critical customer service activities, including account set-up, record retrieval, correspondence, disputes, investigations and adjustments. The Company's systems 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 systems 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, yet drives different processes depending on the customer profile or the nature of the request. The Company's open, multi-tier, client/server systems 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. Intensifying competition is forcing businesses to reduce costs while focusing on customer service management as an important means of differentiation. Due to the volume and precise nature of their transactions, it is especially critical for financial services organizations to implement cost-effective systems to manage customer interactions accurately and efficiently. The Company's solutions provide a service backbone 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 service representatives and enable organizations to address multiple customer needs during a single contact. The Company's objective is to become the leading provider of mission-critical client/server customer service management software to organizations performing a high volume of complex interactions with demanding customers. To achieve this objective, the Company is pursuing a number of strategies, including expanding its marketing to additional business units within its existing customers; leveraging its relationships and expertise with large financial services organizations to penetrate the medium-sized financial services market; targeting new markets such as insurance, telecommunications and public utilities which have similar customer service management needs; and developing standard product templates to facilitate the more rapid implementation of its solutions. The Company markets its software and services primarily through a direct sales force which consisted of 13 people as of October 31, 1996. The Company intends to increase substantially the size and productivity of its sales force, both of which will be necessary if the Company is to achieve significant revenue growth in the future. The Company was incorporated in the Commonwealth of Massachusetts in April 1983 and has been profitable in each quarter since the first quarter of 1985. The Company's principal executive offices are located at 101 Main Street, Cambridge, Massachusetts 02142, and its telephone number is (617) 374-9600. Pegasystems, PegaCARD, PegaCLAIMS, PegaSHARES, PegaTRACE, PegaINDEX, PegaPRISM, PegaREELAY, PegaSEARCH, PegaVIEW-ACE, PegaSTAR, Integrated Service Backbone, Service Excellence Through Automation, and Virtual Archive are trademarks of the Company. This Prospectus also includes trademarks of companies other than the Company. 3 The Offering
Common Stock offered by the Company 1,500,000 shares Common Stock offered by the Selling 745,000 shares Stockholders Common Stock to be outstanding after 28,002,200 shares (1) the offering Use of proceeds by the Company For general corporate purposes, including working capital, product development, capital expenditures and possible acquisitions. See "Use of Proceeds." Nasdaq National Market symbol PEGA
- ------------- (1) Based on the number of shares of Common Stock outstanding on October 31, 1996, plus 120,000 shares of Common Stock issuable upon exercise of stock options to be exercised immediately prior to the closing of this offering. Excludes 2,392,250 shares of Common Stock issuable upon exercise of stock options outstanding as of October 31, 1996, at a weighted average exercise price of $4.39 per share, of which options to purchase 391,190 shares were then exercisable. See "Capitalization" and "Management--Stock Plans." Summary Consolidated Financial Data (in thousands, except per share data)
Nine Months Ended Year ended December 31, September 30, ------------------------------- --------------------- 1993 1994 1995 1995 1996 --------- --------- --------- ------------------- Consolidated Statement of Income Data: Total revenue $10,212 $16,263 $22,247 $14,355 $20,956 Income from operations 793 2,236 3,257 1,010 4,514 License interest income 1,305 1,457 1,486 1,122 1,127 Net income 1,233 2,193 2,878 1,290 3,567 Net income per common and common equivalent share $ 0.05 $ 0.09 $ 0.11 $ 0.05 $ 0.14 Weighted average number of common and common equivalent shares outstanding 24,231 24,102 25,551 25,600 25,952
September 30, 1996 --------------------------- Actual As Adjusted (1) --------- ---------------- Consolidated Balance Sheet Data: Cash and cash equivalents $25,419 $ 71,405 Working capital 34,521 80,507 Long-term license installments, net 18,032 18,032 Total assets 59,728 105,714 Stockholders' equity 48,136 94,122
- ------------- (1) Gives effect to (i) the sale of the 1,500,000 shares of Common Stock offered by the Company hereby at an assumed public offering price of $32.625 per share, after deducting the estimated underwriting discount and offering expenses payable by the Company, and (ii) the exercise of stock options to purchase 120,000 shares of Common Stock at an exercise price of approximately $0.33 per share, which exercise will occur immediately prior to the closing of this offering. See "Use of Proceeds" and "Capitalization." Unless otherwise indicated herein, all information in this Prospectus (i) has been adjusted to give effect to a 15-for-1 split of the outstanding Common Stock, in the form of a stock dividend, effective December 9, 1994, (ii) has been adjusted to give effect to a 3-for-1 split of the outstanding Common Stock, in the form of a stock dividend, effective July 10, 1996, and (iii) assumes no exercise of the Underwriters' over-allotment option. See "Description of Capital Stock" and "Underwriting." 4 RISK FACTORS This Prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. Discussion containing such forward-looking statements may be found in the material set forth under "Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," as well as within this Prospectus generally. Actual results could differ materially from those projected in the forward- looking statements as a result of the risk factors set forth below and the matters set forth in this Prospectus generally. The Company cautions the reader, however, that this list of factors may not be exhaustive. The following risk factors should be considered carefully in addition to the other information contained in this Prospectus before purchasing the Common Stock offered hereby. 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 reflects 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 preceded by an implementation period, typically ranging from three 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. 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 is reinforced by the Company's maintenance contracts, 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on New Products; Rapid Technological Change; Product Development and Implementation Risks The market for customer 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 5 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. See "Business--Products" and "--Product Development." Computing Platform Shift; Compatibility with Third Party Relational Databases The majority of large financial services organizations have traditionally used IBM MVS or Digital Equipment Corporation VMS systems for transaction processing. Increasingly, however, such organizations are migrating towards more open UNIX and Windows/NT server operating systems to meet their transaction processing requirements. Responding to this trend, and while continuing to support its core IBM and Digital Equipment Corporation platforms, 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 and Windows/NT platforms, of which the RS 6000/AIX, Digital OpenVMS and Sun Solaris systems have been brought into initial production use. 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 service 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 RS 6000/AIX and Windows/NT versions of its software capable of storing work items in Oracle 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. See "Business--Product Development." 6 Dependence on the Financial Services Market; Industry Consolidation The Company has derived all of its revenue to date from customers in the financial services market, and the Company's future growth depends, in large 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 financial services market 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. See "Business--Customers." Uncertainty of Growth into other Markets As part of its growth strategy the Company is exploring the possibility of applying its technology to the customer service management requirements of markets other than financial services, such as insurance, telecommunications, medical, public utilities and retail. The Company believes that in connection with such efforts it will be necessary for the Company to hire additional personnel with expertise in these other markets. There can be no assurance that the Company will be successful in adapting its technology to these other markets or in attracting and retaining personnel with the necessary industry expertise. The inability of the Company to penetrate these other markets could have a material adverse effect on its business, operating results and financial condition. See "Business--Business Strategy." Risks of Customer License Non-Renewal To date, a substantial majority of the Company's licenses have been renewed upon expiration. Revenue attributable to license renewals accounted for 32%, 26% and 28% of the Company's total revenue in 1993, 1994 and 1995, respectively, and in each period was attributable to a relatively small number of customers. There can be no assurance that a substantial majority of the Company's customers will continue to renew expiring licenses; 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business--Customers" and Notes 1 and 8 of Notes to Consolidated Financial Statements. Control by Existing Stockholders Upon completion of this offering, Alan Trefler, the Company's President and a member of its Board of Directors, will own approximately 77% of the Company's outstanding Common Stock (76% if the over- allotment option granted to the Underwriters is exercised in full). As of October 31, 1996, there were outstanding options to purchase 2,512,250 shares of the Company's Common Stock, of which options to purchase 515,690 shares were then exercisable. Assuming the exercise of all such outstanding options, Mr. Trefler would own approximately 71% of the outstanding Common Stock (70% if the over-allotment option granted to the Underwriters is exercised in full). There can be no assurance that any such stock options will be exercised. Accordingly, Mr. Trefler will be able to control the Company through his ability to determine the outcome of elections of the Company's directors, amend the Company's Restated Articles of Organization and Restated By-laws and take certain other actions requiring the vote or consent of stockholders of the Company. This concentration of ownership may have the effect of delaying or preventing a change in control of the Company. See "Principal and Selling Stockholders." 7 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, 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, 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 service management software and related consulting and training 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. See "Business--Competition." 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 8 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. See "Business--Business Strategy" and "--Sales and Marketing." Risks Associated with International Operations; Currency and Other Risks Sales to customers headquartered outside of the United States represented approximately 24% and 10% of the Company's total revenue in 1994 and 1995, 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 recently established an office in Paris, France, and may establish additional offices in continental Europe, Australia or elsewhere in 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 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. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Sales and Marketing." Dependence upon Proprietary Rights; Risks of Infringement The Company's success is heavily dependent upon its ability to protect its proprietary technology. To protect its proprietary rights, the Company relies on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements. The Company also has one United States patent application pending. However, existing patent, copyright, trademark and trade secret laws afford only limited protection. In addition, many countries' laws do not protect the Company's proprietary rights to the same extent as do the laws of the United States. Accordingly, there can be no assurance that the Company will be able to protect its proprietary rights against unauthorized third party copying, use or exploitation, any of which could have a material adverse effect on the Company's business, operating results and financial condition. Attempts may be made to copy or reverse engineer aspects of the Company's products, or to obtain, use or exploit information or methods which the Company deems proprietary. Additionally, there can be no assurance that the Company's customers and others will not develop products which infringe upon the Company's rights, or that compete with the Company's products. Policing the use of the Company's products is difficult and expensive, and there is no assurance that such efforts would prove effective. 9 Litigation or other action may be necessary in the future to enforce the Company's proprietary rights, to seek and confirm patent protection for the Company's technologies, or to determine the validity and scope of the proprietary rights of others. The Company expects that its software products may increasingly be subject to claims as the number of products and competitors in the Company's markets grows and the functionality of such products overlaps. Such litigation or proceedings, whether or not meritorious, could result in substantial costs and diversions of resources and management's attention, and could have a material adverse impact on the Company's business, operating results and financial condition. See "Business--Intellectual Property and Licenses." 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. 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 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. Product Liability; Warranty Claims The Company's license agreements with its customers typically contain provisions intended to limit the nature and extent of the Company's liability for product liability claims or claims arising from breaches of warranties. There is no assurance that such limitations would withstand judicial scrutiny or that they would bind a party not in direct privity with the Company. Furthermore, some of the Company's licenses with its customers are governed by laws other than those of the United States, and there is no assurance that purported limitations on liability would be enforced were foreign law to govern. Although the Company has not experienced any material product liability claims to date, the license and support of products by the Company and the incorporation of third party products and components may entail the risk of such claims. A product liability suit or action claiming a breach of warranty, whether or not meritorious, could result in substantial costs and a diversion of management's attention and the Company's resources, which costs and diversion could have a material adverse effect on the Company's business, operating results and financial condition. Additionally, a suit alleging a product defect or a breach of an express or implied warranty, if successful, may also have an adverse precedential effect on other or future actions. Lack of Prior Dividends; No Plans to Pay Dividends in the Foreseeable Future The Company has never declared or paid cash dividends and does not anticipate paying cash dividends in the foreseeable future. The Company's current bank line prohibits payment of dividends without the bank's consent. Potential Adverse Effects of Anti-Takeover Provisions; Possible Issuance of Preferred Stock The Company's Restated Articles of Organization (the "Restated Articles") and Restated By-Laws contain provisions that may make it more difficult for a third party to acquire, or discourage acquisition bids for, the Company. The Restated Articles and Restated By-Laws provide that a stockholder seeking to have business conducted at a meeting of stockholders must give notice to the Company not less than 90 days prior to the scheduled meeting. The Restated By-Laws further provide that a special stockholders meeting may be called by the president or the Board of Directors or upon the request of stockholders 10 holding at least 40% of the voting power of the Company. The Restated Articles and Restated By-Laws provide for a classified Board of Directors, and for the removal of directors only for cause upon the affirmative vote of the holders of a majority of the shares entitled to vote. Moreover, upon completion of this offering, the Company will be subject to an anti-takeover provision of the Massachusetts General Laws which prohibits, subject to certain exceptions, a holder of 5% or more of the outstanding voting stock of a corporation from engaging in certain transactions with the corporation, including a merger or stock or asset sale. These provisions could limit the price that certain investors might be willing to pay in the future for shares of the Company's Common Stock and may have the effect of preventing changes in the management of the Company. In addition, shares of the Company's Preferred Stock may be issued in the future without further stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as the Board of Directors may determine. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of any holders of Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or discouraging a third party from acquiring, a majority of the outstanding voting stock of the Company. The Company has no present plans to issue any shares of Preferred Stock. See "Description of Capital Stock." Shares Eligible for Future Sale Sales of substantial amounts of shares of Common Stock in the public market following this offering could adversely affect the market price of the Common Stock. On the date of this Prospectus, in addition to the 5,862,900 shares (including the 2,245,000 offered hereby) freely tradeable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"), 36,000 shares of Common Stock will be eligible for future sale in the public market pursuant to Rule 144 or Rule 701 under the Securities Act. Upon the expiration of lock-up agreements between certain stockholders of the Company and the representatives of the Underwriters 120 days after the date of the Prospectus, an additional 22,103,300 shares will become eligible for sale in the public market, subject to the provisions of Rule 144 under the Securities Act. The representatives of the Underwriters may waive some or all of the provisions of such lock-up agreements on a case-by-case or general basis, all without notice to the Company, its stockholders or any market on which the Common Stock may then be trading. See "Shares Eligible for Future Sale" and "Underwriting." As of October 31, 1996, giving effect to the exercise of options for the purchase of 120,000 shares immediately prior to the closing of this offering, options to purchase a total of 2,392,250 shares were outstanding (of which 391,190 were then exercisable) and 3,357,750 shares were reserved for future issuance under the Company's stock plans. Shares issuable upon exercise of such options and issuable under such stock plans are eligible for sale in the public market, subject to Rule 144 limitations applicable to affiliates. See "Shares Eligible for Future Sale." Potential Volatility of Stock Price The market price of the Company's Common Stock has been volatile and could be subject to wide fluctuations in the future in response to quarter-to-quarter variations in operating results, the gain or loss of significant contracts, announcements of technological developments or new products by the Company and its competitors, changes in earnings estimates by analysts, market conditions in the industry and general economic conditions. In addition, the stock market has experienced volatility that has particularly affected the market prices for the stock of many technology companies and that often has been unrelated to the operating performance of such companies. These market fluctuations may adversely affect the market price of the Company's Common Stock. See "Price Range of Common Stock" and "Underwriting." 11 USE OF PROCEEDS The net proceeds to the Company from the sale of the 1,500,000 shares of Common Stock offered by the Company pursuant to this offering are estimated to be $45,946,000 ($56,328,000 if the Underwriters' over-allotment option is exercised in full), after deducting the estimated underwriting discount and offering expenses payable by the Company. The principal purposes of this offering are to increase the Company's equity capital and to increase the visibility of the Company in the marketplace. The Company intends to use the net proceeds from this offering for general corporate purposes, including working capital, product development and capital expenditures. The Company may seek acquisitions of businesses, products and technologies that are complementary to those of the Company, and a portion of the net proceeds may be used for such acquisitions. While the Company engages from time to time in discussions with respect to potential acquisitions, the Company has no plans, commitments or agreements with respect to any such acquisitions as of the date of this Prospectus, and there can be no assurance that any such acquisitions will be made. Pending such uses, the Company intends to invest the net proceeds from this offering in short-term, investment-grade, interest-bearing securities. PRICE RANGE OF COMMON STOCK The Company's Common Stock has been traded on the Nasdaq National Market under the symbol "PEGA" since the Company's initial public offering in July 1996. The following table shows the high and low sale prices for one share of Common Stock on the Nasdaq National Market for the periods indicated. High Low ------------------ 1996 - ---- Third quarter (beginning July 19, 1996) $ 27.00 $ 10.00 Fourth quarter (through November 19, 1996) $35.875 $26.125 On November 19, 1996, the closing sale price of the Common Stock was $32.625. As of November 19, 1996, there were approximately 25 holders of record of the Company's Common Stock. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings to fund the development and growth of its business. The Company's current loan agreement with a bank prohibits the payment of dividends without the bank's consent. 12 CAPITALIZATION The following table sets forth the capitalization of the Company as of September 30, 1996 and as adjusted to give effect to the sale of 1,500,000 shares of Common Stock offered by the Company hereby at an assumed public offering price of $32.625 per share and the receipt of the proceeds therefrom, after deducting the estimated underwriting discount and offering expenses payable by the Company. See "Use of Proceeds." This information should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing elsewhere in this Prospectus.
September 30, 1996 ------------------------ Actual Adjusted (1) --------- ------------- (in thousands except share-related data) Stockholders' equity Common Stock, $.01 par value, 45,000,000 shares authorized, 26,372,000 shares issued and outstanding (actual); and 27,992,000 shares issued and outstanding (as adjusted) (2) (3) $ 264 $ 280 Additional paid-in capital 29,994 75,964 Deferred compensation (77) (77) Retained earnings 18,089 18,089 Cumulative foreign currency translation adjustment (134) (134) --------- --------- Total stockholders' equity 48,136 94,122 --------- --------- Total capitalization $48,136 $94,122 ========= =========
- ------------- (1) Adjusted to give effect to (i) the sale of 1,500,000 shares of Common Stock offered by the Company hereby at an assumed public offering price of $32.625 per share, after deducting the estimated underwriting discount and offering expenses payable by the Company, and (ii) the exercise of stock options to purchase 120,000 shares of Common Stock at an exercise price of approximately $0.33 per share, which exercise will occur immediately prior to the closing of this offering. (2) Includes 120,000 shares of Common Stock issuable upon exercise of stock options to be exercised immediately prior to the closing of this offering. (3) Excludes 2,397,950 shares of Common Stock issuable pursuant to the exercise of options outstanding at September 30, 1996, of which options to purchase 401,390 shares were then exercisable. See "Management--Stock Plans." 13 SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data at December 31, 1994 and 1995 and for the three years ended December 31, 1995, are derived from consolidated financial statements of Pegasystems Inc., which have been audited by Ernst & Young LLP, independent auditors. The selected consolidated financial data at December 31, 1991, 1992 and 1993 and for each of the two years ended December 31, 1992, are derived from consolidated financial statements of the Company audited by Ernst & Young LLP but not included in this Prospectus. The selected consolidated financial data presented below at and for the nine months ended September 30, 1995 and 1996 are derived from the Company's unaudited financial statements also appearing herein and which, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the unaudited interim periods. The results of operations for the nine months ended September 30, 1996 are not necessarily indicative of the results that may be expected for the full year or for any future period. The data presented below should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Nine Months Ended Year Ended December 31, September 30, -------------------------------------------------- --------------------- 1991 1992 1993 1994 1995 1995 1996 -------- -------- --------- --------- --------- --------- ---------- (in thousands, except per share data) Consolidated Statement of Income Data: Total revenue $ 7,784 $ 8,963 $10,212 $16,263 $22,247 $14,355 $20,956 Income from operations 1,858 1,944 793 2,236 3,257 1,010 4,514 License interest income 987 1,220 1,305 1,457 1,486 1,122 1,127 Net income 1,791 1,867 1,233 2,193 2,878 1,290 3,567 Net income per common and common equivalent share $ 0.07 $ 0.08 $ 0.05 $ 0.09 $ 0.11 $ 0.05 $ 0.14 Weighted average common and common equivalent shares outstanding 24,471 24,471 24,231 24,102 25,551 25,600 25,952
December 31, September 30, -------------------------------------------------------------- 1991 1992 1993 1994 1995 1996 -------- -------- -------- -------- -------- --------------- (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents $ 80 $ 336 $ 435 $ 456 $ 511 $25,419 Working capital 1,904 3,428 4,231 4,441 4,393 34,521 Long-term license installments, net 5,512 6,319 6,782 9,135 13,399 18,032 Total assets 11,992 14,387 17,057 20,787 25,876 59,728 Long-term debt 108 118 458 450 816 -- Stockholders' equity 6,576 8,444 9,676 11,872 14,674 48,136
14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operation of the Company should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto, and the other financial information included elsewhere in this Prospectus. 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. 15 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. Results of Operations The following table sets forth, for the periods indicated, certain items in the Company's consolidated statement of income reflected as a percentage of total revenue:
Nine Months Year Ended Ended December 31, September 30, ------------------------- ---------------- 1993 1994 1995 1995 1996 ------- ------- ------- ------- -------- Revenue: Software license 63.1% 59.4% 60.8% 58.6% 61.5% Services 36.9 40.6 39.2 41.4 38.5 ------- ------- ------- ------- -------- Total revenue 100.0 100.0 100.0 100.0 100.0 ------- ------- ------- ------- -------- Cost of revenue: Cost of software license 12.2 6.6 2.9 3.5 1.7 Cost of services 21.8 23.3 27.7 29.7 23.9 ------- ------- ------- ------- -------- Total cost of revenue 34.0 29.9 30.6 33.2 25.6 ------- ------- ------- ------- -------- Gross profit 66.0 70.1 69.4 66.8 74.4 ------- ------- ------- ------- -------- Operating expenses: Research and development 36.9 33.5 31.7 34.5 28.1 Sales and marketing 13.2 16.2 16.1 17.7 18.5 General and administrative 8.2 6.7 6.9 7.6 6.3 ------- ------- ------- ------- -------- Total operating expenses 58.3 56.4 54.7 59.8 52.9 ------- ------- ------- ------- -------- Income from operations 7.7 13.7 14.7 7.0 21.5 License interest income 12.8 9.0 6.7 7.8 5.4 Other interest income 0.3 0.1 0.1 0.1 1.4 Interest expense (0.3) (0.3) (0.5) (0.4) (0.4) ------- ------- ------- ------- -------- Income before provision for income taxes 20.5 22.5 21.0 14.5 27.9 Provision for income taxes 8.4 9.0 7.9 5.5 10.9 ------- ------- ------- ------- -------- Net income 12.1% 13.5% 13.1% 9.0% 17.0% ======= ======= ======= ======= ========
16 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, 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. 17 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. Year Ended December 31, 1995 Compared to Year Ended December 31, 1994 Revenue Total revenue for 1995 increased 36.8% to $22.2 million from $16.3 million for 1994 due primarily to an increase in software license revenue, and to a lesser extent, an increase in services revenue. Software license revenue for 1995 increased 40.0% to $13.5 million from $9.7 million in 1994 due to increased product acceptances and license renewals. Services revenue for 1995 increased 32.1% to $8.7 million from $6.6 million in 1994 primarily due to an increase in the amount of implementation and consulting services provided, and to a lesser extent, increases in the billing rates of the personnel providing these services and an increase in training revenue. Cost of Revenue Cost of software license for 1995 decreased 40.9% to $640,000 from $1.1 million for 1994, and decreased as a percentage of total revenue from 6.6% for 1994 to 2.9% for 1995. As a percentage of software license revenue, cost of software license decreased from 11.1% for 1994 to 4.7% for 1995. Such decreases were due to reduced amortization of capitalized software development costs. Cost of services for 1995 increased 62.5% to $6.2 million from $3.8 million for 1994 and increased as a percentage of total revenue from 23.3% for 1994 to 27.7% for 1995. Cost of services as a percentage of total services revenue increased from 57.4% for 1994 to 70.7% for 1995. Such increases were due to the hiring of additional personnel to provide implementation and consulting services to support the Company's growing customer base. Operating Expenses Research and development expenses for 1995 increased 29.8% to $7.1 million from $5.4 million for 1994 as a result of increased efforts by the Company to develop versions of its products capable of running on multiple UNIX platforms in a client/server environment. As a percentage of total revenue, research and development expenses declined from 33.5% for 1994 to 31.7% for 1995 due to the growth in the Company's total revenue. Sales and marketing expenses for 1995 increased 36.6% to $3.6 million from $2.6 million for 1994 due to the hiring of additional sales and marketing personnel, increased sales commission payments and increased investment in trade shows and other sales and marketing efforts. As a percentage of total revenue, sales and marketing expenses decreased slightly from 16.2% for 1994 to 16.1% for 1995 due to growth in the Company's total revenue. General and administrative expenses for 1995 increased 41.2% to $1.5 million from $1.1 million for 1994 due to increased management recruiting costs, the establishment of two new regional offices in Chicago and Dallas/Fort Worth and the relocation of the Company's United Kingdom office. General and administrative expenses were 6.9% of total revenue in 1995 and 6.7% in 1994. License Interest Income License interest income for 1995 and 1994 remained constant at $1.5 million. 18 Provision for Income Taxes The provisions for federal, state and foreign taxes were $1.5 million and $1.8 million for 1994 and 1995, respectively. The effective tax rates were 40% for 1994 and 38% for 1995. The decrease in the effective tax rate was primarily due to increased availability of research and development tax credits. See Note 7 of Notes to Consolidated Financial Statements. Year Ended December 31, 1994 Compared to Year Ended December 31, 1993 Revenue Total revenue for 1994 increased 59.2% to $16.3 million from $10.2 million for 1993. In January 1994, the Company organized Pegasystems Limited, a wholly-owned subsidiary based in the United Kingdom. In its first year of operation, Pegasystems Limited introduced the Company's products into Ireland, France and Luxembourg. Financial results for 1994 and subsequent years reflect the consolidated earnings of Pegasystems Inc. and Pegasystems Limited. Software license revenue represented 59.4% and 63.1% of total revenue for 1994 and 1993, respectively. Software license revenue for 1994 increased 49.8% to $9.7 million from $6.4 million for 1993. The increase in software license revenue in 1994 was primarily attributable to increased product acceptances by customers headquartered outside of the United States. The Company's software license revenue from customers headquartered outside of the United States was $3.1 million, or 32.5% of software license revenue, and $0.7 million, or 10.8% of software license revenue, in 1994 and 1993, respectively. Services revenue for 1994 increased 75.3% to $6.6 million from $3.8 million for 1993 primarily due to the increased amount of implementation and consulting services provided to a widening customer base. Following a focused internal reengineering effort which began in 1993 and continued into 1994, the Company redeveloped its strategy for new customer implementations leading to greater services revenue from more effective and timely implementations and the creation of standard training courses. Cost of Revenue Cost of software license decreased 13.5% to $1.1 million for 1994 from $1.2 million for 1993 and decreased as a percentage of total revenue from 12.2% for 1993 to 6.6% for 1994. As a percentage of software license revenue, cost of software license decreased from 19.3% for 1993 to 11.1% for 1994. Such decreases were due to reduced amortization of capitalized software development costs. Cost of services for 1994 increased 70.3% to $3.8 million from $2.2 million for 1993 and increased as a percentage of total revenue from 21.8% for 1993 to 23.3% for 1994. Such increases were due to the costs associated with establishing the Company's United Kingdom office in January 1994 and with developing new training facilities in Cambridge, Massachusetts and San Francisco, California. Cost of services as a percentage of total services revenue decreased from 59.2% for 1993 to 57.4% for 1994 due to increased utilization of service personnel. Operating Expenses Research and development expenses for 1994 increased 44.4% to $5.4 million from $3.8 million for 1993 primarily as a result of efforts by the Company to develop versions of its products capable of running on multiple UNIX platforms in a client/server environment. As a percentage of total revenue, research and development expenses declined to 33.5% for 1994 from 36.9% for 1993 due to growth in the Company's total revenue. Sales and marketing expenses for 1994 increased 94.7% to $2.6 million from $1.4 million for 1993, representing 16.2% and 13.2% of total revenue in the respective years. Such increases reflected the establishment of a sales operation in the United Kingdom and increased sales commission payments. General and administrative expenses for 1994 increased 30.8% to $1.1 million from $830,000 for 1993 due to overhead associated with the expansion of the Company's headquarters in Cambridge, Massachusetts, relocation of the regional office in San Francisco, California, and the establishment of 19 operations in the United Kingdom. General and administrative expenses as a percentage of total revenue declined slightly to 6.7% for 1994 from 8.2% for 1993 due to the growth in the Company's total revenue. License Interest Income License interest income for 1994 increased 11.6% to $1.5 million from $1.3 million in 1993 primarily due to the prepayment by one customer in 1994 of certain monthly software license fees. Provision for Income Taxes The provisions for federal, state and foreign taxes were $860,000 and $1.5 million for 1993 and 1994, respectively. The effective tax rates were 41% for 1993 and 40% for 1994. The decrease in the effective tax rate was primarily due to the use of certain tax credits. See Note 7 of Notes to Consolidated Financial Statements. Quarterly Operating Results The following tables set forth certain unaudited consolidated financial information for each of the four quarters in 1995 and for the first three quarters of 1996. In management's opinion, this unaudited quarterly information has been prepared on the same basis as the audited consolidated financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the quarters presented, when read in conjunction with the audited consolidated financial statements and notes thereto included elsewhere in this Prospectus. The Company believes that quarter-to-quarter comparisons of its financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. 20
Three Months Ended --------------------------------------------------------------------------------- March 31, June 30, September 30, December 31, March 31, June 30, September 30, 1995 1995 1995 1995 1996 1996 1996 --------- --------- ------------------------- --------- --------- ------------- (in thousands except percentage data) Consolidated Statement of Income Data: Revenue: Software license $2,209 $2,581 $3,624 $5,114 $2,520 $3,874 $6,502 Services 1,796 2,113 2,032 2,778 2,421 2,575 3,064 --------- --------- ---------- ---------- --------- --------- ---------- Total revenue 4,005 4,694 5,656 7,892 4,941 6,449 9,566 --------- --------- ---------- ---------- --------- --------- ---------- Cost of revenue: Cost of software license 191 190 127 127 118 118 118 Cost of services 1,249 1,404 1,605 1,903 1,405 1,584 2,017 --------- --------- ---------- ---------- --------- --------- ---------- Total cost of revenue 1,440 1,594 1,732 2,030 1,523 1,702 2,135 --------- --------- ---------- ---------- --------- --------- ---------- Gross profit 2,565 3,100 3,924 5,862 3,418 4,747 7,431 --------- --------- ---------- ---------- --------- --------- ---------- Operating expenses: Research and development $1,438 $1,640 $1,871 $2,112 $1,604 $1,918 $2,361 Sales and marketing 797 867 878 1,050 974 1,282 1,614 General and administrative 327 380 381 453 389 399 541 --------- --------- ---------- ---------- --------- --------- ---------- Total operating expenses 2,562 2,887 3,130 3,615 2,967 3,599 4,516 --------- --------- ---------- ---------- --------- --------- ---------- Income from operations 3 213 794 2,247 451 1,148 2,915 --------- --------- ---------- ---------- --------- --------- ---------- License interest income 370 368 384 364 368 378 381 Other interest income 6 4 6 0 12 11 273 Interest expense (18) (17) (33) (50) (39) (30) (16) --------- --------- ---------- ---------- --------- --------- ---------- Income before provision for income taxes 361 568 1,151 2,561 792 1,507 3,553 Provision for income taxes 137 216 437 973 311 588 1,386 --------- --------- ---------- ---------- --------- --------- ---------- Net income $ 224 $ 352 $ 714 $1,588 $ 481 $ 919 $2,167 ========= ========= ========== ========== ========= ========= ========== Percent of Total Revenue: Revenue: Software license 55.2% 55.0% 64.1% 64.8% 51.0% 60.1% 68.0% Services 44.8 45.0 35.9 35.2 49.0 39.9 32.0 --------- --------- ---------- ---------- --------- --------- ---------- Total revenue 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Cost of revenue: Cost of software license 4.8 4.1 2.2 1.6 2.4 1.8 1.2 Cost of services 31.2 29.9 28.4 24.1 28.4 24.6 21.1 --------- --------- ---------- ------------ --------- --------- ---------- Total cost of revenue 36.0 34.0 30.6 25.7 30.8 26.4 22.3 --------- --------- ---------- ------------ --------- --------- ---------- Gross profit 64.0 66.0 69.4 74.3 69.2 73.6 77.7 --------- --------- ---------- ------------ --------- --------- ---------- Operating expenses: Research and development 35.9 34.9 33.1 26.8 32.5 29.7 24.7 Sales and marketing 19.9 18.5 15.5 13.3 19.7 19.9 16.9 General and administrative 8.2 8.1 6.7 5.7 7.8 6.2 5.6 --------- --------- ---------- ------------ --------- --------- ---------- Total operating expenses 64.0 61.5 55.3 45.8 60.0 55.8 47.2 --------- --------- ---------- ------------ --------- --------- ---------- Income from operations 0.0 4.5 14.1 28.5 9.2 17.8 30.5 License interest income 9.2 7.8 6.8 4.6 7.4 5.9 4.0 Other interest income 0.2 0.1 0.1 0.0 0.2 0.1 2.9 Interest expense (0.4) (0.3) (0.6) (0.7) (0.8) (0.4) (0.2) --------- --------- ---------- ------------ --------- --------- ---------- Income before provision for income taxes 9.0 12.1 20.4 32.4 16.0 23.4 37.2 Provision for income taxes 3.4 4.6 7.8 12.3 6.3 9.1 14.5 --------- --------- ---------- ------------ --------- --------- ---------- Net income 5.6% 7.5% 12.6% 20.1% 9.7% 14.3% 22.7% ========= ========= ========== ============ ========= ========= ==========
21 The Company's business has experienced and is expected to 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 its 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 is reinforced by the Company's maintenance contracts, 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. Cost of software license has been declining due to decreasing amortization expense relating to capitalized software development costs. No software development costs were capitalized in 1995 or the first nine months of 1996. The increase in total operating expenses in the fourth quarter of 1995 reflected primarily an adjustment for bad debt exposure which developed in such quarter. Liquidity and Capital Resources Since its inception, the Company has funded its operations primarily through cash flow from operations and bank borrowings. 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. 22 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. Significant Customers In 1993, First Interstate Bank and Fidelity Investments accounted for approximately 12.9% and 12.3%, respectively, of the Company's total revenue. In 1994, Chemical Bank accounted for approximately 16.8% of the Company's total revenue. In 1995, Citibank, Household Credit Services and Chemical Bank accounted for approximately 16.2%, 14.9% and 12.6%, respectively, of the Company's total revenue. During the nine months ended September 30, 1996, Chase Manhattan Bank accounted for approximately 14.4% of the Company's total revenue. 23 BUSINESS Pegasystems develops customer service management software to automate customer interactions across transaction-intensive enterprises. Many of the world's largest banks, mutual funds and credit card organizations use the Company's solutions to integrate, automate, standardize and manage a broad array of mission-critical customer service activities, including account set-up, record retrieval, correspondence, disputes, investigations and adjustments. The Company's systems 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 systems 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, yet drives different processes depending on the customer profile or the nature of the request. The Company's open, multi-tier, client/server systems 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 service management as an 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 their transactions, it is especially critical for financial services organizations to implement cost-effective systems to manage customer interactions accurately and efficiently. Providing high quality, cost-effective customer service 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 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 service management solutions that can be implemented on an enterprise-wide basis to facilitate consistent, cost-effective customer service management. A 1995 report of the Aberdeen Group, Inc., a market research firm, estimates the size of the customer interaction software market at $1.7 billion in 1996, and projects that it will grow to $2.7 billion by 1998. Of this market, the share held by independent software vendors is estimated at $540 million in 1996, growing to $925 million in 1998. The total market, as defined by the Aberdeen Group, includes software supporting customer service, internal help desks, field and telesales automation, order entry, sales or product configuration, service dispatching and quality assurance. 24 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 financial services organizations, including account set-up, record retrieval, correspondence, disputes, investigations and adjustments. Pegasystems' solutions provide a service backbone 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 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 service representative. 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 customize" its services. Scalability and Robust Functionality. The scalability of the Company's multi-tier client/server architecture allows an organization to add branches or 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 more than 4,000 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 application, PegaVIEW-ACE, increases the effectiveness and productivity of customer service representatives by providing them with a flexible graphical user interface and processing capabilities that leverage the power of client/server desktop computers. The Company's solutions allow customer service representatives to focus on delivering superior customer service, 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. 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 and UNIX systems, Microsoft's Windows/NT system and Sun Microsystems' Solaris UNIX system. Improved Efficiency of Customer Service Representatives. Pegasystems' solutions actually perform work, rather than simply track a customer service representative's tasks. Variable data elements (for example, date, amount, customer, account) automatically route service requests and invoke system processes, depending on an organization's rule base. This feature allows customer service representatives to focus on revenue enhancing opportunities, such as cross-selling, and other matters requiring personal attention. When service representative involvement is required 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. 25 Business Strategy Pegasystems' objective is to become the leading provider of mission-critical client/server customer service 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 service 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 a sales group 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. Target Other Markets. Pegasystems believes that the insurance, telecommunications, medical, public utilities, retail and other markets have similar customer service management needs and that the Company's core technology is readily adaptable to these additional markets. The Company is exploring these additional markets, and if appropriate, expects to develop the necessary industry specific extensions of its core technology and hire or otherwise gain access to personnel with expertise in such markets. Increase Sales and Support Efforts. Pegasystems intends to establish additional sales and support offices and to increase significantly its domestic and international direct sales forces. In addition, the Company plans to develop further its relationships with financial transaction processors and consulting firms through which the Company's products can be distributed and implemented. Develop Standard Product Templates. The Company recently commenced licensing standard product templates that give organizations an advanced starting point for configuring their work processes. The Company intends to continue to develop and market standard product templates for financial services organizations, including templates for outbound telemarketing, collections and account set-up. 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. 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 configuration by an organization of its customer service management system, the integration of the Company's products with additional databases, the Internet and intranet systems and support of emerging technical and workflow standards. Technology The Company's technology is designed to optimize the performance of mission-critical, customer service management processes over a variety of computer platforms, networks and databases. Pegasystems' solutions have the following key technological attributes: "Any-Call, Any-Time, Anywhere" 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 service management systems centralize core customer information to facilitate global access. Multi-tier, Dynamic Distributed Processing. Although the Company's systems are currently used primarily in a two-tier client/server environment, they are also designed to run in an advanced, highly scalable three-tier environment. In traditional three-tier client/server environments, the user interface, the application code, and the data are segregated onto separate tiers. In the Pegasystems three-tier 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 26 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. Distributed Processing Environment [Graphic Representation of Pegasystems Worldwide Platform Processing Environment] Satellite Server Code Rules Central Server Code Rules Work Item Data Satellite Server Code Rules Satellite Server Code Rules Inherited Workflow. Pegasystems solutions maintain organizational consistency while providing the flexibility needed for mass customization. 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. Resiliency. Fallback options are provided to deal with hardware or network failure. For example, in a three-tier environment, the PC client can bypass a failed satellite server and connect directly to the central server. The Company is presently working to enhance its systems so that should a failure occur at the central server, each satellite server's replicated code and rule base could support continued processing, with "store and forward" capabilities to automatically re-synchronize the central server when it resumes operation. 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 its advanced Windows-based PegaVIEW-ACE application for the desktop, the Company's server applications can also drive "dumb terminals", allowing organizations to preserve their investments in legacy networks. 27 Pegasystems Platform Options [Graphic of Pegasystems Platform Options]
Desktop Local Distributed Global Central Networks Satellite Servers Networks Servers Windows TCP/IP IBM AIX TCP/IP IBM MVS UNIX CICS Windows 95 LU6.2 DEC Open LU6.2 IBM AIX VMS UNIX Windows NT Pathworks Microsoft Pathworks DEC Open Data Windows NT VMS OS/2 Novell SUN Solaris Novell SUN Solaris Data IPX UNIX IPX UNIX IBM 3270 IBM DEC UNIX IBM DEC UNIX Data "Dumb Terminal" VTAM LU2 VTAM LU2 Character-Based Async IBM MVS Async Windows NT "Dumb Terminal" CICS Netscape Microsoft HP/UX* SNA HP/UX* Motif DDE UNIX UNIX Netscape Procedure Windows Call * Availability planned in Q1, 1997
Internet and Intranet Access. Pegasystems' solutions use the Internet-based HTML (Hypertext Markup Language) to define display attributes for its PegaVIEW-ACE graphical user interface, leveraging logic and presentation rules between PegaVIEW-ACE and Internet/Intranet workflows. Pegasystems' rules dynamically create HTML forms, menus and displays, thereby facilitating interaction with the Internet. Pegasystems is a Netscape Development partner and supports the Netscape Commerce Server interface. 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' solutions also integrate with other applications, accounting systems and imaging products. The Company's systems 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. 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 designed to run on Windows/NT can store customer service request data in Microsoft's SQL Server relational database, and the Company has developed similar compatibility in the Windows/NT and RS 6000/AIX environments for databases from Oracle Corporation. Products The Company's products employ a consistent architecture and support the following customer service management functions: Receiving. Organizations receive service requests by telephone, mail, facsimile, or personal contact. Customer service representatives enter details of incoming requests into PegaVIEW-ACE, the Company's easy-to-use, graphical user interface. Alternatively, electronic service requests received from various networks and systems, such as the SWIFT network, Fedwire system, and the VISA and 28 MasterCard networks are entered directly into the Company's system. The Company's systems also support direct electronic access by customers through PCs, Internet browsers and voice response units. In all cases, the service request automatically initiates appropriate processing. Routing. As processing steps are completed, the Company's systems categorize and queue the request either for automatic or manual processing. Productivity-based load leveling and dynamic prioritization ensure high performance and responsiveness. As work is processed, each service representative's "work-list" is automatically updated in real time. The systems monitor each service 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, where to locate it, 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 all 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. Reporting. Data automatically collected by the Company's systems enables an organization to analyze service representative efficiency and determine needs for service representative training or changes to work processes. The Company's 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, each with components and features designed to address particular business areas, but all sharing core technology and adaptable rule-driven processing: PegaCARD manages credit and debit card customer service operations by supporting a wide variety of interactions with cardholders and merchants, including simple inquiries (for example, balances or credit limits), customer requests (address changes, additional cards, credit line increases) and problem management (disputes, chargebacks, fraud, financial adjustments, penalties). Automated features include processing of electronic chargeback messages and images from the MasterCard and VISA networks. PegaCARD allows service representatives to move seamlessly among multiple back-end accounting systems without having to be familiar with the different protocols of each system. PegaCLAIMS manages corporate and wholesale banking customer service by supporting a broad spectrum of customer interactions, including inquiries (product terms, rates), customer requests (account data changes, duplicate copies), and problem management (research, financial adjustments). PegaCLAIMS processes customer service interactions relating to money transfers, securities movement and control, global custody, trade services, foreign exchange and cash management, and features electronic message routing, SWIFT processing and interbank financial compensation management. PegaSHARES manages customer service for transfer agents, brokers, dealers, shareholder servicers and mutual fund managers by supporting inquiries (share balances, net asset values, transactions), customer requests (account changes, copies of statements) and problem resolution (incorrect purchases, monetary 29 adjustments). Automated features include share transfer accounting, literature fulfillment and securities processing compliance. PegaTRACE facilitates retail banking and check clearing customer service by processing inquiries (account balances, fees), customer requests (copies of statements, account transfers) and problem management (research, financial adjustments). PegaTRACE securely manages the suspense accounts that major organizations use to control the flow of accounting entries. Additional features include integration with check clearing systems, suspense ledger management, multi-debit/credit adjustments, and electronic check presentment (ECP) interfaces. PegaSEARCH and PegaINDEX manage high volumes of archived data, such as check information, contained on multiple types of storage media including magnetic disk, optical disk and magnetic tape silos. These systems are designed for organizations that process tens of millions of checks per day and require seven years of archived check data. PegaPRISM and PegaREELAY are used by customer service representatives to retrieve images, view them on a PC and correlate them with specific customer service requests. PegaREELAY is a specialized image retrieval product that automates request processing of reel microfilm. PegaVIEW-ACE (the Advanced Client Environment) is a graphical client application designed for use with the Company's server applications to increase the effectiveness and productivity of customer service representatives. PegaVIEW-ACE organizes customer data to facilitate service representative effectiveness and supports graphical methods to view and enter information. 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 product is installed, and the scope of business usage. Typical recent individual system licenses have provided for the payment of monthly installments of between $5,000 and $50,000. Some organizations receive discounts for licensing multiple systems. The monthly license payments generally begin once a system is installed and accepted. The term of such licenses is typically five years, subject to automatic renewal at the organization's option. Services Pegasystems' Reengineering and Client Services Group, which as of October 31, 1996 was comprised of 62 people located in the Company's six offices, provides consulting, training and customer support. Consulting Services. The Company works with its customers during and after system installation to reengineer customer workflows to leverage the capabilities of the Company's systems. Using an installation approach based on its PegaSTAR (the Pegasystems Structured Technique for Analysis and Reengineering) methodology, the Company's consultants assist customers in six major areas--analysis, data collection, process definition, configuration, piloting and measurement. 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. Training. The Company offers training programs for those persons within the customer organization responsible for evolving the rules that drive the various processes related to customer interactions. Pegasystems also organizes periodic user group meetings enabling customers to exchange ideas, learn about product directions and influence Pegasystems' development process. 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. 30 Each organization which licenses the Company's systems is required to 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 equal to approximately 18% of the license fee. The Company's maintenance agreements typically obligate Pegasystems to provide up to a specified number of hours of consulting and support. Organizations seeking additional consulting and support services are generally charged an incremental fee ranging between $90 and $170 per hour. 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: Advanta Services Corporation -- Credit card operations, including telephony center, correspondence generation, dispute and chargeback processing. 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, 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 -- Institutional funds transfer and foreign exchange customer service for international operations. Credit card (merchant and individual) service including telephony center, correspondence, dispute and chargeback processing. Cedel Bank -- Global custody and securities movement and control customer service. Citibank -- Global funds transfer and foreign exchange customer service. Check-related customer service and research. Domestic MasterCard service including image integration, correspondence, 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. First National Bank of Chicago -- Retail/check customer service and research. Wholesale banking, funds transfer, check, corporate lockbox and interbank compensation service for global operations. Franklin/Templeton -- Mutual fund customer service supporting telephony center, correspondence and research. Household Credit Services -- Credit card service including telephony center, correspondence, dispute and chargeback processing. Private label customer service for major retailers. Marine Midland -- Institutional funds transfer customer service. Mellon Bank -- Retail/check customer service, research and archive. Wholesale, institutional, cash management, and corporate lockbox customer service. Prudential Securities -- "All-in-one" account support and service for brokerage, credit, and clearing transactions. Trans Union Corporation -- Credit bureau data-management customer service for institutional customers and real estate property appraisal processing. 31 Sales and Marketing The Company markets its software and services primarily through a direct sales force. As of October 31, 1996, the Company's sales force consisted of a total of thirteen salespersons in the Company's domestic and foreign offices. The Company intends 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. See "Risk Factors--Dependence on Key Personnel." The Company has recently begun to develop an indirect distribution channel by entering into an agreement with a third party, under which the Company's PegaSHARES product will be integrated with a shareholder servicing product distributed by such third party. In addition, the Company has established a joint marketing relationship with Sun Microsystems. 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, system 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, VARs and other third parties. In 1993, 1994 and 1995, international sales represented 10%, 24% and 10%, respectively, of the Company's total revenue. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations." 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; (3) developing standard Application Programming Interfaces that allow other client workstation and server applications to interoperate with the Company's systems; and (4) enhancing existing interfaces between the Company's systems and popular applications such as e-mail and spreadsheets. In 1993, 1994, 1995 and the nine months ended September 30, 1996, the Company's research and development expenses were approximately $3.8 million, $5.4 million, $7.1 million and $5.9 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 as Remedy Corporation, Scopus Technology, Inc. and The Vantive Corporation; (2) companies that target specific service areas such as DST Systems Inc. and First Data Corp.; 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. 32 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. See "Risk Factors--Intense Competition." 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. 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. 33 Employees As of October 31, 1996, the Company had a total of 200 employees, of whom 163 were based in the United States and 37 were based in Europe. Of the total, 82 were in research and development, 62 were in consulting and customer support, 38 were in sales and marketing, and 18 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. See "Risk Factors-- Dependence on Key Personnel." Facilities Pegasystems' principal administrative, sales, marketing, support, and research and development operations are located in a 35,000 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 offices in New York, New York, Chicago, Illinois, Dallas, Texas, San Francisco, California, Reading, United Kingdom and Paris, France pursuant to leases expiring between December 1996 and July 2006. The Company believes that additional or alternative space will be available in the future on commercially reasonable terms as needed. Legal Proceedings The Company is not a party to any material pending litigation or other legal proceedings. 34 MANAGEMENT Executive Officers and Directors The executive officers and directors of the Company and their ages are as follows:
Name Age Position - ---- --- -------- Alan Trefler 40 President, Clerk and Director Clifford R. Balzer 46 Vice President of Reengineering and Client Services Eugene A. Bonte 46 Vice President of Market Strategy and Delivery Joseph J. Friscia 41 Vice President of Sales and Marketing Kenneth W. Olson 46 Vice President of Technical Development Michael R. Pyle 42 Vice President of Applications Development Ira Vishner 43 Vice President of Corporate Services, Treasurer, Chief Financial Officer and Director Edward A. Maybury(1)(2) 57 Director Edward B. Roberts(1) 60 Director Leonard A. Schlesinger(2) 44 Director Thomas E. Swithenbank 51 Director
- ------------- (1) Member of Audit Committee (2) Member of Compensation Committee 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. Clifford R. Balzer joined the Company in December 1995 as Vice President of Reengineering and Client Services. From January through November 1995, he was a Senior Consultant for Arthur D. Little, a research and consulting firm. From July 1990 through January 1995, Mr. Balzer was employed as a Director of U.S. Consulting by DMR Group, Inc., an international consulting firm. Mr. Balzer holds a B.A. from Kansas Wesleyan University and an M.B.A. from Fordham University. Eugene A. Bonte joined the Company in April 1996 as Vice President of Market Strategy and Development. 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 and has served as Vice President of Sales and Marketing since 1987. 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 35 London. Prior to joining the Company, Mr. Pyle worked in Europe and the United States 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. Edward A. Maybury has been a director of the Company since its organization in 1983. Since July 1991, he has served as a director, and from July 1991 through May 1993 was the President and Chief Executive Officer, of Creative Systems, Inc., a software and services company. Prior thereto, Mr. Maybury was the Chief Executive Officer of Data Architect Systems, Inc., a software and services company. Edward B. Roberts has been a director of the Company since June 1996. Since 1961, he has been a Professor of Management of Technologies at the Massachusetts Institute of Technology. He was co-founder and chairman, from 1963 until June 1995, of Pugh-Roberts Associates, Inc., an international management consulting firm specializing in strategic planning and technology management. In addition, Dr. Roberts co-founded and is a director of Medical Information Technology, Inc., a provider of hospital information systems. Dr. Roberts is also a director of Advanced Magnetics, Inc., a medical imaging company, and Selfcare, Inc., a manufacturer of home medical diagnostic products, and is a general partner of Zero Stage Capital, a venture capital firm. Leonard A. Schlesinger has been a director of the Company since June 1996. He has been a Professor of Business Administration at the Harvard Business School since 1988, where he is chairman of the Service Management Group, an interdisciplinary faculty group that focuses on customer service. Professor Schlesinger is also a director of Limited, Inc., a clothing retailer, and Borders Group, Inc., a book and movie store chain. Thomas E. Swithenbank has been a director of the Company since June 1996. Since 1990, he has been President and Chief Executive Officer of Harte-Hanks Data Technologies, a computer software and servicing company specializing in database marketing systems. Prior thereto, Mr. Swithenbank was President of International Data Corporation, a world-wide computer marketing consulting firm. Mr. Swithenbank has an A.B. from Harvard University and an M.B.A. from the Harvard Business School. Classes of Directors The Board of Directors is divided into three classes, each of whose members serve for a staggered three-year term. Messrs. Swithenbank and Trefler serve in the class whose term expires in 1997; Messrs. Maybury and Schlesinger serve in the class whose term expires in 1998; and Messrs. Roberts and Vishner serve in the class whose term expires in 1999. Upon the expiration of the term of a class of directors, directors within such class are elected for a three-year term at the annual meeting of stockholders in the year in which such term expires. Executive Officers 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. Board Committees The Company's Board of Directors has established an Audit Committee and a Compensation Committee. The Audit Committee is responsible for nominating the Company's independent accountants for approval by the Board of Directors, reviewing the scope, results and costs of the audit with the Company's independent accountants and reviewing the financial statements of the Company. Messrs. Maybury and Roberts are currently the members of the Audit Committee. The Compensation Committee is responsible for recommending compensation and benefits for the executive officers of the Company to the Board of Directors and for administering the Company's stock plans. Messrs. Maybury and Schlesinger are currently the members of the Compensation Committee. 36 Director Compensation Each non-employee director of the Company receives $1,000 for every Board or committee meeting attended. The Company also reimburses non-employee directors for expenses incurred in attending Board meetings. In addition, non-employee directors of the Company are eligible to receive stock options under the 1996 Non-Employee Director Stock Option Plan. See "Management--Stock Plans." No other compensation is paid to directors for attending Board or committee meetings. Messrs. Maybury, Roberts, Schlesinger and Swithenbank are currently the non-employee directors of the Company. Executive Compensation The following table sets forth all compensation awarded to, earned by or paid for services rendered to the Company in all capacities during the year ended December 31, 1995 by (i) the Company's Chief Executive Officer and (ii) the four most highly compensated other executive officers who received annual compensation in excess of $100,000 (collectively, the "Named Executive Officers"): Summary Compensation Table
Annual Compensation (1) ------------------------- All Other Name and Principal Position Salary Bonus Compensation - --------------------------------------------------- ----------- ------------- --------------- Alan Trefler, President $171,250 $23,545 (2) -- Joseph J. Friscia, Vice President of Sales and Marketing 124,583 24,154 (3) -- Michael R. Pyle, Vice President of Applications Development 102,083 23,044 (2) -- Ira Vishner, Vice President of Corporate Services, Treasurer and Chief Financial Officer 100,500 16,892 (2) $ 8,483 (4) Kenneth W. Olson, Vice President of Technical Development 98,083 13,118 (2) 30,000 (4)
- ------------- (1) In accordance with the rules of the Securities and Exchange Commission, other compensation in the form of perquisites and other personal benefits has been omitted because the aggregate amount of such perquisites and other personal benefits constituted less than the lesser of $50,000 or 10% of the total of annual salary and bonuses for each of the Named Executive Officers for 1995. (2) The amounts presented are bonuses earned between July 1994 and June 1995, and paid in 1995. Bonuses, if any, for the period from July 1995 through June 1996 have not yet been determined. (3) The amount presented is bonus earned in 1995 and paid in February 1996. Mr. Friscia earned a bonus of $66,650 in 1994, which was paid in February 1995. (4) Represents payments in lieu of paid days off. Option Grants No stock options or stock appreciation rights ("SARs") were granted to any of the Named Executive Officers during 1995. 37 Year-End Option Table The following table sets forth certain information concerning the number and value of unexercised stock options held by each of the Named Executive Officers as of December 31, 1995. No SARs or stock options were exercised during 1995. Year-End Option Values
Number of Shares Underlying Value of Unexercised Unexercised Options In-the-Money Options at at Year-End (1) Year-End (2) ------------------------------- ------------------------------- Name Exercisable Unexercisable Exercisable Unexercisable ------------------ -------------- ---------------- -------------- ---------------- Alan Trefler -- -- -- -- Joseph J. Friscia 180,000 216,000 (3) $2,101,200 $2,521,440 Michael R. Pyle 151,200 172,800 (3) 1,765,008 2,017,152 Ira Vishner -- -- -- -- Kenneth W. Olson -- -- -- --
- ------------- (1) The exercise price for each of the unexercised options included in the above table is approximately $0.33 per share. (2) There was no public trading market for the Common Stock as of December 31, 1995. Accordingly, as permitted by the rules of the Securities and Exchange Commission, these values have been calculated on the basis of an assumed market value equal to the initial public offering price of $12.00 per share. (3) These options vest in equal installments on December 29, 1996, 1997, 1998 and 1999. Merit Payment Program The Company frequently awards merit payments to its employees as part of a performance assessment process, under which employees may be awarded cash payments based upon individual performance. All employees are eligible to receive merit payments. Historically, the Company's supervisors have been responsible for recommending the amount of merit payment for each of the employees under their direct review. These recommendations are then reviewed by the Board of Directors to promote consistency among departments. Awards of merit payments are made at the discretion of supervisors and the Board of Directors, based upon their opinions of employees' respective contributions to the Company. Awards have generally been made in connection with annual employee reviews. Sales Compensation In addition to base salary, the Company pays commissions to its sales personnel based on the attainment of annual sales quotas, monthly fees generated during the period from July 1 through June 30 of each year, and cash received by the Company from new accounts within one year after the initial signing of a contract with a customer. Stock Plans 1994 Long-Term Incentive Plan The Company's 1994 Long-Term Incentive Plan (the "1994 Plan") was adopted by the Board of Directors on November 23, 1994, and approved by the stockholders on April 21, 1995. The 1994 Plan provides for the issuance of a maximum of 5,000,000 shares of Common Stock pursuant to the grant of incentive stock options ("ISOs") to employees and nonqualified stock options ("NSOs"), stock appreciation rights ("SARs"), restricted stock or long-term performance awards to employees, consultants, directors and officers of the Company. Long-term performance awards may be made in cash or in stock, must be awarded in connection with a performance period of at least two years, and are based on performance objectives determined by the Compensation Committee. At October 31, 1996, the Company had approximately 200 employees eligible to participate in the 1994 Plan and options to purchase 2,422,250 shares were outstanding. To date, no restricted stock, SARs or long-term performance awards have been granted under the 1994 Plan. 38 The 1994 Plan is administered by the Compensation Committee of the Board of Directors (the "Compensation Committee"). Subject to the provisions of the 1994 Plan, the Compensation Committee has the authority to select the optionees or SAR, long-term performance award or restricted stock recipients and determine the terms of the options, SARs, long-term performance awards or restricted stock granted, including: (i) the number of shares or SARs; (ii) the option exercise terms; (iii) the amount of awards; (iv) the exercise or purchase price (which in the case of an incentive stock option cannot be less than the market price of the Common Stock as of the date of grant); (v) the type and duration of transfer or other restrictions; and (vi) the time and form of payment for restricted stock and upon exercise of options. Generally, an option is not transferable by the optionholder except by will or by the laws of descent and distribution. No option may be exercised following termination for cause or voluntary termination, or more than three months following involuntary termination. Upon termination due to death, an option is exercisable for a maximum of one year after such termination, and upon termination due to disability, the option is exercisable for a maximum of two years after such termination. 1996 Non-Employee Director Stock Option Plan The 1996 Non-Employee Director Stock Option Plan (the "Director Plan") was adopted by the Board of Directors on May 13, 1996 and approved by the stockholders on June 26, 1996. The Director Plan provides for the grant of options for the purchase of up to 250,000 shares of Common Stock of the Company. As of October 31, 1996, options to purchase 90,000 shares were outstanding under the Director Plan. The Director Plan is administered by the Compensation Committee and provides that each person who becomes a director of the Company after May 13, 1996, and who is not also an employee of the Company will receive upon initial election to the Board of Directors an option to purchase 30,000 shares of Common Stock vesting in equal annual installments over five years. The exercise price for all options granted under the Director Plan is equal to the market price of the Common Stock as of the date of grant. Options may not be assigned or transferred except by will or by the laws of descent and distribution and are exercisable, only to the extent vested, within 90 days after the optionee ceases to serve as a director of the Company (except that if a director dies or becomes disabled while he or she is serving as a director of the Company, the option is exercisable until the earlier of the scheduled expiration date of the option or one year from the date of death or disability). 1996 Employee Stock Purchase Plan The 1996 Employee Stock Purchase Plan (the "Stock Purchase Plan") was adopted by the Board of Directors on May 13, 1996 and approved by the stockholders on June 26, 1996. An aggregate of 500,000 shares of Common Stock are reserved for issuance pursuant to this plan. The Stock Purchase Plan is administered by the Compensation Committee. All employees of the Company whose customary employment is in excess of 20 hours per week and more than five months per year, other than those employees who own 5% or more of the stock of the Company, are eligible to participate in the Stock Purchase Plan. As of October 31, 1996, approximately 200 of the Company's employees were eligible to participate in the Stock Purchase Plan. The Stock Purchase Plan is implemented by one or more offerings of such duration as the Compensation Committee may determine, provided that no offering period may be longer than 27 months. An eligible employee participating in an offering is able to purchase Common Stock at a price equal to the lesser of: (i) 85% of its fair market value on the date the right was granted, or (ii) 85% of its fair market value on the date the right was exercised. Payment for Common Stock purchased under the Stock Purchase Plan is through regular payroll deduction or lump sum cash payment, or both, as determined by the Compensation Committee. The maximum value of Common Stock an employee may purchase during an offering period is 10% of the employee's base salary during such period, calculated on the basis of the employee's compensation rate on the date the employee elects to participate in that offering. To date, there have been no offerings under the Stock Purchase Plan and no shares of Common Stock have been issued thereunder. 39 401(k) Plan In December 1989, the Company adopted a tax-qualified employee savings and retirement plan (the "401(k) Plan") covering all of the Company's domestic employees upon commencement of employment and attainment of the age of 18. Participants may elect to contribute to the 401(k) Plan up to the lesser of the statutorily prescribed annual limit ($9,500 in 1996) or 20% of their total pre-tax compensation. The 401(k) Plan permits, but does not require, the Company to make additional matching contributions on behalf of participants. The 401(k) Plan is intended to qualify under Section 401 of the Code so that contributions by employees or by the Company to the 401(k) Plan, and income earned on plan contributions, are not taxable to employees until withdrawn from the 401(k) Plan, and so that contributions by the Company, if any, will be deductible by the Company when made. Participants are fully vested in their deferred salary contributions, and Company contributions, if any, vest 20% after three years and an additional 20% on each anniversary thereof. The administrator of the 401(k) Plan, at the direction of each participant, invests the plan assets of such participant among various investment options. Participants have the option of obtaining loans from the 401(k) Plan secured by their account balances. Vacation Policy The Company generally provides its employees with a flexible vacation and paid time off policy. This policy provides that employees are given one block of paid days off for all uses, including vacation, sick days, personal days and holidays. The number of paid days off given to each employee per year varies according to each employee's length of service with the Company. Unused paid days off are carried over from year to year. Employees are generally entitled to payment in cash for the value of unused paid days off. The Company retains the right to repurchase paid days off in excess of thirty at the end of any quarter from employees who have accumulated more than thirty paid days off. Compensation Committee Interlocks and Insider Participation In 1995, decisions concerning compensation of executive officers were made by the Board of Directors which included Mr. Trefler, the President of the Company, and Mr. Vishner, a Vice President and the Chief Financial Officer of the Company. The Company has established a Compensation Committee of its Board of Directors, which currently consists of Messrs. Maybury and Schlesinger. No executive officer of the Company has served as a director or member of the compensation committee (or other committee serving an equivalent function) of any other entity, whose executive officers served as a director of the Company. CERTAIN TRANSACTIONS The Company has adopted a policy whereby all future transactions between the Company and its officers, directors, principal stockholders and their affiliates will be on terms no less favorable to the Company than could be obtained from unrelated third parties and will be approved by a majority of the disinterested members of the Company's Board of Directors. No such transactions are currently being considered. The Company borrowed $230,000 from its President, Alan Trefler, in order to increase the Company's working capital and to fund operations. This loan, which was evidenced by a note renewed in January 1993 and bearing interest at a rate of 8.5% per annum, was repaid in full by the Company in 1995. 40 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of October 31, 1996, and as adjusted for the sale of the shares of Common Stock offered hereby, by: (i) each person who is known by the Company to own beneficially more than 5% of the Common Stock, (ii) each director and Named Executive Officer of the Company, (iii) all directors and executive officers of the Company as a group, and (iv) each Selling Stockholder. Unless otherwise indicated below, to the knowledge of the Company, all persons listed below have sole voting and investment power with respect to their shares of Common Stock, except to the extent authority is shared by spouses under applicable law.
Shares Beneficially Shares to be Owned Prior to Beneficially Owned Offering (1) After Offering (1) (2) ----------------------- ------------------------ Number of Number of Shares Number of Name Shares Percent Offered Shares Percent - ---- --------- ------- --------- --------- ------- Alan Trefler 22,091,100 83.7% 500,000 21,591,100 77.1% Joseph J. Friscia (3) 198,000 * 70,000 128,000 * Michael R. Pyle (4) 129,600 * 50,000 79,600 * Ira Vishner 277,200 1.1 55,000 222,200 * Kenneth W. Olson 360,000 1.4 70,000 290,000 1.0 Edward A. Maybury (5) 7,200 * -- 7,200 * Edward B. Roberts 5,000 * -- 5,000 * Leonard A. Schlesinger -- -- -- -- -- Thomas E. Swithenbank -- -- -- -- -- All directors and executive officers as a group (11 persons) (6) 23,080,100 86.3 745,000 22,335,100 79.1
- ------------- * Less than 1% of the outstanding Common Stock. (1) The number of shares of Common Stock deemed outstanding prior to the offering includes (i) 26,382,200 shares of Common Stock outstanding as of October 31, 1996 and (ii) shares issuable pursuant to outstanding options held by the respective person or group which are currently exercisable or which will be exercisable within 60 days of October 31, 1996, as set forth below. The number of shares of Common Stock deemed outstanding after this offering includes (i) 1,500,000 shares which are being offered for sale by the Company in this offering and (ii) 120,000 shares issuable upon exercise of stock options to be exercised immediately prior to the closing of this offering. (2) Assumes no exercise of the Underwriters' over-allotment option. (3) Consists solely of shares of Common Stock subject to stock options exercisable within 60 days of October 31, 1996, 70,000 of which shares will be issued upon the exercise of options immediately prior to the closing of the offering. (4) Consists solely of shares of Common Stock subject to stock options exercisable within 60 days of October 31, 1996, 50,000 of which shares will be issued upon the exercise of options immediately prior to the closing of this offering. (5) Consists solely of shares of Common Stock subject to stock options exercisable within 60 days of October 31, 1996. (6) Shares beneficially owned prior to offering includes 346,800 shares of Common Stock subject to stock options exercisable within 60 days of October 31, 1996, 120,000 of which shares will be issued upon the exercise of options immediately prior to the closing of this offering; shares to be beneficially owned after offering includes 226,800 shares of Common Stock subject to stock options exercisable within 60 days of October 31, 1996. 41 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 45,000,000 shares of Common Stock, $.01 par value per share, and 1,000,000 shares of preferred stock, $.01 par value per share (the "Preferred Stock"), which may be issued in one or more series. Common Stock As of September 30, 1996, there were 26,372,000 shares of Common Stock outstanding and held of record by 30 stockholders. Based upon the number of shares outstanding as of that date and giving effect to (i) the issuance of the 1,500,000 shares of Common Stock offered by the Company hereby, and (ii) the exercise of options to purchase 120,000 shares of Common Stock anticipated to occur immediately prior to the closing of this offering, there will be 27,992,000 shares of Common Stock outstanding upon the closing of this offering. Holders of Common Stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Accordingly, holders of a majority of the shares of Common Stock entitled to vote in any election of directors may elect all of the directors standing for election. Holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor, subject to any preferential dividend rights of outstanding Preferred Stock. Upon the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to receive ratably the net assets of the Company available after the payment of all debts and other liabilities and subject to the prior rights of any outstanding Preferred Stock. Holders of the Common Stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of Common Stock are, and the shares offered by the Company in this offering will be, when issued and paid for, fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of Preferred Stock which the Company may designate and issue in the future. Upon the closing of this offering, there will be no shares of Preferred Stock outstanding. Preferred Stock The Board of Directors is authorized, subject to certain limitations prescribed by law, without further stockholder approval, to issue from time to time up to an aggregate of 1,000,000 shares of Preferred Stock in one or more series and to fix or alter the designations, preferences, rights and any qualifications, limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption (including sinking fund provisions), redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of such series. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change of control of the Company. The Company has no present plans to issue any shares of Preferred Stock. See "Risk Factors--Potential Adverse Effects of Anti-Takeover Provisions; Possible Issuance of Preferred Stock." Massachusetts Law and Certain Provisions of the Company's Restated Articles of Organization and Restated By-Laws The Company is subject to Chapter 110F of the Massachusetts General Laws, an anti-takeover law. In general, this statute prohibits a publicly held Massachusetts corporation from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person becomes an interested stockholder, unless (i) the interested stockholder obtains the approval of the Board of Directors prior to becoming an interested stockholder, (ii) the interested stockholder acquires 90% of the outstanding voting stock of the corporation (excluding shares held by certain affiliates of the corporation) at the time it becomes an interested stockholder, or (iii) the business combination is approved by both the Board of Directors and the holders of two-thirds of the outstanding voting stock of the corporation (excluding shares held by the interested stockholder). An "interested stockholder" is a person who, together with affiliates and associates, owns (or at any time within the prior 42 three years did own) 5% or more of the outstanding voting stock of the corporation. A "business combination" includes a merger, a stock or asset sale, and certain other transactions resulting in a financial benefit to the interested stockholder. The Company's Restated Articles of Organization (the "Restated Articles") and the Restated By-Laws (the "Restated By-Laws") provide for a classified board of directors consisting of three classes as nearly equal in size as possible. See "Management--Executive Officers and Directors." In addition, the Restated Articles and Restated By-Laws provide that directors may be removed only for cause by the affirmative vote of the holders of a majority of the shares issued outstanding and entitled to vote. Under the Restated Articles and Restated By-Laws, any vacancy, however occurring, including a vacancy resulting from an enlargement of the Board, may only be filled by a vote of a majority of the directors then in office. The classification of the Board of Directors and the limitations on the removal of directors and filling of vacancies could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, control of the Company. The Restated By-Laws include a provision excluding the Company from the applicability of Massachusetts General Laws Chapter 110D, entitled "Regulation of Control Share Acquisitions". In general, this statute provides that any stockholder of a corporation subject to this statute who acquires 20% or more of the outstanding voting stock of a corporation may not vote such stock unless the stockholders of the corporation so authorize. The Board of Directors may amend the Company's Restated By-Laws at any time to subject the Company to this statute prospectively. The Restated By-Laws also require that a stockholder seeking to have any business conducted at a meeting of stockholders give notice to the Company not less than 90 days prior to the scheduled meeting. The notice from the stockholder must describe the proposed business to be brought before the meeting and include information about the stockholder making the proposal, any beneficial owner on whose behalf the proposal is made and any other stockholder known to be supporting the proposal. The Restated By- Laws further provide that a special stockholders meeting may be called by the president or the Board of Directors or upon the request of stockholders holding at least 40% of the voting power of the Company. These provisions may discourage another person or entity from making a tender offer for the Company's Common Stock, because such person or entity, even if it acquired a majority of the outstanding shares, would be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders meeting. The Restated By-Laws provide that the directors, officers, employees and certain other agents of the Company shall be indemnified by the Company to the fullest extent authorized by Massachusetts law, as it now exists or may in the future be amended, against all expenses and liabilities reasonably incurred in connection with service for or on behalf of the Company. In addition, the Restated Articles provide that the directors of the Company will not be personally liable for monetary damages to the Company for breaches of their fiduciary duty as directors, unless they violated their duty of loyalty to the Company or its stockholders, acted in bad faith, knowingly or intentionally violated the law, authorized illegal dividends or redemptions or derived an improper personal benefit from their action as directors. Transfer Agent and Registrar The transfer agent and registrar for the Company's Common Stock is Fleet National Bank. 43 SHARES ELIGIBLE FOR FUTURE SALE Upon the closing of this offering, the Company will have an aggregate of 28,002,200 shares of Common Stock outstanding, assuming no exercise of the Underwriters' over-allotment option and no exercise of outstanding options to purchase Common Stock other than the options to purchase 120,000 shares to be exercised immediately prior to the closing of this offering by certain Selling Stockholders. Of these shares, 5,862,900 shares (including the 2,245,000 shares sold in this offering) are freely tradable without restriction or further registration under the Securities Act of 1933, as amended (the "Securities Act"), except that any shares held by "affiliates" of the Company, as that term is defined in Rule 144 under the Securities Act ("Rule 144"), may generally only be sold in compliance with the limitations of Rule 144 described below. The remaining 22,139,300 shares of Common Stock are deemed "Restricted Securities" as defined under Rule 144. Restricted Securities may be sold in the public market only if registered or if they qualify for an exemption from registration under Rules 144 or 701 promulgated under the Securities Act, which rules are summarized below. Subject to the executive officers of the Company entering into lock-up agreements described below and the provisions of Rules 144, 144(k) and 701, additional shares will be available for sale in the public market (subject in the case of shares held by affiliates to compliance with the Rule 144 volume limitations) as follows: (i) 36,000 shares will be eligible for immediate sale in the public market on the date of this Prospectus and (ii) 22,103,300 shares will be eligible for sale upon the expiration of lock-up agreements 120 days after the date of this Prospectus. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated), including an affiliate, who has beneficially owned shares for at least two years is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock (approximately 280,000 shares immediately after this offering) or (ii) the average weekly trading volume in the Common Stock during the four calendar weeks preceding the date on which notice of such sale is filed, subject to certain restrictions. In addition, a person who is not deemed to have been an affiliate of the Company at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least three years would be entitled to sell such shares under Rule 144(k) without regard to the requirements described above. To the extent that shares were acquired from an affiliate of the Company, such stockholder's holding period for the purpose of effecting a sale under Rule 144 commences on the date of transfer from the affiliate. Rule 701 promulgated under the Securities Act provides that shares of Common Stock acquired pursuant to written plans such as the 1994 Plan may be resold by persons other than affiliates, subject only to the manner of sale provisions of Rule 144, and by affiliates, subject to all provisions of Rule 144 except its two-year minimum holding period. In addition, as of October 31, 1996, the Company had reserved 5,750,000 shares of Common Stock for issuance under its stock plans. See "Management--Stock Plan." Shares issuable under the Company's stock plans have been registered pursuant to a Registration Statement on Form S-8 and are therefore freely tradeable, subject to Rule 144 limitations applicable to affiliates. The Company can make no prediction as to the effect, if any, that market sales of shares of Common Stock or the availability of shares for sale will have on the market price of the Common Stock prevailing from time to time. Nevertheless, sales of substantial amounts of Common Stock in the public market could adversely affect the market price of the Common Stock and could impair the Company's future ability to raise capital through the sale of its equity securities. Except to the extent they have agreed to sell shares in the offering, officers, who hold in the aggregate 22,728,300 shares of Common Stock and options to purchase 769,200 shares of Common Stock, have agreed, pursuant to agreements with the representatives of the Underwriters, that they will not, without the prior written consent of the representatives of the Underwriters, sell or otherwise dispose of any shares of Common Stock or options to acquire shares of Common Stock during the 120-day period following the date of this Prospectus. The Company has agreed not to sell or otherwise dispose of any shares of Common Stock during the 120-day period following the date of the Prospectus, except the Company may issue, and grant options to purchase, shares of Common Stock under its stock plans. In addition, the Company may issue shares 44 of Common Stock in connection with any acquisition of another company if the terms of such issuance provide that such Common Stock shall not be resold prior to the expiration of the 120-day period referenced in the preceding sentence. LEGAL MATTERS The validity of the shares of Common Stock offered by this Prospectus will be passed upon for the Company and the Selling Stockholders by Choate, Hall & Stewart, Boston, Massachusetts. Certain legal matters in connection with the offering will be passed upon for the Underwriters by Hale and Dorr, Boston, Massachusetts. EXPERTS The consolidated financial statements of Pegasystems Inc., at December 31, 1994 and 1995 and for each of the three years in the period ended December 31, 1995, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. AVAILABLE INFORMATION The Company is subject to the informational reporting requirements of the Securities Exchange Act of 1934, as amended, and, in accordance therewith, files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information filed with the Commission may be inspected and copied at the Commission's Public Reference Room, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices at Seven World Trade Center, 13th Floor, New York, New York 10048, and at Northwest Atrium Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661. Copies of such materials may be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 upon payment of prescribed fees. The Commission maintains a site on the World Wide Web at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, such as the Company, that file electronically with the Commission through the Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. ADDITIONAL INFORMATION The Company has filed with the Commission a Registration Statement on Form S-1 under the Securities Act with respect to the shares of Common Stock offered hereby. As permitted by the rules and regulations of the Commission, this Prospectus omits certain information contained in the Registration Statement. For further information with respect to the Company and the Common Stock offered hereby, reference is hereby made to the Registration Statement and to the exhibits and schedules filed therewith. Statements contained in this Prospectus as to the contents of any agreement or other document filed as an exhibit to the Registration Statement are not necessarily complete, and in each instance reference is made to the copy of such agreement filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. The Registration Statement, including the exhibits and schedules filed therewith, may be inspected without charge at the Commission's Public Reference Room, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices in New York and Chicago, the addresses of which are set forth in "Available Information." Copies of the Registration Statement may be obtained from the Commission from its Public Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of prescribed fees. The Registration Statement may also be accessed electronically at the Commission's site on the World Wide Web at http://www.sec.gov. The Company distributes to its stockholders annual reports containing financial statements audited by its independent accountants and makes available copies of quarterly reports for the first three quarters of each fiscal year containing unaudited financial statements. 45 PEGASYSTEMS INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Auditors F-2 Consolidated Balance Sheets as of December 31, 1994 and 1995 and as of September 30, 1996 (unaudited) F-3 Consolidated Statements of Income for the years ended December 31, 1993, 1994 and 1995 and for the nine months ended September 30, 1995 and 1996 (unaudited) F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1993, 1994 and 1995 and for the nine months ended September 30, 1996 (unaudited) F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 and for the nine months ended September 30, 1995 and 1996 (unaudited) F-6 Notes to Consolidated Financial Statements F-7
F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors Pegasystems Inc. We have audited the accompanying consolidated balance sheets of Pegasystems Inc. as of December 31, 1994 and 1995 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pegasystems Inc. at December 31, 1994 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Boston, Massachusetts May 6, 1996, except for Note 10, as to which the date is July 10, 1996 and Note 11, as to which the date is November 19, 1996. F-2 PEGASYSTEMS INC. CONSOLIDATED BALANCE SHEETS
December 31, --------------------------- September 30, 1994 1995 1996 ---- ---- ---- (unaudited) (in thousands except share-related data) Assets Current assets: Cash and cash equivalents $ 456 $ 511 $25,419 Trade and installment accounts receivable, net of allowance for doubtful accounts of $0 and $434 at December 31, 1994 and 1995, respectively, and $839 at September 30, 1996 8,315 8,896 12,701 Prepaid expenses and other assets 204 425 1,002 ------- ------- ------- Total current assets 8,975 9,832 39,122 Long-term license installments, net 9,135 13,399 18,032 Equipment and improvements, net 1,564 2,172 2,451 Software development costs, net 1,113 473 123 ------- ------- ------- Total assets $20,787 $25,876 $59,728 ======= ======= ======= Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accrued expenses $ 1,991 $ 1,747 $ 1,549 Deferred revenue 139 114 263 Current portion of long-term debt 378 782 -- Deferred income taxes 1,976 2,796 2,789 Note payable to stockholder 50 -- -- ------- ------- ------- Total current liabilities 4,534 5,439 4,601 Deferred income taxes 3,931 4,947 6,991 Long-term debt 450 816 -- 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, 23,490,000 shares issued and outstanding at December 31, 1995 and 1994, 26,372,000 shares issued and outstanding at September 30, 1996 235 235 264 Additional paid-in-capital 15 106 29,994 Deferred compensation -- (91) (77) Retained earnings 11,644 14,522 18,089 Cumulative foreign currency translation adjustment (22) (98) (134) ------- ------- ------- 11,872 14,674 48,136 ------- ------- ------- Total liabilities and stockholders' equity $20,787 $25,876 $59,728 ======= ======= =======
See accompanying notes. F-3 PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended Year Ended December 31, September 30, ----------------------------------------- -------------------------- 1993 1994 1995 1995 1996 ---- ---- ---- ---- ---- (unaudited) (in thousands except share-related data) Revenue Software license $ 6,448 $ 9,662 $ 13,528 $ 8,414 $ 12,896 Services 3,764 6,601 8,719 5,941 8,060 ----------- ----------- ----------- ----------- ----------- Total Revenue 10,212 16,263 22,247 14,355 20,956 Cost of Revenue Cost of software license 1,242 1,075 635 508 354 Cost of services 2,227 3,791 6,161 4,258 5,006 ----------- ----------- ----------- ----------- ----------- Total cost of revenue 3,469 4,866 6,796 4,766 5,360 ----------- ----------- ----------- ----------- ----------- Gross profit 6,743 11,397 15,451 9,589 15,596 Operating expenses Research and development 3,766 5,440 7,061 4,949 5,883 Sales and marketing 1,350 2,629 3,592 2,542 3,870 General and administrative 834 1,092 1,541 1,088 1,329 ----------- ----------- ----------- ----------- ----------- Total operating expenses 5,950 9,161 12,194 8,579 11,082 ----------- ----------- ----------- ----------- ----------- Income from operations 793 2,236 3,257 1,010 4,514 License interest income 1,305 1,457 1,486 1,122 1,127 Other interest income 27 21 16 16 296 Interest expense (32) (56) (118) (68) (85) ----------- ----------- ----------- ----------- ----------- Income before provision for income taxes 2,093 3,658 4,641 2,080 5,852 Provision for income taxes 860 1,465 1,763 790 2,285 ------------- ----------- ----------- ----------- ----------- Net income $ 1,233 $ 2,193 $ 2,878 $ 1,290 $ 3,567 =========== =========== =========== =========== =========== Net income per common and common equivalent share $ .05 $ .09 $ .11 $ 0.05 $ 0.14 =========== =========== =========== =========== =========== Weighted average number of common and common equivalent shares outstanding 24,231,000 24,102,000 25,551,000 25,600,000 25,952,000 =========== =========== =========== =========== ===========
See accompanying notes. F-4 PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Cumulative --------------------------- Foreign Number Additional Currency Total of Paid-in Deferred Retained Translation Stockholders' Shares Amount Capital Compensation Earnings Adjustment Equity ------ ------ ------- ------------ -------- ---------- ------ (in thousands except for share-related data) Balance at December 31, 1992 22,500,000 $225 -- -- $ 8,218 -- $ 8,443 Exercise of stock options 117,000 1 -- -- -- -- 1 Net income -- -- -- -- 1,233 -- 1,233 ---------- ---- ------- ----- ------- ----- -------- Balance at December 31, 1993 22,617,000 226 -- -- 9,451 -- 9,677 Exercise of stock options 873,000 9 $ 15 -- -- -- 24 Foreign currency translation adjustment -- -- -- -- -- $ (22) (22) Net income -- -- -- -- 2,193 -- 2,193 ---------- ---- ------- ----- ------- ----- -------- Balance at December 31, 1994 23,490,000 235 15 _ 11,644 (22) 11,872 Foreign currency translation adjustment -- -- -- -- -- (76) (76) Issuance of stock options -- -- 91 $(91) -- -- -- Net income -- -- -- -- 2,878 -- 2,878 ---------- ---- ------- ----- ------- ----- -------- Balance at December 31, 1995 23,490,000 235 106 (91) 14,522 (98) 14,674 Issuance of common stock 2,700,000 27 29,369 -- -- -- 29,396 Exercise of stock options 182,000 2 58 -- -- -- 60 Tax benefit from exercise of stock options 461 461 Foreign currency translation adjustment -- -- -- -- -- (36) (36) Amortization of deferred compensation -- -- -- 14 -- -- 14 Net income (unaudited) -- -- -- -- 3,567 -- 3,567 ---------- ---- ------- ----- ------- ----- -------- Balance at September 30, 1996 (unaudited) 26,372,000 $264 $29,994 $(77) $18,089 $(134) $48,136 ========== ==== ======= ===== ======= ===== ========
See accompanying notes. F-5 PEGASYSTEMS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended Year Ended December 31, September 30, ------------------------------- --------------------- 1993 1994 1995 1995 1996 ---- ---- ---- ---- ---- (unaudited) (in thousands) Operating activities Net income $ 1,233 $ 2,193 $ 2,878 $ 1,393 $ 3,567 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for deferred income taxes 629 961 1,836 819 2,037 Depreciation and amortization 1,536 1,511 1,455 975 1,152 Provision for doubtful accounts 326 -- 793 -- -- Change in operating assets and liabilities: (Increase) in trade and installment accounts receivable (2,149) (3,988) (5,638) (3,240) (8,438) (Increase) in prepaid expenses and other assets (121) (16) (221) (206) (116) Decrease (increase) in inventory (215) 215 -- -- -- Increase (decrease) in accounts payable and accrued expenses 8 971 (244) (895) (198) Increase (decrease) in deferred revenue 333 (336) (25) 769 149 ------- ------- ------- ------- ------- Net cash provided (used) by operating activities 1,580 1,511 834 (385) (1,847) Investing activities Purchase of equipment and improvements (888) (1,131) (1,423) (851) (1,067) Software development costs (1,060) (297) -- -- -- ------- ------- ------- ------- ------- Net cash used in investing activities (1,948) (1,428) (1,423) (851) (1,067) Financing activities Repayment of note payable to shareholder -- (180) (50) (50) -- Proceeds from issuance of long-term debt 710 380 1,345 1,347 -- Repayments of long-term debt (243) (263) (575) (299) (1,598) Issuance of common stock 29,396 Exercise of stock options -- 23 -- -- 60 ------- ------- ------- ------- ------- Net cash provided (used) by financing activities 467 (40) 720 998 27,858 Effect of exchange rate on cash -- (22) (76) (17) (36) ------- ------- ------- ------- ------- Net increase (decrease) in cash 99 21 55 (255) 24,908 Cash and equivalents at beginning of year 336 435 456 456 511 ------- ------- ------- ------- ------- Cash and equivalents at end of period $ 435 $ 456 $ 511 $ 201 $25,419 ======= ======= ======= ======= ======= Supplemental Disclosure of Cash Flow Information: Cash paid during period: Interest $ 32 $ 56 $ 119 $ 69 $ 85 ======= ======= ======= ======= ======= Income taxes $ 553 $ 135 $ 315 $ 274 $ 28 ======= ======= ======= ======= =======
See accompanying notes. F-6 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 1. Significant Accounting Policies Business Pegasystems Inc. (the Company) was incorporated on April 21, 1983, and develops customer service management software used by large, transaction-intensive organizations to automate and manage their customer interactions. Customers of the Company include large banks and credit card processors and mutual fund companies. The Company also offers consulting, training and maintenance and support services to facilitate the installation and use of its solutions. The environment of rapid technological change and intense competition which is characteristic of the software development industry results in frequent new products and evolving industry standards. The Company's continued success depends upon its ability to enhance current products and develop new products on a timely basis which keep pace with the changes in technology and competitors' innovations. International revenue is subject to various risks including imposition of government controls, export license requirements, political and economic conditions and instability, trade restrictions, currency fluctuations, changes in taxes, difficulties in staffing and managing international operations, and high local wage scales and other operating costs and expenses. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Pegasystems Limited. All intercompany accounts and transactions have been eliminated in consolidation. Foreign Currency Translation The translation of assets and liabilities of the Company's foreign subsidiary is made at year-end rates of exchange, while revenue and expense accounts are recorded at the average rates of exchange. The resulting translation adjustments are excluded from net income and are charged or credited to "Cumulative foreign currency translation adjustment" included as part of stockholder's equity. Realized and unrealized exchange gains or losses from transaction adjustments are reflected in operations and are not material. Revenue Recognition The Company recognizes revenue in accordance with Statement of Position 91-1, Software Revenue Recognition, issued by the American Institute of Certified Public Accountants. Specifically, revenue from software licenses is recognized upon product acceptance pursuant to noncancelable license agreements, and is based on management's assessment that the collectibility risk on the long-term license installments is low. Upon acceptance, the Company has no significant vendor obligations. The Company accrues the estimated cost of warranty and product returns in the period in which product revenue is recognized; historically these amounts have not been material. In the case of license renewals, revenue is recognized upon execution of the renewal license 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. Maintenance fees are recognized ratably over the term of the maintenance agreement. The Company recognizes implementation as well as consulting and training fees as the services are provided. Software license revenue represents the present value of future payments under noncancelable license agreements which provide for payment in installments typically over a five-year period. A portion of the revenue from each agreement is recognized as interest income over the term of the agreement. F-7 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 1. Significant Accounting Policies (Continued) The discount rate in effect for 1993, 1994, 1995 and the three months ended March 31, 1996 was 7%. The discount rate for the six month period ended September 30, 1996 was 6.75%. The trade and installment accounts receivable recorded on the balance sheet are net of $3,477,000, $3,937,000 and $3,779,000 as of December 31, 1994 and 1995, and September 30, 1996, respectively, which represents the imputed interest portion of future payments due under the Company's license agreements. Deferred revenue represents payments from customers, primarily for maintenance services, which are recognized as revenue as the related services are performed. Cash and Cash Equivalents Cash and cash equivalents are stated at cost, which approximates market, and consist of short-term, highly liquid investments with original maturities of less than three months. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of trade accounts receivable and long-term license installments. The Company records long-term license installments in accordance with its revenue recognition policy which results in receivables from customers, primarily large financial service organizations with strong credit ratings. Interim Financial Statements The consolidated balance sheet at September 30, 1996, the consolidated statements of income and consolidated statements of cash flows for the nine months ended September 30, 1995 and 1996 and the consolidated statement of stockholders' equity for the nine months ended September 30, 1996 are unaudited, but, in the opinion of management, include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of results for these interim periods. The results of operations for the nine months ended September 30, 1996 are not necessarily indicative of results to be expected for the entire year. Equipment and Improvements Equipment and improvements are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets which are three years for equipment and five years for furniture and fixtures. Leasehold improvements are amortized over the life of the lease. Software Development Costs In compliance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, certain software development costs are capitalized in the accompanying consolidated balance sheets. Capitalization of software development costs begins upon the establishment of technological feasibility, defined by the Company as a working model or an operative version of the computer software product that is completed in the same language and is capable of running on all of the platforms as the product to be ultimately marketed. During 1994, the Company capitalized $297,000 of software costs. No costs were capitalized during 1995 or the nine months ended September 30, 1996. Amortization of capitalized software development cost is included in costs of software license revenue and is provided on a straight-line basis of two years, which approximates the estimated useful life of the software as it relates to the Company's sales. The straight line amortization is not materially different from the amortization computed using the current period revenues as a percent of total expected product revenues. Total amortization expense charged to operations was $1,242,000, $1,075,000, $635,000 and $350,000 during 1993, 1994 and 1995 and the nine months ended September 30, 1996, respectively. F-8 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 1. Significant Accounting Policies (Continued) Net Income Per Share Net income per common and common equivalent share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during each period, assuming the exercise of stock options into common stock under the treasury stock method. Stock issued after May 14, 1995 and common stock issuable pursuant to stock options granted after May 14, 1995 have been reflected as outstanding for all of 1993, 1994 and 1995, using the treasury stock method. Fully diluted earnings per common share are not presented as they are not materially different from primary earnings per common share. Dilutive common equivalent shares consist of stock options (using the treasury stock method and using the assumed initial public offering price). Net income per share also reflects a fifteen- for-one stock split effective December 9, 1994, and a three-for-one stock split effective on July 10, 1996. Stock Options The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the estimated fair market value of the shares at the date of the grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees," and intends to continue to do so. Accordingly, the Company recognizes no compensation expense for stock option grants. Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Some of the areas where estimates are utilized included allowance for bad debts, capitalized software, income taxes, revenue and various accrued expenses. Actual results could differ from those estimates. 2. EQUIPMENT AND IMPROVEMENTS The cost and accumulated depreciation of equipment and improvements consist of the following: December 31, -------------------- (in thousands) 1994 1995 ---- ---- Equipment $1,435 $ 2,186 Furniture and fixtures 630 863 Leasehold improvements 202 434 ------ ------- 2,267 3,483 Less accumulated depreciation (703) (1,311) ------ ------- Equipment and improvements, net $1,564 $ 2,172 ====== ======= F-9 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 3. ACCOUNTS PAYABLE AND ACCRUED EXPENSE Accounts payable and accrued expenses consist of the following: December 31, ----------------- (in thousands) 1994 1995 ---- ---- Trade accounts payable $ 744 $ 557 Employee compensation and benefits 508 568 Accrued income taxes 253 -- Other 486 622 ------ ------ $1,991 $1,747 ====== ====== 4. DEBT AND OTHER FINANCIAL INSTRUMENTS Long-term debt consists of the following: December 31, -------------- (in thousands) 1994 1995 ---- ---- Note payable to bank, with monthly payments of $3,750 plus interest through December 15, 1995 $ 45 -- Note payable to bank, with monthly payments of $17,222 plus interest through December 1, 1996 413 $ 207 Note payable to bank, with monthly payments of $10,556 plus interest through December 1, 1997 370 243 Note payable to bank, with monthly payments of $32,778 plus interest through June 28, 1998 -- 983 Note payable to bank, with monthly payments of $4,583 plus interest through December 28, 1998 -- 165 ---- ----- 828 1,598 Less current portion 378 782 ---- ------ $450 $ 816 ==== ====== The notes bear interest at the bank's prime rate (6% at December 31, 1993 and 8.5% at December 31, 1994 and 1995) plus 1/2%. The notes are secured by all computer equipment and furniture and fixtures of the Company. Maturities of these notes are $782,000 in 1996, $564,000 in 1997 and $252,000 in 1998. As of September 30, 1996, the Company had repaid all of the notes. As of December 31, 1995, the Company had a line of credit with a bank allowing for borrowings up to $2,500,000 at the prime rate, which line of credit was scheduled to expire on June 1, 1996. The Company had no drawings against the line of credit at December 31, 1995 and 1994. Borrowings are subject to various covenants which call for a specified level of working capital and net worth, maintenance of certain financial ratios and restrictions on the payments of dividends. As of September 30, 1996, the Company's bank line of credit had been increased to $5,000,000 and extended until June 30, 1997. The Company had no drawings against the line of credit at September 30, 1996. The Company had a note payable of $50,000 to the president at December 31, 1994, which was repaid in full during 1995. The interest rate on the note was 8.5% in 1994 and 1995. F-10 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 4. DEBT AND OTHER FINANCIAL INSTRUMENTS (Continued) Financial instruments outstanding at December 31, 1995 are as follows: Carrying Fair Amount Value ------ ----- (in thousands) Assets Cash and cash equivalents $ 511 $ 511 Liabilities Notes payable to bank ($1,598) ($1,598) The fair value of the long-term debt approximates the carrying amount due to the variable interest rate of the debt. 5. EMPLOYEE BENEFIT PLANS Stock Option Plan The Company adopted an incentive stock option plan effective July 29, 1983 (the 1983 Plan). Key employees, as selected by the Board of Directors of the Company, were granted options to purchase the Company's common stock at a price, which in the Board of Directors' opinion, reflected fair value on the date of the grant. The 1983 plan expired in 1993. At December 31, 1995, no options issued under this plan were outstanding. Long-Term Incentive Plan During the year ended December 31, 1994, the Company adopted a Long-Term Incentive Plan (the 1994 Plan) to provide incentives to employees, directors and consultants through opportunities to purchase stock through incentive stock options and through options which do not qualify as incentive stock options. In addition to options, eligible participants under the 1994 Plan may be granted stock appreciation rights, restricted stock and long-term performance awards. At December 31, 1995, a maximum of 2,400,000 shares are reserved for issuance under the plan. Shares equal to 2% of the outstanding shares at the start of each fiscal year shall be reserved for granting of replacement options; however, this may not cause the maximum shareholder dilution caused by the Plan to exceed the 2,400,000 shares of stock reserved for issuance under the plan. As of September 30, 1996, the Company had approved an increase in the number of shares issuable under the 1994 Long-Term Incentive Plan from 2,400,000 to 5,000,000. The option price per share is to be determined at the date of grant. For incentive stock options, the option price may not be less than 100% of the fair market value of the Company's common stock at the grant date. Incentive stock options granted to a person having greater than 10% of the voting power of all classes of stock must have an exercise price of at least 110% of fair market value of the Company's common stock. F-11 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 5. EMPLOYEE BENEFIT PLANS (Continued) Stock option activity is summarized as follows:
September 30, December 31, 1996 1993 1994 1995 (unaudited) ---- ---- ---- ----------- Outstanding options at beginning of period 1,494,000 1,269,000 1,671,750 1,924,500 Granted -- 1,635,750 335,250 885,250 Exercised (117,000) (873,000) -- (182,000) Canceled (108,000) (360,000) (82,500) (109,800) --------- --------- --------- ----------- Outstanding at end of period 1,269,000 1,671,750 1,924,500 2,517,950 ========= ========= ========= =========== Price range of outstanding options $.01-$.69 $.33-$.69 $.33-$.39 $.33-$26.50 ========= ========= ========= =========== Exercisable at end of period 1,216,125 396,000 605,850 521,390 ========= ========= ========= =========== Available for grant at end of period -- 764,250 475,500 382,050 ========= ========= ========= ===========
In December 1995, the Company granted options to purchase 335,250 shares of Common Stock at an exercise price of $.39 per share. The Company recorded an increase to additional paid-in-capital and a corresponding charge to deferred compensation in the amount of $90,518 to recognize the aggregate difference between the deemed fair value for accounting purposes of the stock options at the date of grant and the exercise price. The deferred compensation will be amortized over the option vesting period of five years. 6. LEASES The Company leases certain equipment and office space under noncancelable operating leases. Future minimum rental payments required under the operating leases with noncancelable terms in excess of one year at December 31, 1995 are as follows: Year ended December 31, (in thousands) 1996 $1,016 1997 1,090 1998 1,090 1999 579 ------ Total $3,775 ====== Total rent expense under operating leases was approximately $800,000, $863,000, and $1,100,000 for the years ended December 31, 1993, 1994 and 1995, respectively. 7. INCOME TAXES Income before income taxes consists of the following: 1993 1994 1995 ---- ---- ---- (in thousands) Domestic $2,093 $3,512 $4,318 Foreign 0 146 323 ------ ------ ------ Total $2,093 $3,658 $4,641 ====== ====== ====== F-12 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 7. INCOME TAXES (Continued) The provision (benefit) for income taxes for the years ended December 31, 1993, 1994 and 1995 consisted of the following: 1993 1994 1995 ---- ---- ---- (in thousands) Current: Federal $180 $ 297 $ (107) State 51 176 (39) Foreign -- 31 73 ---- ----- ----- Total current 231 504 (73) Deferred: Federal 449 691 1,563 State 180 270 273 ---- ----- ----- Total deferred 629 961 1,836 ---- ----- ----- $860 $1,465 $1,763 ==== ===== ===== The effective income tax rate differed from the statutory federal income tax rate due to: 1993 1994 1995 ---- ---- ---- Statutory federal income tax rate 34.0% 34.0% 34.0% State income taxes, net of federal benefit 7.3 7.3 5.8 Permanent differences 1.5 2.0 0.7 Tax credits (1.7) (3.3) (2.5) ---- ---- ---- Effective income tax rate 41.1% 40.0% 38.0% ==== ==== ==== At December 31, 1993, 1994 and 1995, the Company had research and development credit carryforwards of approximately $495,000, $421,000 and $440,000, respectively, available to offset future federal taxable income. These carryforward amounts generally expire from 2004 to 2008. In addition, as of December 31, 1993, 1994 and 1995, the Company had available alternative minimum tax (AMT) credit carryforwards of approximately $194,000. The carryforward period for the AMT credit is unlimited. Deferred income taxes at December 31, 1994 and 1995 reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1994 and 1995 are as follows: F-13 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 7. INCOME TAXES (Continued) December 31, 1994 1995 ---- ---- (in thousands) Deferred tax liabilities: Software revenue $(6,924) $(9,303) Capitalized software (501) (213) Depreciation -- (142) Other -- (41) ------- ------- Total deferred tax liabilities (7,425) (9,699) Deferred tax assets: Deferred state taxes 590 729 License fees 119 119 Vacation accrual 64 109 Other 133 274 Tax credits 612 725 ------- ------- Total deferred tax assets 1,518 1,956 ------ ------- Net deferred tax liabilities (5,907) (7,743) Less current portion (1,976) (2,796) ------ ------- $(3,931) $(4,947) ====== ======= 8. SIGNIFICANT CUSTOMERS During 1993 the Company had two customers that accounted for 12.9% and 12.3%, respectively, of the Company's consolidated revenue. In 1994 one customer accounted for 16.8% of the Company's consolidated revenue. This customer also accounted for 12.6% of the Company's 1995 consolidated revenue. Additionally, in 1995 two other customers accounted for 16.2% and 14.9%, respectively, of the Company's consolidated revenue. 9. INTERNATIONAL OPERATIONS The Company's export sales from the United States are as follows: 1993 1994 1995 ---- ---- ---- (in thousands) United Kingdom $ 488 $1,515 $1,343 Ireland 0 1,288 355 Canada 58 1,008 114 Switzerland 469 49 125 France 0 25 297 Other 0 47 100 ------ ------ ------ Total $1,015 $3,932 $2,334 ====== ====== ====== 10. RECAPITALIZATION AND STOCK SPLIT During the year ended December 31, 1994, the Company increased the number of shares authorized from 600,000 shares of $.01 par value common stock to 9 million shares of $.01 par value common stock. On December 9, 1994, the Company's Board of Directors declared a fifteen-for-one split of shares of $.01 par value common stock effected in the form of a dividend. This dividend resulted in 7,830,000 F-14 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 10. RECAPITALIZATION AND STOCK SPLIT (Continued) shares of common stock being issued and outstanding after the split. The par value of the additional shares of common stock issued in connection with the stock split was credited to common stock and a like amount was charged to additional paid-in capital to the extent available, and the remainder to retained earnings. On July 10, 1996, the Company increased the number of shares of common stock authorized from 9 million to 45 million shares. The Company's Board of Directors approved a three-for-one stock split in the form of a stock dividend effective on July 10, 1996. The financial statements give effect to both stock splits for all periods presented. The Board of Directors is authorized, subject to certain limitations prescribed by law, without further stockholder approval, to issue from time to time up to an aggregate 1,000,000 shares of Preferred Stock in one or more series and to fix or alter the designations, preferences, rights and any qualifying limitations or restrictions of the shares of each such series thereof, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemptions (including sinking fund provisions), redemption price or prices, liquidation preferences and the number of shares constituting any shares or designations of such series. 11. SUBSEQUENT EVENTS 1996 Non-Employee Director Stock Option Plan The 1996 Non-Employee Director Stock Option Plan (the "Director Plan") was adopted by the Board of Directors on May 13, 1996. The Director Plan provides for the grant of options for the purchase of up to 250,000 shares of common stock of the Company. As of September 30, 1996, options for the purchase of 90,000 shares have been granted under the Director Plan. The Director Plan is administered by the Compensation Committee and provides that each person who becomes a director of the Company after May 13, 1996 and who is not also an employee of the Company will receive upon his initial election to the Board of Directors, an option to purchase 30,000 shares of common stock vesting in equal annual installments over five years. The exercise price per share for all options granted under the Director Plan will be equal to the market price of the common stock as of the date of grant. Options may not be assigned or transferred except by will or by the laws of descent and distribution and are exercisable, only to the extent vested, within 90 days after the optionee ceases to serve as a director of the Company (except that if a director dies or becomes disabled while he or she is serving as a director of the Company, the option is exercisable until the earlier of the scheduled expiration date of the option or one year from the date of death or disability). 1996 Employee Stock Purchase Plan The 1996 Employee Stock Purchase Plan (the "Stock Purchase Plan") was adopted by the Board of Directors on May 13, 1996. An aggregate of 500,000 shares of common stock are reserved for issuance pursuant to this plan. The Stock Purchase Plan is administered by the Compensation Committee. All employees of the Company whose customary employment is in excess of 20 hours per week and more than five months per year, other than those employees who own 5% or more of the stock of the Company, are eligible to participate in the Stock Purchase Plan. The Stock Purchase Plan will be implemented by one or more offerings of such duration as the Compensation Committee may determine, provided that no offering period may be longer than 27 months. An eligible employee participating in an offering will be able to purchase common stock at a price equal to the lesser of: (i) 85% of its fair market value on the date the right was granted, or (ii) 85% of its fair market value on the date the right was exercised. Payment for common stock purchased under the Stock Purchase Plan will be through regular payroll deduction or lump sum cash payment, or both, as determined by the Compensation Committee. The maximum value of common stock an employee may purchase during an offering period is 10% of the employee's base salary F-15 PEGASYSTEMS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1995 11. SUBSEQUENT EVENTS (Continued) during such period, calculated on the basis of the employee's compensation rate on the date the employee elects to participate in that offering. To date, there have been no offerings under the Stock Purchase Plan and no shares of common stock have been issued thereunder. Line of Credit The Company's bank line of credit was increased to $5 million and extended until June 30, 1997. 1994 Long Term Incentive Plan On May 13, 1996, the Company approved an increase in the number of shares issuable under the 1994 Long-Term Incentive Plan from 2,400,000 to 5,000,000. Initial Public Offering On July 24, 1996, the Company completed an initial public offering of 2.7 million shares of its common stock at $12.00 per share. F-16 UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement, the Company and the Selling Stockholders have agreed to sell to each of the Underwriters named below, and each of such Underwriters, for whom Goldman, Sachs & Co., Cowen & Company and Montgomery Securities are acting as representatives, has severally agreed to purchase from the Company and the Selling Stockholders, the respective number of shares of Common Stock set forth opposite its name below: Number of Shares of Underwriter Common Stock ----------- ------------ Goldman, Sachs & Co. Cowen & Company Montgomery Securities --------- Total 2,245,000 ========= Under the terms and conditions of the Underwriting Agreement, the Underwriters are committed to take and pay for all of the shares offered hereby, if any are taken. The Underwriters propose to offer the shares of Common Stock in part directly to the public at the public offering price set forth on the cover page of this Prospectus and in part to certain securities dealers at such price less a concession of $ per share. The Underwriters may allow, and such dealers may reallow, a concession not in excess of per share to certain brokers and dealers. After the shares of Common Stock are released for sale to the public, the offering price and other selling terms may from time to time be varied by the representatives. The Company has granted the Underwriters an option exercisable for 30 days after the date of this Prospectus to purchase up to an aggregate of 336,750 additional shares of Common Stock to cover over- allotments, if any. If the Underwriters exercise their over-allotment option, the Underwriters have severally agreed, subject to certain conditions, to purchase approximately the same percentage thereof that the number of shares to be purchased by each of them, as shown in the foregoing table, bears to the 2,245,000 shares of Common Stock offered. The Company and the Selling Stockholders have agreed that, subject to certain exceptions, during the period beginning from the date of this Prospectus and continuing to and including the date 120 days after the date of the Prospectus, they will not offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or of any other securities of the Company (other than pursuant to stock plans existing on the date of this Prospectus) which are substantially similar to the shares of Common Stock or which are convertible or exchangeable into securities which are substantially similar to the shares of Common Stock without the prior written consent of the representatives, except for the shares of Common Stock offered in connection with the offering. The Company and the Selling Stockholders have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act. In connection with this offering, certain Underwriters and selling group members (if any) or their respective affiliates who are qualifying registered market makers on Nasdaq, may engage in passive market making transactions in the Common Stock of the Company on Nasdaq in accordance with Rule 10b-6A under the Securities Exchange Act of 1934 during the two business day period before commencement of offers or sales of the Common Stock offered hereby. The passive market making transactions must comply with applicable volume and price limits and be identified as such. In general, a passive market maker may display its bid at a price not in excess of the highest independent bid for the security; if all independent bids are lowered below the passive market maker's bid, however, such bid must then be lowered when certain purchase limits are exceeded. U-1 Picture of Pegasus, the winged horse of mythology, flying out of a computer terminal screen, against a background of stars. Service Excellence Through Automation ================================================================================ No person has been authorized to give any information or to make any representations other than those contained in this Prospectus, and, if given or made, such information or representations must not be relied upon as having been authorized. This Prospectus does not constitute an offer to sell or the solicitation of an offer to buy any securities other than the securities to which it relates or an offer to sell or the solicitation of an offer to buy such securities in any circumstances in which such offer or solicitation is unlawful. Neither the delivery of this Prospectus nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the Company since the date hereof or that the information contained herein is correct as of any time subsequent to its date. ------------- TABLE OF CONTENTS Page --------- Prospectus Summary 3 Risk Factors 5 Use of Proceeds 12 Price Range of Common Stock 12 Dividend Policy 12 Capitalization 13 Selected Consolidated Financial Data 14 Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Business 24 Management 35 Certain Transactions 40 Principal and Selling Stockholders 41 Description of Capital Stock 42 Shares Eligible for Future Sale 44 Legal Matters 45 Experts 45 Available Information 45 Additional Information 45 Index to Consolidated Financial Statements F-1 Underwriting U-1 2,245,000 Shares Pegasystems Inc. Common Stock (par value $.01 per share) ------------- [PEGASYSTEMS INC. LOGO] ------------- Goldman, Sachs & Co. Cowen & Company Montgomery Securities Representatives of the Underwriters ================================================================================ PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution. Estimated expenses (other than underwriting discounts and commissions) payable in connection with the sale of the Common Stock offer hereby are as follows: SEC registration fee $ 25,525 NASD filing fee 8,923 Nasdaq National Market listing fee 17,500 Printing and engraving expenses 80,000 Legal fees and expenses 75,000 Accounting fees and expenses 75,000 Blue Sky fees and expenses 10,000 Transfer agent and registrar fees and expenses 5,000 Miscellaneous 3,052 -------- Total $300,000 ======== The Registrant will bear all expenses shown above. Item 14. Indemnification of Directors and Officers. Section 67 of Chapter 156B of the Massachusetts General Laws provides that a corporation may indemnify its directors and officers to the extent specified in or authorized by (i) the articles of organization, (ii) a by-law adopted by the stockholders, or (iii) a vote adopted by the holders of a majority of the shares of stock entitled to vote on the election of directors. In all instances, the extent to which a corporation provides indemnification to its directors and officers under Section 67 is optional. In its Restated Articles of Organization, the Registrant has elected to commit to provide indemnification to its directors and officers in specified circumstances. Generally, the Restated Articles of Organization provide that the Registrant shall indemnify directors and officers of the Registrant against liabilities and expenses arising out of legal proceedings brought against them by reason of their status as directors or officers or by reason of their agreeing to serve, at the request of the Registrant, as a director or officer with another organization. Under this provision, a director or officer of the Registrant shall be indemnified by the Registrant for all costs and expenses (including attorneys' fees), judgments, liabilities and amounts paid in settlement of such proceedings, even if he is not successful on the merits, if he acted in good faith in the reasonable belief that his action was in the best interests of the Registrant. The Board of Directors may authorize advancing litigation expenses to a director or officer at his request upon receipt of an undertaking by any such director or officer to repay such expenses if it is ultimately determined that he is not entitled to indemnification for such expenses. Article VI of the Registrant's Restated Articles of Organization eliminates the personal liability of the Registrant's directors to the Registrant or its stockholders for monetary damages for breach of a director's fiduciary duty, except for liability (i) for any breach of a director's duty of loyalty to the Registrant or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of laws, (iii) for authorization of illegal dividends or redemptions, or (iv) for any transaction in which a director derived an improper personal benefit. Section 8 of the Underwriting Agreement provides that the Underwriters are obligated, under certain circumstances, to indemnify the Company, directors, officers and controlling persons of the Company against certain liabilities, including liabilities under the Securities Act. Reference is made to the form of Underwriting Agreement filed as Exhibit 1.1 hereto. The Company maintains directors and officers liability insurance for the benefit of its directors and certain of its officers. II-1 Item 15. Recent Sales of Unregistered Securities. In the three years preceding the filing of this registration statement, the Company has issued the below-listed securities that were not registered under the Securities Act. The numbers below have been adjusted to give effect to (i) the 15-for-1 split of the Registrant's Common Stock, in the form of a dividend, which became effective on December 9, 1994 and (ii) the 3-for-1 split of the Registrant's Common Stock, in the form of a dividend, which became effective on July 10, 1996. Between December 1993 and July 31, 1996, the Registrant issued an aggregate of 1,090,800 shares of Common Stock upon the exercise of options, at a weighted average exercise price of approximately $0.05 per share, to certain officers and employees of the Registrant for total consideration of $57,728. Between December 1994 and July 31, 1996, the Registrant issued options to certain officers, directors and employees of the Registrant to purchase an aggregate of 2,339,700 shares of Common Stock under the Registrant's 1994 Long-Term Incentive Plan and 1996 Non-Employee Director Stock Option Plan at a weighted average exercise price of approximately $3.13 per share. No underwriters were involved in the foregoing sales of securities. Such sales were made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Section 4(2) thereof relative to sales by an issuer not involving any public offering or the rules and regulations thereunder, or, in the case of options, Rule 701 of the Securities Act. All of the foregoing securities are deemed restricted securities for the purposes of the Securities Act. Item 16. Exhibits and Financial Statement Schedules. (a) Exhibits:
Exhibit No. Description - --- ----------- 1.1. Form of Underwriting Agreement. 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. 5.1. Opinion of Choate, Hall & Stewart with respect to the legality of the securities of the Registrant being registered. 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. 21.1.* Subsidiaries of the Registrant. 23.1. Consent of Ernst & Young LLP. 23.2. Consent of Choate, Hall & Stewart (included in Exhibit 5.1). 23.6. Consent of the Aberdeen Group, Inc. 24.1. Powers of Attorney (included on the signature page). II-2 Exhibit No. Description - --- ----------- 27.1. Financial Data Schedule. 99.1 Valuation and Qualifying Accounts of the Registrant.
- ------------- *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. (b) Financial Statement Schedules: Schedule II--Valuation and Qualifying Accounts All other schedules are omitted because they are not applicable, not required under the instructions, or all of the information required is set forth in the financial statements or notes thereto. Item 17. Undertakings. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to provisions described in Item 14 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The Registrant hereby undertakes (1) to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser; (2) that for purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective; and (3) that for the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Cambridge, Massachusetts on November 20, 1996. PEGASYSTEMS INC. By /s/ Alan Trefler ---------------------------------- Alan Trefler President POWER OF ATTORNEY AND SIGNATURES We, the undersigned officers and directors of Pegasystems Inc., hereby severally constitute and appoint Alan Trefler, Ira Vishner and Robert V. Jahrling III, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all pre-effective and post-effective amendments to this registration statement and any related subsequent registration statement pursuant to Rule 462(b) of the Securities Act of 1933, as amended, and generally to do all things in our names and on our behalf in such capacities to enable Pegasystems Inc. to comply with the provisions of the Securities Act of 1933, as amended, and all requirements of the Securities and Exchange Commission. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated.
Signature Title(s) Date --------- -------- ---- /s/ Alan Trefler President and Director - ------------------------------- (Principal Executive Officer) November 20, 1996 Alan Trefler /s/ Ira Vishner Vice President of Corporate Services, - ------------------------------- Treasurer and Director (Principal Ira Vishner Financial and Accounting Officer) November 20, 1996 /s/ Edward A. Maybury Director November 20, 1996 - ------------------------------- Edward A. Maybury - ------------------------------- Director November 20, 1996 Edward B. Roberts /s/ Leonard A. Schlesinger Director November 20, 1996 - ------------------------------- Leonard A. Schlesinger /s/ Thomas E. Swithenbank Director November 20, 1996 - ------------------------------- Thomas E. Swithenbank
II-4 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------- EXHIBITS TO FORM S-1 REGISTRATION STATEMENT Under The Securities Act of 1933 ------------- PEGASYSTEMS INC. (Exact Name of Registrant As Specified In its Charter) ------------- 101 Main Street Cambridge, Massachusetts 02142 (Address of Principal Executive Offices) ================================================================================ EX-1 2 UNDERWRITING AGREEMENT Pegasystems Inc. Common Stock --------------- Underwriting Agreement December __, 1996 Goldman, Sachs & Co. Cowen & Company Montgomery Securities As representatives of the several Underwriters named in Schedule I hereto, c/o Goldman, Sachs & Co., 85 Broad Street, New York, New York 10004 Ladies and Gentlemen: Pegasystems Inc., a Massachusetts corporation (the "Company"), proposes, subject to the terms and conditions stated herein, to issue and sell to the Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of 1,500,000 shares and, at the election of the Underwriters, up to 336,750 additional shares of Common Stock, $.01 par value ("Stock") of the Company and the stockholders of the Company named in Schedule II hereto (the "Selling Stockholders") propose, subject to the terms and conditions stated herein, to sell to the Underwriters an aggregate of 745,000 shares of Stock. The aggregate of 2,245,000 shares to be sold by the Company and the Selling Stockholders is herein called the "Firm Shares" and the aggregate of 336,750 additional shares to be sold by the Company is herein called the "Optional Shares." The Firm Shares and the Optional Shares that the Underwriters elect to purchase pursuant to Section 2 hereof are herein collectively called the "Shares." 1. (a) The Company represents and warrants to, and agrees with, each of the Underwriters that: (i) A registration statement on Form S-1 (File No. 333-____) (the -1- "Initial Registration Statement") in respect of the Shares has been filed with the Securities and Exchange Commission (the "Commission"); the Initial Registration Statement and any post-effective amendment thereto, each in the form heretofore delivered to you, and, excluding exhibits thereto, to you for each of the other Underwriters, have been declared effective by the Commission in such form; other than a registration statement, if any, increasing the size of the offering (the "Rule 462(b) Registration Statement"), filed pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the "Act"), which became effective upon filing, no other document with respect to such registration statement has heretofore been filed with the Commission; and no stop order suspending the effectiveness of the Initial Registration Statement, any post-effective amendment thereto or the Rule 462(b) Registration Statement, if any, has been issued and no proceeding for that purpose has been initiated or threatened by the Commission (any preliminary prospectus included in the Initial Registration Statement and the Rule 462(b) Registration Statement, if any, or filed with the Commission pursuant to Rule 424(a) of the rules and regulations of the Commission under the Act is hereinafter called a "Preliminary Prospectus"; the various parts of the Initial Registration Statement and the Rule 462(b) Registration Statement, if any, including all exhibits thereto and including the information contained in the form of final prospectus filed with the Commission pursuant to Rule 424(b) under the Act in accordance with Section 5(a) hereof and deemed by virtue of Rule 430A under the Act to be part of the Initial Registration Statement at the time it was declared effective, each as amended at the time such part of the Initial Registration Statement became effective or such part of the Rule 462(b) Registration Statement, if any, became or hereafter becomes effective, are hereinafter collectively called the "Registration Statement"; and such final prospectus, in the form first filed pursuant to Rule 424(b) under the Act, is hereinafter called the "Prospectus"); (ii) No order preventing or suspending the use of any Preliminary Prospectus has been issued by the Commission, and each Preliminary Prospectus, at the time of filing thereof, conformed in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder, and did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for -2- use therein or by a Selling Stockholder expressly for use in the preparation of the answers therein to Items 7 and 11(l) of Form S-1; (iii) The Registration Statement conforms, and the Prospectus and any further amendments or supplements to the Registration Statement or the Prospectus will conform, in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder and do not and will not, as of the applicable effective date as to the Registration Statement and any amendment thereto and as of the applicable filing date as to the Prospectus and any amendment or supplement thereto, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein or by a Selling Stockholder expressly for use in the preparation of the answers therein to Items 7 and 11(l) of Form S-1; (iv) Neither the Company nor any of its subsidiaries has sustained since the date of the latest audited financial statements included in the Prospectus any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus; and, since the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been any change in the capital stock or long-term debt of the Company or any of its subsidiaries or any material adverse change, or any development involving a prospective material adverse change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus; (v) The Company and its subsidiaries do not own any real property; the Company and its subsidiaries have good and marketable title to all personal property owned by them, in each case free and clear of all liens, encumbrances and defects except such as are described in the Prospectus or such as do not materially affect the value of such property and do not interfere with the use made and proposed to be made of such property by the Company and its subsidiaries; and any real property and buildings held under lease by the Company and its subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company and its subsidiaries; -3- (vi) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the Commonwealth of Massachusetts, with power and authority (corporate and other) to own its properties and conduct its business as described in the Prospectus, and has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of each other jurisdiction in which it owns or leases properties or conducts any business so as to require such qualification, or is subject to no material liability or disability by reason of the failure to be so qualified in any such jurisdiction; and each subsidiary of the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation; (vii) The Company has an authorized capitalization as set forth in the Prospectus, and all of the issued shares of capital stock of the Company have been duly and validly authorized and issued, are fully paid and non-assessable and conform to the description of the Stock contained in the Prospectus; and all of the issued shares of capital stock of each subsidiary of the Company have been duly and validly authorized and issued, are fully paid and non-assessable and (except for directors' qualifying shares) are owned directly or indirectly by the Company, free and clear of all liens, encumbrances, equities or claims; (viii)The unissued Shares to be issued and sold by the Company to the Underwriters hereunder have been duly and validly authorized and, when issued and delivered against payment therefor as provided herein, will be duly and validly issued and fully paid and non-assessable and will conform to the description of the Stock contained in the Prospectus; (ix) The issue and sale of the Shares to be sold by the Company and the compliance by the Company with all of the provisions of this Agreement and the consummation of the transactions herein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries is bound or to which any of the property or assets of the Company or any of its subsidiaries is subject, nor will such action result in any violation of the provisions of the Articles of Organization or By-laws of the Company or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties; and no consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body is required for the issue and sale of the Shares or the consummation by the Company of the transactions contemplated by this Agreement, except the registration under the Act of the Shares and such consents, approvals, authorizations, registrations or qualifications may be required -4- under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters or under the rules of the National Association of Securities Dealers, Inc.; (x) Neither the Company nor any of its subsidiaries is in violation of its Articles of Organization or By-laws (or other charter documents) or in default in the performance or observance of any material obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, loan agreement, lease or other agreement or instrument to which it is a party or by which it or any of its properties may be bound; (xi) The statements set forth in the Prospectus under the caption "Description of Capital Stock", insofar as they purport to constitute a summary of the terms of the Stock and under the caption "Underwriting", insofar as they purport to describe the provisions of the laws and documents referred to therein, are accurate, complete and fair; (xii) There are no legal or governmental proceedings pending to which the Company or any of its subsidiaries is a party or of which any property of the Company or any of its subsidiaries is the subject which, if determined adversely to the Company or any of its subsidiaries, would individually or in the aggregate have a material adverse effect on the current or future consolidated financial position, stockholders' equity or results of operations of the Company and its subsidiaries taken as a whole; and, to the best of the Company's knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others; (xiii)The Company is not and, after giving effect to the offering and sale of the Shares, will not be an "investment company" or an entity "controlled" by an "investment company", as such terms are defined in the Investment Company Act of 1940, as amended (the "Investment Company Act"); (xiv) Neither the Company nor any of its affiliates does business with the government of Cuba or with any person or affiliate located in Cuba within the meaning of Section 517.075, Florida Statutes; (xv) Ernst & Young LLP, who have certified certain financial statements of the Company and its subsidiaries, are independent public accountants as required by the Act and the rules and regulations of the Commission thereunder; (xvi) To the best of the Company's knowledge, each of the Company and its subsidiaries owns, is licensed to use or otherwise possesses adequate rights to use all material patents, patent rights, inventions, trade secrets, know-how, trademarks, service marks, trade names and copyrights described or referred to -5- in the Prospectus as owned or used by it or which are necessary for the conduct of its businesses as described in the Prospectus; and the Company has not received any notice of, and has no knowledge of, any infringement of or conflict with asserted rights of others with respect to any patent, patent rights, inventions, trade secrets, know-how, trademarks, service marks, trade names or copyrights; (xvii)The Company has filed all reports it has been required to file under the Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission thereunder (the "Exchange Act"); such reports when filed conformed in all material respects to the requirements of the Exchange Act; and none of such reports contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein to make the statements therein, in light of the circumstances under which they were made, not misleading; and (xviiiThe Common Stock is registered pursuant to Section 12(g) of the Exchange Act, and is listed on NASDAQ (as defined below), and the Company has taken no action designed to, or likely to have the effect of, terminating the registration of the Common Stock under the Exchange Act or delisting the Common Stock from NASDAQ, nor has the Company received any notification that the Commission or NASDAQ is contemplating terminating such registration or listing. (b) Each of the Selling Stockholders severally represents and warrants to, and agrees with, each of the Underwriters and the Company that: (i) All consents, approvals, authorizations and orders necessary for the execution and delivery by such Selling Stockholder of this Agreement and the Power of Attorney and the Custody Agreement hereinafter referred to, and for the sale and delivery of the Shares to be sold by such Selling Stockholder hereunder, have been obtained; and such Selling Stockholder has full right, power and authority to enter into this Agreement, the Power of Attorney and the Custody Agreement and to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder hereunder; (ii) The sale of the Shares to be sold by such Selling Stockholder hereunder and the compliance by such Selling Stockholder with all of the provisions of this Agreement, the Power of Attorney and the Custody Agreement and the consummation of the transactions herein and therein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any statute, indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the property or assets of such Selling Stockholder is subject, nor will such -6- action result in any violation of any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over such Selling Stockholder or the property of such Selling Stockholder; (iii) Such Selling Stockholder has, and immediately prior to each Time of Delivery (as defined in Section 4 hereof) such Selling Stockholder will have, good and valid title to the Shares to be sold by such Selling Stockholder hereunder, free and clear of all liens, encumbrances, equities or claims; and, upon delivery of such Shares and payment therefor pursuant hereto, good and valid title to such Shares, free and clear of all liens, encumbrances, equities or claims, will pass to the several Underwriters; (iv) During the period beginning from the date hereof and continuing to and including the date 120 days after the date of the Prospectus, such Selling Stockholder shall not offer, sell, contract to sell or otherwise dispose of, except as provided hereunder, any Stock, or any securities of the Company that are substantially similar to the Shares, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, Stock or any such substantially similar securities (other than pursuant to employee stock option plans existing on the date of this Agreement), without your prior written consent; (v) Such Selling Stockholder has not taken and will not take, directly or indirectly, any action which is designed to or which has constituted or which might reasonably be expected to cause or result in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares; (vi) To the extent that any statements or omissions made in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto are made in reliance upon and in conformity with written information furnished to the Company by such Selling Stockholder expressly for use therein, such Preliminary Prospectus and the Registration Statement did, and the Prospectus and any further amendments or supplements to the Registration Statement and the Prospectus, when they become effective or are filed with the Commission, as the case may be, will conform in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder and will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading; (vii) In order to document the Underwriters' compliance with the reporting and withholding provisions of the Tax Equity and Fiscal Responsibility Act of 1982 with respect to the transactions herein contemplated, such Selling Stockholder will deliver to you prior to or at the First Time of Delivery (as -7- hereinafter defined) a properly completed and executed United States Treasury Department Form W-9 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof); (viii)Certificates in negotiable form representing all of the Shares to be sold by such Selling Stockholder hereunder, or stock option agreements, accompanied by duly completed notices of exercise for all of the Shares to be sold by such Selling Stockholder hereunder, and the exercise price therefor, have been placed in custody under a Custody Agreement, in the form heretofore furnished to you (the "Custody Agreement"), duly executed and delivered by such Selling Stockholder and such Selling Stockholder has duly executed and delivered a Power of Attorney, in the form heretofore furnished to you (the "Power of Attorney"), appointing the persons indicated in Schedule II hereto, and each of them, as such Selling Stockholder's attorneys-in-fact (the "Attorneys-in-Fact") with authority to execute and deliver this Agreement on behalf of such Selling Stockholder, to determine the purchase price to be paid by the Underwriters to the Selling Stockholders as provided in Section 2 hereof, to authorize the delivery of the Shares to be sold by such Selling Stockholder hereunder and otherwise to act on behalf of such Selling Stockholder in connection with the transactions contemplated by this Agreement and the Custody Agreement; and (ix) The Shares represented by the certificates and the notices of exercise of options, accompanied by the exercise price therefor, each as held in custody for such Selling Stockholder under the Custody Agreement, are subject to the interests of the Underwriters hereunder; the arrangements made by such Selling Stockholder for such custody, and the appointment by such Selling Stockholder of the Attorneys-in-Fact by the Power of Attorney, are to that extent irrevocable; the obligations of the Selling Stockholders hereunder shall not be terminated by operation of law, whether by the death or incapacity of any individual Selling Stockholder or, in the case of an estate or trust, by the death or incapacity of any executor or trustee or the termination of such estate or trust, or in the case of a partnership or corporation, by the dissolution of such partnership or corporation, or by the occurrence of any other event; if any individual Selling Stockholder or any such executor or trustee should die or become incapacitated, or if any such estate or trust should be terminated, or if any such partnership or corporation should be dissolved, or if any other such event should occur, before the delivery of the Shares hereunder, certificates representing the Shares shall be delivered by or on behalf of the Selling Stockholders in accordance with the terms and conditions of this Agreement and of the Custody Agreements; and actions taken by the Attorneys-in-Fact pursuant to the Powers of Attorney shall be as valid as if such death, incapacity, termination, dissolution or other event had not occurred, regardless of whether or not the Custodian, the Attorneys-in-Fact, or any of them, shall have received notice of such death, incapacity, termination, dissolution or other event. -8- 2. Subject to the terms and conditions herein set forth, (a) the Company and each of the Selling Stockholders agree, severally and not jointly, to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company and each of the Selling Stockholders, at a purchase price per share of $____, the number of Firm Shares (to be adjusted by you so as to eliminate fractional shares) determined by multiplying the aggregate number of Shares to be sold by the Company and each of the Selling Stockholders as set forth opposite their respective names in Schedule II hereto by a fraction, the numerator of which is the aggregate number of Firm Shares to be purchased by such Underwriter as set forth opposite the name of such Underwriter in Schedule I hereto and the denominator of which is the aggregate number of Firm Shares to be purchased by all of the Underwriters from the Company and all of the Selling Stockholders hereunder and (b) in the event and to the extent that the Underwriters shall exercise the election to purchase Optional Shares as provided below, the Company agrees to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company, at the purchase price per share set forth in clause (a) of this Section 2, that portion of the number of Optional Shares as to which such election shall have been exercised (to be adjusted by you so as to eliminate fractional shares) determined by multiplying such number of Optional Shares by a fraction the numerator of which is the maximum number of Optional Shares which such Underwriter is entitled to purchase as set forth opposite the name of such Underwriter in Schedule I hereto and the denominator of which is the maximum number of Optional Shares that all of the Underwriters are entitled to purchase hereunder. The Company hereby grants to the Underwriters the right to purchase at their election up to 336,750 Optional Shares, at the purchase price per share set forth in the paragraph above, for the sole purpose of covering overallotments in the sale of the Firm Shares. Any such election to purchase Optional Shares may be exercised only by written notice from you to the Company, given within a period of 30 calendar days after the date of this Agreement and setting forth the aggregate number of Optional Shares to be purchased and the date on which such Optional Shares are to be delivered, as determined by you but in no event earlier than the First Time of Delivery (as defined in Section 4 hereof) or, unless you and the Company otherwise agree in writing, earlier than two or later than ten business days after the date of such notice. 3. Upon the authorization by you of the release of the Firm Shares, the several Underwriters propose to offer the Firm Shares for sale upon the terms and conditions set forth in the Prospectus. 4. (a) The Shares to be purchased by each Underwriter hereunder, in definitive form, and in such authorized denominations and registered in such names as Goldman, Sachs & Co. may request upon at least forty-eight hours' prior notice to the Company and the Selling Stockholders shall be delivered by or on behalf of the -9- Company and the Selling Stockholders to Goldman, Sachs & Co., for the account of such Underwriter, against payment by or on behalf of such Underwriter of the purchase price therefor by wire transfer or certified or official bank check or checks, payable to the order of the Company and the Custodian, as their interests may appear, in federal (same day) funds. The Company will cause the certificates representing the Shares to be made available for checking and packaging at least twenty-four hours prior to the Time of Delivery (as defined below) with respect thereto at the office of Goldman, Sachs & Co., 85 Broad Street, New York, New York 10004 (the "Designated Office"). The time and date of such delivery and payment shall be, with respect to the Firm Shares, 9:30 a.m., New York time, on July 24, 1996 or such other time and date as Goldman, Sachs & Co., the Company and the Selling Stockholders may agree upon in writing, and, with respect to the Optional Shares, 9:30 a.m., New York time, on the date specified by Goldman, Sachs & Co. in the written notice given by Goldman, Sachs & Co. of the Underwriters' election to purchase such Optional Shares, or such other time and date as Goldman, Sachs & Co. and the Company may agree upon in writing. Such time and date for delivery of the Firm Shares is herein called the "First Time of Delivery", such time and date for delivery of the Optional Shares, if not the First Time of Delivery, is herein called the "Second Time of Delivery", and each such time and date for delivery is herein called a "Time of Delivery". (b) The documents to be delivered at each Time of Delivery by or on behalf of the parties hereto pursuant to Section 7 hereof, including the cross receipt for the Shares and any additional documents requested by the Underwriters pursuant to Section 7(j) hereof, and the check or checks specified in subsection (a) above, if any, will be delivered at the offices of Hale and Dorr, 60 State Street, Boston, Massachusetts 02109 (the "Closing Location"), and the Shares will be delivered at the Designated Office, all at such Time of Delivery. A meeting will be held at the Closing Location at 2:00 p.m., New York City time, on the New York Business Day next preceding such Time of Delivery, at which meeting the final drafts of the documents to be delivered pursuant to the preceding sentence will be available for review by the parties hereto. For the purposes of this Section 4, "New York Business Day" shall mean each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banking institutions in New York are generally authorized or obligated by law or executive order to close. 5. The Company agrees with each of the Underwriters: (a) To prepare the Prospectus in a form approved by you and to file such Prospectus pursuant to Rule 424(b) under the Act not later than the Commission's close of business on the second business day following the execution and delivery of this Agreement, or, if applicable, such earlier time as may be required by Rule 430A(a)(3) under the Act; to make no further amendment or any supplement to the Registration Statement or Prospectus prior to the last Time of Delivery which shall be disapproved by you promptly after reasonable notice thereof; to advise you, promptly after it receives -10- notice thereof, of the time when any amendment to the Registration Statement has been filed or becomes effective or any supplement to the Prospectus or any amended Prospectus has been filed and to furnish you with copies thereof; to advise you, promptly after it receives notice thereof, of the issuance by the Commission of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or prospectus, of the suspension of the qualification of the Shares for offering or sale in any jurisdiction, of the initiation or threatening of any proceeding for any such purpose, or of any request by the Commission for the amending or supplementing of the Registration Statement or Prospectus or for additional information; and, in the event of the issuance of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or prospectus or suspending any such qualification, promptly to use its best efforts to obtain the withdrawal of such order; (b) Promptly from time to time to take such action as you may reasonably request to qualify the Shares for offering and sale under the securities laws of such jurisdictions as you may request and to comply with such laws so as to permit the continuance of sales and dealings therein in such jurisdictions for as long as may be necessary to complete the distribution of the Shares, provided that in connection therewith the Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any jurisdiction; (c) Prior to 12:00 p.m., New York City time, on the New York Business Day next succeeding the date of this Agreement and from time to time, to furnish the Underwriters with copies of the Prospectus in New York City in such quantities as you may reasonably request, and, if the delivery of a prospectus is required at any time prior to the expiration of nine months after the time of issue of the Prospectus in connection with the offering or sale of the Shares and if at such time any events shall have occurred as a result of which the Prospectus as then amended or supplemented would include an untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made when such Prospectus is delivered, not misleading, or, if for any other reason it shall be necessary during such period to amend or supplement the Prospectus in order to comply with the Act, to notify you and upon your request to prepare and furnish without charge to each Underwriter and to any dealer in securities as many copies as you may from time to time reasonably request of an amended Prospectus or a supplement to the Prospectus which will correct such statement or omission or effect such compliance, and in case any Underwriter is required to deliver a prospectus in connection with sales of any of the Shares at any time nine months or more after the time of issue of the Prospectus, upon your request but at the expense of such Underwriter, to prepare and deliver to such Underwriter as many copies as you may request of an amended or supplemented Prospectus complying with Section 10(a)(3) of the Act; (d) To make generally available to its securityholders as soon as practicable, -11- but in any event not later than eighteen months after the effective date of the Registration Statement (as defined in Rule 158(c) under the Act), an earnings statement of the Company and its subsidiaries (which need not be audited) complying with Section 11(a) of the Act and the rules and regulations of the Commission thereunder (including, at the option of the Company, Rule 158); (e) During the period beginning from the date hereof and continuing to and including the date 120 days after the date of the Prospectus, not to offer, sell, contract to sell or otherwise dispose of, except as provided hereunder, any securities of the Company that are substantially similar to the Shares, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, Stock or any such substantially similar securities (other than option issuances and the issuance of Stock upon the exercise of options pursuant to employee stock plans existing on the date of this Agreement), without your prior written consent, except that the Company may issue such securities in exchange for all of the equity or substantially all of the assets of a company in connection with a merger or acquisition, provided that prior to any such issuance the recipients of such securities shall have agreed with Goldman, Sachs & Co. in writing to be bound by this provision for the remainder of the 120-day period; (f) To furnish to its stockholders as soon as practicable after the end of each fiscal year an annual report (including a balance sheet and statements of income, stockholders' equity and cash flows of the Company and its consolidated subsidiaries certified by independent public accountants) and, as soon as practicable after the end of each of the first three quarters of each fiscal year (beginning with the fiscal quarter ending after the effective date of the Registration Statement), consolidated summary financial information of the Company and its subsidiaries for such quarter in reasonable detail; (g) During a period of five years from the effective date of the Registration Statement, to furnish to you copies of all reports or other communications (financial or other) furnished to stockholders, and to deliver to you (i) as soon as they are available, copies of any reports and financial statements furnished to or filed with the Commission or any national securities exchange on which any class of securities of the Company is listed; and (ii) such additional information concerning the business and financial condition of the Company as you may from time to time reasonably request (such financial statements to be on a consolidated basis to the extent the accounts of the Company and its subsidiaries are consolidated in reports furnished to its stockholders generally or to the Commission); (h) To use the net proceeds received by it from the sale of the Shares pursuant to this Agreement in the manner specified in the Prospectus under the caption "Use of Proceeds"; -12- (i) To use its best efforts to list for quotation the Shares on the National Association of Securities Dealers Automated Quotations National Market System ("NASDAQ"); and (j) If the Company elects to rely on Rule 462(b), to file a Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) by 10:00 p.m., Washington, D.C. time, on the date of this Agreement, and at the time of filing either to pay to the Commission the filing fee for the Rule 462(b) Registration Statement or to give irrevocable instructions for the payment of such fee pursuant to Rule 111(b) under the Act. 6. (a) The Company covenants and agrees with each Selling Stockholder and the several Underwriters that the Company will pay or cause to be paid the following: (i) the fees, disbursements and expenses of the Company's counsel and accountants in connection with the registration of the Shares under the Act and all other expenses in connection with the preparation, printing and filing of the Registration Statement, any Preliminary Prospectus and the Prospectus and amendments and supplements thereto and the mailing and delivering of copies thereof to the Underwriters and dealers; (ii) the cost of printing or producing any Agreement among Underwriters, this Agreement, the Blue Sky Memorandum, closing documents (including any compilations thereof) and any other documents in connection with the offering, purchase, sale and delivery of the Shares; (iii) all expenses in connection with the qualification of the Shares for offering and sale under state securities laws as provided in Section 5(b) hereof, including the fees and disbursements of counsel for the Underwriters in connection with such qualification and in connection with the Blue Sky survey; (iv) all fees and expenses in connection with listing the Shares on NASDAQ; and (v) the filing fees incident to any required review by the National Association of Securities Dealers, Inc. of the terms of the sale of the Shares; (vi) the cost of preparing stock certificates; (vii) the cost and charges of any transfer agent or registrar and (viii) all other costs and expenses incident to the performance of its obligations hereunder which are not otherwise specifically provided for in this Section. (b) The Company further covenants and agrees with each of the Selling Stockholders and the several Underwriters that the Company will pay or cause to be paid all costs and expenses incident to the performance of such Selling Stockholder's obligations hereunder which are not otherwise specifically provided for in this Section, including (i) any fees and expenses of counsel for such Selling Stockholder, (ii) the fees and expenses of the Attorneys-in-Fact and the Custodian, and (iii) all expenses and taxes incident to the sale and delivery of the Shares to be sold by such Selling Stockholder to the Underwriters hereunder. In connection with clause (iii) of the preceding sentence, Goldman, Sachs & Co. agrees to pay New York State stock transfer tax, and the Selling Stockholder agrees to reimburse Goldman, Sachs & Co. for associated carrying costs if such tax payment is not rebated on the day of payment and -13- for any portion of such tax payment not rebated. It is understood, however, that the Company shall bear, and the Selling Stockholders shall not be required to pay or to reimburse the Company for, the cost of any other matters not directly relating to the sale and purchase of the Shares pursuant to this Agreement, and that, except as provided in this Section, and Sections 8 and 11 hereof, the Underwriters will pay all of their own costs and expenses, including the fees of their counsel, stock transfer taxes on resale of any of the Shares by them, and any advertising expenses connected with any offers they may make. 7. The obligations of the Underwriters hereunder, as to the Shares to be delivered at each Time of Delivery, shall be subject, in their discretion, to the condition that all representations and warranties and other statements of the Company and of the Selling Stockholders herein are, at and as of such Time of Delivery, true and correct, the condition that the Company and the Selling Stockholders shall have performed all of its and their obligations hereunder theretofore to be performed, and the following additional conditions: (a) The Prospectus shall have been filed with the Commission pursuant to Rule 424(b) within the applicable time period prescribed for such filing by the rules and regulations under the Act and in accordance with Section 5(a) hereof; if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have become effective by 10:00 p.m., Washington, D.C. time, on the date of this Agreement, no stop order suspending the effectiveness of the Registration Statement or any part thereof shall have been issued and no proceeding for that purpose shall have been initiated or threatened by the Commission; and all requests for additional information on the part of the Commission shall have been complied with to your reasonable satisfaction; (b) Hale and Dorr, counsel for the Underwriters, shall have furnished to you such opinion or opinions (a draft of each such written opinion is attached as Annex II(a) hereto), dated such Time of Delivery, with respect to the matters covered in paragraphs (i), (ii), (vii), (x) and (xii) of subsection (c) below as well as such other related matters as you may reasonably request, and such counsel shall have received such papers and information as they may reasonably request to enable them to pass upon such matters; (c) Choate, Hall & Stewart, counsel for the Company, shall have furnished to you their written opinion (a draft of such opinion is attached as Annex II(b) hereto), dated such Time of Delivery, in form and substance satisfactory to you, to the effect that: (i) The Company has been duly incorporated and is validly existing as a corporation in good corporate standing under the laws of The Commonwealth of Massachusetts, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; -14- (ii) The Company has an authorized capitalization as set forth in the Prospectus, and all of the issued shares of capital stock of the Company (including the Shares being delivered at such Time of Delivery) have been duly and validly authorized and issued and are fully paid and non-assessable; and the Shares conform to the description of the Stock contained in the Prospectus; (iii) The Company has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of each of the States of California, Texas, New York and Illinois, which to such counsel's knowledge are the only jurisdictions within the United States in which the Company owns or leases real property or maintains an office. (iv) Each subsidiary of the Company has been duly incorporated and is validly existing as a corporation in good corporate standing under the laws of its jurisdiction of incorporation; and all of the issued shares of capital stock of each such subsidiary have been duly and validly authorized and issued, are fully paid and non-assessable, and (except for directors' qualifying shares) are owned directly or indirectly by the Company, free and clear of all liens, encumbrances, equities or claims (such counsel being entitled to rely in respect of the opinion in this clause upon opinions of local counsel and in respect of matters of fact upon certificates of officers of the Company or its subsidiaries, provided that such counsel shall state that they believe that both you and they are justified in relying upon such opinions and certificates); (v) Any real property and buildings held under lease by the Company and its subsidiaries are held by them under valid, subsisting and enforceable (except to the extent that the rights and remedies created thereby may be limited by applicable bankruptcy, insolvency, reorganization and similar laws affecting rights and remedies of creditors and that the remedy of specific performance is subject to the discretion of a court) leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company and its subsidiaries (in giving the opinion in this clause, such counsel may rely in respect of matters of fact, upon certificates of officers of the Company or its subsidiaries, provided that such counsel shall state that they believe that both you and they are justified in relying upon such certificates); (vi) To such counsel's knowledge and other than as set forth in the Prospectus, there are no legal or governmental proceedings pending to which the Company or any of its subsidiaries is a party or of which any property of the Company or any of its subsidiaries is the subject which would individually or in the aggregate reasonably be expected to have a material adverse effect on the current or future consolidated financial position, stockholders' equity or results of operations of the Company and its subsidiaries; and, to such counsel's -15- knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others; (vii) This Agreement has been duly authorized, executed and delivered by the Company; (viii)The issue and sale of the Shares being delivered at such Time of Delivery to be sold by the Company and the compliance by the Company with all of the provisions of this Agreement and the consummation of the transactions herein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust, loan agreement or other material agreement or instrument known to such counsel to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries is bound or to which any of the property or assets of the Company or any of its subsidiaries is subject, nor will such action result in any violation of the provisions of the Articles of Organization or By-laws of the Company or any statute or any order, rule or regulation known to such counsel of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties; (ix) No consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body is required for the issue and sale of the Shares or the consummation by the Company of the transactions contemplated by this Agreement, except the registration under the Act of the Shares, and such consents, approvals, authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters or under the rules of the National Association of Securities Dealers, Inc.; (x) The statements set forth in the Prospectus under the caption "Description of Capital Stock", insofar as they purport to constitute a summary of the terms of the Stock and under the caption "Underwriting", insofar as they purport to describe the provisions of the laws and documents referred to therein, are accurate and complete summaries of such terms and provisions in all material respects; (xi) The Company is not an "investment company" or an entity controlled by an "investment company", as such terms are defined in the Investment Company Act; and (xii) The Registration Statement and the Prospectus and any further amendments and supplements thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no belief) comply as to form in all material -16- respects with the requirements of the Act and the rules and regulations thereunder; although they do not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus, except for those referred to in the opinion in subsection (x) of this Section 7(c), no facts have come to their attention that have caused them to believe that, as of its effective date, the Registration Statement or any further amendment thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no belief) contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that, as of its date, the Prospectus or any further amendment or supplement thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no belief) contained an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading or that, as of such Time of Delivery, either the Registration Statement or the Prospectus or any further amendment or supplement thereto made by the Company prior to such Time of Delivery (other than the financial statements and related schedules therein, as to which such counsel need express no belief) contains an untrue statement of a material fact or omits to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and they do not know of any amendment to the Registration Statement required to be filed or of any contracts or other documents of a character required to be filed as an exhibit to the Registration Statement or required to be described in the Registration Statement or the Prospectus which are not filed or described as required. (d) Choate, Hall & Stewart, counsel for each of the Selling Stockholders, shall have furnished to you their written opinion with respect to each of the Selling Stockholders (such opinion to be incorporated in the opinion attached as Annex II(b) hereto), dated such Time of Delivery, in form and substance satisfactory to you, to the effect that: -17- (i) A Power of Attorney and a Custody Agreement have been duly executed and delivered by such Selling Stockholder and constitute valid and binding agreements of such Selling Stockholder in accordance with their terms (except to the extent that the rights and remedies created thereby may be limited by applicable bankruptcy, insolvency, reorganization and similar laws affecting rights and remedies of creditors and that the remedy of specific performance is subject to the discretion of a court); (ii) This Agreement has been duly executed and delivered by or on behalf of such Selling Stockholder; and the sale of the Shares to be sold by such Selling Stockholder hereunder and the compliance by such Selling Stockholder with all of the provisions of this Agreement, the Power of Attorney and the Custody Agreement and the consummation of the transactions herein and therein contemplated will not conflict with or result in a breach or violation of any terms or provisions of, or constitute a default under, any statute, indenture, mortgage, deed of trust, loan agreement or other agreement or instrument known to such counsel to which such Selling Stockholder is a party or by which such Selling Stockholder is bound or to which any of the property or assets of such Selling Stockholder is subject, nor will such action result in any violation of any order, rule or regulation known to such counsel of any court or governmental agency or body having jurisdiction over such Selling Stockholder or the property of such Selling Stockholder; (iii) No consent, approval, authorization or order of any court or governmental agency or body is required for the consummation of the transactions contemplated by this Agreement in connection with the Shares to be sold by such Selling Stockholder hereunder, except such as have been obtained under the Act and such as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of such Shares by the Underwriters or under the rules of the National Association of Securities Dealers, Inc.; (iv) Immediately prior to such Time of Delivery, such Selling Stockholder was the sole registered and, to such counsel's knowledge, beneficial, owner of the Shares to be sold at such Time of Delivery by such Selling Stockholder under this Agreement, and, to such counsel's knowledge, had full right, power and authority to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder hereunder; and (v) Immediately prior to the Time of Delivery, each Selling Stockholder was the sole registered owner of the Shares to be sold by such Selling Stockholder. Upon registration of the Shares in the names of the Underwriters in the stock records of the Company, the Underwriters will have acquired the Shares, free and clear of any liens, encumbrances, equities or claims (assuming -18- that the Underwriters are without notice of any adverse claim, as defined in the Uniform Commercial Code, and are otherwise bona fide purchasers for the purposes of the Code and that such Underwriters' rights are not limited by subsection (4) of Section 8-302 of the Uniform Commercial Code). (e) On the date of the Prospectus at a time prior to the execution of this Agreement, at 9:30 a.m., New York City time, on the effective date of any post-effective amendment to the Registration Statement filed subsequent to the date of this Agreement and also at each Time of Delivery, Ernst & Young LLP shall have furnished to you a letter or letters, dated the respective dates of delivery thereof, in form and substance satisfactory to you, to the effect set forth in Annex I hereto (the executed copy of the letter delivered prior to the execution of this Agreement is attached as Annex I(d) hereto and a draft of the form of letter to be delivered on the effective date of any post-effective amendment to the Registration Statement and as of each Time of Delivery is attached as Annex I(e) hereto); (f)(i)Neither the Company nor any of its subsidiaries shall have sustained since the date of the latest audited financial statements included in the Prospectus any loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus, and (ii) since the respective dates as of which information is given in the Prospectus there shall not have been any change in the capital stock (other than as a result of the exercise of stock options) or long-term debt of the Company or any of its subsidiaries or any change, or any development involving a prospective change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus, the effect of which, in any such case described in clause (i) or (ii), is in the judgment of the Representatives so material and adverse as to make it impracticable or inadvisable to proceed with the public offering or the delivery of the Shares being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; (g) On or after the date hereof there shall not have occurred any of the following: (i) a suspension or material limitation in trading in securities generally on the New York Stock Exchange or on NASDAQ; (ii) a suspension or material limitation in trading in the Company's securities on NASDAQ; (iii) a general moratorium on commercial banking activities declared by either Federal or New York or Massachusetts State authorities; or (iv) the outbreak or escalation of hostilities involving the United States or the declaration by the United States of a national emergency or war, if the effect of any such event specified in this clause (iv) in the judgment of the Representatives makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Shares being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; -19- (h) The Shares at the such Time of Delivery shall have been duly listed for quotation on NASDAQ; (i) The Company has obtained and delivered to the Underwriters executed copies of an agreement from each stockholder of the Company substantially to the effect set forth in Subsection 1(b)(iv) hereof in form and substance satisfactory to you; and (j) The Company and the Selling Stockholders shall have furnished or caused to be furnished to you at such Time of Delivery certificates of officers of the Company and of the Selling Stockholders, respectively, satisfactory to you as to the accuracy of the representations and warranties of the Company and the Selling Stockholders, respectively, herein at and as of such Time of Delivery, as to the performance by the Company and the Selling Stockholders of all of their respective obligations hereunder to be performed at or prior to such Time of Delivery, and as to such other matters as you may reasonably request, and the Company shall have furnished or caused to be furnished certificates as to the matters set forth in subsections (a) and (f) of this Section; and (k) The Company shall have complied with the provisions of Section 5(c) hereof with respect to the furnishing of prospectuses on the New York Business Day next succeeding the date of this Agreement. 8. (a) The Company and each of the Selling Stockholders, jointly and severally, will indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that the Company and the Selling Stockholders shall not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by any Underwriter through Goldman, Sachs & Co. expressly for use therein; provided further, that the liability of a Selling Stockholder pursuant to this subsection (a) shall not exceed the -20- product of the number of Shares sold by such Selling Stockholder and the initial public offering price of the Shares as set forth in the Prospectus. (b) Each Underwriter will indemnify and hold harmless the Company and each Selling Stockholder against any losses, claims, damages or liabilities to which the Company or such Selling Stockholder may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by such Underwriter through Goldman, Sachs & Co. expressly for use therein; and will reimburse the Company and each Selling Stockholder for any legal or other expenses reasonably incurred by the Company or such Selling Stockholder in connection with investigating or defending any such action or claim as such expenses are incurred. (c) Promptly (but in any event within 30 days) after receipt by an indemnified party under subsection (a) or (b) above of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party under such subsection, notify the indemnifying party in writing of the commencement thereof. No indemnification under subsection (a) or (b) above shall be available to any party who shall so fail to give such notice if the party to whom such notice was not given was unaware of the action to which the notice would have related and was prejudiced by the failure to give the notice, but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party otherwise than under such subsection. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party (who shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under such subsection for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the defense thereof other than reasonable costs of investigation. No indemnifying party shall, without the written consent of the indemnified party, effect the settlement or compromise of, or consent to the entry of any judgment with respect to, any pending or threatened action or claim in respect of which -21- indemnification or contribution may be sought hereunder (whether or not the indemnified party is an actual or potential party to such action or claim) unless such settlement, compromise or judgment (i) includes an unconditional release of the indemnified party from all liability arising out of such action or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of any indemnified party. (d) If the indemnification provided for in this Section 8 is unavailable to or insufficient to hold harmless an indemnified party under subsection (a) or (b) above in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other from the offering of the Shares. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law or if the indemnified party failed to give the notice required under subsection (c) above, then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company and the Selling Stockholders on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Company and the Selling Stockholders bear to the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or the Selling Stockholders on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, each of the Selling Stockholders and the Underwriters agree that it would not be just and equitable if contributions pursuant to this subsection (d) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this subsection (d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this subsection (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection (d), no Underwriter shall be required to contribute any amount in excess -22- of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this subsection (d) to contribute are several in proportion to their respective underwriting obligations and not joint. Notwithstanding the foregoing, the liability of a Selling Stockholder pursuant to this subsection (d) shall not exceed the product of the number of Shares sold by such Selling Stockholder and the initial public offering price of the Shares as set forth in the Prospectus. (e) The obligations of the Company and the Selling Stockholders under this Section 8 shall be in addition to any liability which the Company and the respective Selling Stockholders may otherwise have and shall extend, upon the same terms and conditions,to each person, if any, who controls any Underwriter within the meaning of the Act; and the obligations of the Underwriters under this Section 8 shall be in addition to any liability which the respective Underwriters may otherwise have and shall extend, upon the same terms and conditions, to each officer and director of the Company (including any person who, with his or her consent, is named in the Registration Statement as about to become a director of the Company) and to each person, if any, who controls the Company or any Selling Stockholder within the meaning of the Act. 9. (a) If any Underwriter shall default in its obligation to purchase the Shares which it has agreed to purchase hereunder at a Time of Delivery, you may in your discretion arrange for you or another party or other parties to purchase such Shares on the terms contained herein. If within thirty-six hours after such default by any Underwriter you do not arrange for the purchase of such Shares, then the Company and the Selling Stockholders shall be entitled to a further period of thirty-six hours within which to procure another party or other parties satisfactory to you to purchase such Shares on such terms. In the event that, within the respective prescribed periods, you notify the Company and the Selling Stockholders that you have so arranged for the purchase of such Shares, or the Company and the Selling Stockholders notify you that they have so arranged for the purchase of such Shares, you or the Company and the Selling Stockholders shall have the right to postpone such Time of Delivery for a period of not more than seven days, in order to effect whatever changes may thereby be made necessary in the Registration Statement or the Prospectus, or in any other documents or arrangements, and the Company agrees to file promptly any amendments to the Registration Statement or the Prospectus which in your opinion may thereby be made necessary. The term "Underwriter" as used in this Agreement shall include any person substituted under this Section with like effect as if such person had originally been a party to this Agreement with respect to such Shares. (b) If, after giving effect to any arrangements for the purchase of the Shares of -23- a defaulting Underwriter or Underwriters by you and the Company and the Selling Stockholders as provided in subsection (a) above, the aggregate number of such Shares which remains unpurchased does not exceed one-eleventh of the aggregate number of all the Shares to be purchased at such Time of Delivery, then the Company and the Selling Stockholders shall have the right to require each non-defaulting Underwriter to purchase the number of Shares which such Underwriter agreed to purchase hereunder at such Time of Delivery and, in addition, to require each non-defaulting Underwriter to purchase its pro rata share (based on the number of Shares which such Underwriter agreed to purchase hereunder) of the Shares of such defaulting Underwriter or Underwriters for which such arrangements have not been made; but nothing herein shall relieve a defaulting Underwriter from liability for its default. (c) If, after giving effect to any arrangements for the purchase of the Shares of a defaulting Underwriter or Underwriters by you and the Company and the Selling Stockholders as provided in subsection (a) above, the aggregate number of such Shares which remains unpurchased exceeds one-eleventh of the aggregate number of all of the Shares to be purchased at such Time of Delivery, or if the Company and the Selling Stockholders shall not exercise the right described in subsection (b) above to require non-defaulting Underwriters to purchase Shares of a defaulting Underwriter or Underwriters, then this Agreement (or, with respect to the Second Time of Delivery, the obligations of the Underwriters to purchase and of the Company and the Selling Stockholders to sell the Optional Shares) shall thereupon terminate, without liability on the part of any non-defaulting Underwriter or the Company or the Selling Stockholders, except for the expenses to be borne by the Company and the Selling Stockholders and the Underwriters as provided in Section 6 hereof and the indemnity and contribution agreements in Section 8 hereof; but nothing herein shall relieve a defaulting Underwriter from liability for its default. 10. The respective indemnities, agreements, representations, warranties and other statements of the Company, the Selling Stockholders and the several Underwriters, as set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement, shall remain in full force and effect, regardless of any investigation (or any statement as to the results thereof) made by or on behalf of any Underwriter or any controlling person of any Underwriter, or the Company, or any of the Selling Stockholders, or any officer or director or controlling person of the Company, or any controlling person of any Selling Stockholder, and shall survive delivery of and payment for the Shares. 11. If this Agreement shall be terminated pursuant to Section 9 hereof, neither the Company nor the Selling Stockholders shall then be under any liability to any Underwriter except as provided in Sections 6 and 8 hereof; but, if for any other reason any Shares are not delivered by or on behalf of the Company and the Selling Stockholders as provided herein, the Company and each of the defaulting Selling Stockholders, if any, pro rata (with the Company's portion based on the number of -24- Shares to be sold by the Company and all non-defaulting Selling Stockholders hereunder and the defaulting Selling Stockholder's portion based on the number of Shares to be sold by such defaulting Selling Stockholder, if any, hereunder) will reimburse the Underwriters through you for all out-of-pocket expenses approved in writing by you, including fees and disbursements of counsel, reasonably incurred by the Underwriters in making preparations for the purchase, sale and delivery of the Shares not so delivered, but the Company and the Selling Stockholders shall then be under no further liability to any Underwriter in respect of the Shares not so delivered except as provided in Sections 6 and 8 hereof. Notwithstanding the provisions of this Section 11, in the event any Shares are not delivered by or on behalf of the Company and the Selling Stockholders as provided herein as a result of the failure to meet the conditions set forth in Section 7(g), then the Company and the Selling Stockholders shall not be obligated to reimburse the Underwriters for the above-referenced out-of-pocket expenses. 12. In all dealings hereunder, you shall act on behalf of each of the Underwriters, and the parties hereto shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of any Underwriter made or given by you jointly or by Goldman, Sachs & Co. on behalf of you as the representatives; and in all dealings with any Selling Stockholder hereunder, you and the Company shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of such Selling Stockholder made or given by any or all of the Attorneys-in-Fact for such Selling Stockholder. All statements, requests, notices and agreements hereunder shall be in writing, and if to the Underwriters shall be delivered or sent by mail, telex or facsimile transmission to you as the representatives in care of Goldman, Sachs & Co., 85 Broad Street, New York, New York 10004, Attention: Registration Department; if to any Selling Stockholder shall be delivered or sent by mail, telex or facsimile transmission to counsel for such Selling Stockholder at its address set forth in Schedule II hereto; and if to the Company shall be delivered or sent by mail, telex or facsimile transmission to the address of the Company set forth in the Registration Statement, Attention: President; provided, however, that any notice to an Underwriter pursuant to Section 8(c) hereof shall be delivered or sent by mail, telex or facsimile transmission to such Underwriter at its address set forth in its Underwriters' Questionnaire or telex constituting such Questionnaire, which address will be supplied to the Company or the Selling Stockholders by you on request. Any such statements, requests, notices or agreements shall take effect upon receipt thereof. 13. This Agreement shall be binding upon, and inure solely to the benefit of, the Underwriters, the Company and the Selling Stockholders and, to the extent provided in Sections 8 and 10 hereof, the officers and directors of the Company and each person who controls the Company, any Selling Stockholder or any Underwriter, and their respective heirs, executors, administrators, successors and assigns, and no other -25- person shall acquire or have any right under or by virtue of this Agreement. No purchaser of any of the Shares from any Underwriter shall be deemed a successor or assign by reason merely of such purchase. 14. Time shall be of the essence of this Agreement. As used herein, the term "business day" shall mean any day when the Commission's office in Washington, D.C. is open for business. 15. This Agreement shall be governed by and construed in accordance with the laws of the State of New York. 16. This Agreement may be executed by any one or more of the parties hereto in any number of counterparts, each of which shall be deemed to be an original, but all such counterparts shall together constitute one and the same instrument. [remainder of page intentionally left blank] -26- If the foregoing is in accordance with your understanding, please sign and return to us seven counterparts hereof, and upon the acceptance hereof by you, on behalf of each of the Underwriters, this letter and such acceptance hereof shall constitute a binding agreement among each of the Underwriters, the Company and each of the Selling Stockholders. It is understood that your acceptance of this letter on behalf of each of the Underwriters is pursuant to the authority set forth in a form of Agreement among Underwriters, the form of which shall be submitted to the Company and the Selling Stockholders for examination, upon request, but without warranty on your part as to the authority of the signers thereof. Any person executing and delivering this Agreement as Attorney-in-Fact for a Selling Stockholder represents by so doing that he has been duly appointed as Attorney- in-Fact by such Selling Stockholder pursuant to a validly existing and binding Power-of- Attorney which authorizes such Attorney-in-Fact to take such action. Very truly yours, PEGASYSTEMS INC. By: -------------------- Name: Alan Trefler Title: President THE PERSONS LISTED AS SELLING STOCKHOLDERS ON SCHEDULE II HERETO By: -------------------- Name: Alan Trefler Title: President As Attorney-in-Fact acting on behalf of each of the Selling Stockholders named in Schedule II to this Agreement. -27- Accepted as of the date hereof at New, York, New York: Goldman, Sachs & Co. Cowen & Company Montgomery Securities By: ---------------------------------------------- (Goldman, Sachs & Co.) On behalf of each of the Underwriters -28- SCHEDULE I
Number of Optional Total Number of Shares to be Purchased Firm Shares if Maximum Underwriter to be Purchased Option Exercised Goldman, Sachs & Co. Cowen & Company Montgomery Securities ------------ ------------ TOTAL 2,245,000 336,750
-1- SCHEDULE II
Number of Optional Shares to be Total Number of Purchased Firm Shares if Maximum to be Purchased Option Exercised The Company.................................. 1,500,000 336,750 The Selling Stockholders(a).................. -- -- -- -- -- --------- --------- Total 2,245,000 336,750
(a) All Selling Stockholders are represented by Choate, Hall & Stewart and have appointed Alan Trefler and Ira Vishner, and each of them, as the Attorneys-in-Fact for such Selling Stockholder. -2- ANNEX I Pursuant to Section 7(d) of the Underwriting Agreement, the accountants shall furnish letters to the Underwriters to the effect that: (i) They are independent certified public accountants with respect to the Company and its subsidiaries within the meaning of the Act and the applicable published rules and regulations thereunder; (ii) In their opinion, the financial statements and any supplementary financial information and schedules (and, if applicable, financial forecasts and/or pro forma financial information) examined by them and included in the Prospectus or the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations thereunder; and they have made a review in accordance with standards established by the American Institute of Certified Public Accountants of the unaudited consolidated interim financial statements, selected financial data, pro forma financial information, financial forecasts and/or condensed financial statements derived from audited financial statements of the Company for the periods specified in such letter, as indicated in their reports thereon, copies of which have been separately furnished to the representatives of the Underwriters (the "Representatives"); (iii) They have made a review in accordance with standards established by the American Institute of Certified Public Accountants of the unaudited condensed consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus as indicated in their reports thereon copies of which have been separately furnished to the Representatives and on the basis of specified procedures including inquiries of officials of the Company who have responsibility for financial and accounting matters regarding whether the unaudited condensed consolidated financial statements referred to in paragraph (vi)(A)(i) below comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations, nothing came to their attention that caused them to believe that the unaudited condensed consolidated financial statements do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations; (iv) They have compared the information in the Prospectus under selected captions with the disclosure requirements of Regulation S-K and on the basis of limited procedures specified in such letter nothing came to their attention as a result of the foregoing procedures that caused them to believe that this -1- information does not conform in all material respects with the disclosure requirements of Items 301, 302, 402 and 503(d), respectively, of Regulation S-K; (v) On the basis of limited procedures, not constituting an examination in accordance with generally accepted auditing standards, consisting of a reading of the unaudited financial statements and other information referred to below, a reading of the latest available interim financial statements of the Company and its subsidiaries, inspection of the minute books of the Company and its subsidiaries since the date of the latest audited financial statements included in the Prospectus, inquiries of officials of the Company and its subsidiaries responsible for financial and accounting matters and such other inquiries and procedures as may be specified in such letter, nothing came to their attention that caused them to believe that: (A) (i) the unaudited consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations, or (ii) any material modifications should be made to the unaudited condensed consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Prospectus for them to be in conformity with generally accepted accounting principles; (B) any other unaudited income statement data and balance sheet items included in the Prospectus do not agree with the corresponding items in the unaudited consolidated financial statements from which such data and items were derived, and any such unaudited data and items were not determined on a basis substantially consistent with the basis for the corresponding amounts in the audited consolidated financial statements included in the Prospectus; (C) the unaudited financial statements which were not included in the Prospectus but from which were derived any unaudited condensed financial statements referred to in Clause (A) and any unaudited income statement data and balance sheet items included in the Prospectus and referred to in Clause (B) were not determined on a basis substantially consistent with the basis for the audited consolidated financial statements included in the Prospectus; (D) any unaudited pro forma consolidated condensed financial statements included in the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act -2- and the published rules and regulations thereunder or the pro forma adjustments have not been properly applied to the historical amounts in the compilation of those statements; (E) as of a specified date not more than five days prior to the date of such letter, there have been any changes in the consolidated capital stock (other than issuances of capital stock upon exercise of options which were outstanding on the date of the latest financial statements included in the Prospectus) or any increase in the consolidated long-term debt of the Company and its subsidiaries, or any decreases in consolidated net current assets or stockholders' equity or other items specified by the Representatives, or any increases in any items specified by the Representatives, in each case as compared with amounts shown in the latest balance sheet included in the Prospectus, except in each case for changes, increases or decreases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (F) for the period from the date of the latest financial statements included in the Prospectus to the specified date referred to in Clause (E) there were any decreases in consolidated net revenues or operating profit or the total or per share amounts of consolidated net income or other items specified by the Representatives, or any increases in any items specified by the Representatives, in each case as compared with the comparable period of the preceding year and with any other period of corresponding length specified by the Representatives, except in each case for decreases or increases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (vi) In addition to the examination referred to in their report(s) included in the Prospectus and the limited procedures, inspection of minute books, inquiries and other procedures referred to in paragraphs (iii) and (vi) above, they have carried out certain specified procedures, not constituting an examination in accordance with generally accepted auditing standards, with respect to certain amounts, percentages and financial information specified by the Representatives, which are derived from the general accounting records of the Company and its subsidiaries, which appear in the Prospectus, or in Part II of, or in exhibits and schedules to, the Registration Statement specified by the Representatives, and have compared certain of such amounts, percentages and financial information with the accounting records of the Company and its subsidiaries and have found them to be in agreement. -3- EX-5.1 3 OPINION OF CHOATE, HALL & STEWART November 20, 1996 Pegasystems Inc. 101 Main Street Cambridge, MA 02142 Gentlemen: This opinion is delivered to you in connection with the registration statement (the "Registration Statement") on Form S-1 of Pegasystems Inc. (the "Company") filed on November 20, 1996 with the Securities and Exchange Commission by the Company under the Securities Act of 1933, as amended (the "Securities Act"), for registration under said Act of 2,581,750 shares of the common stock, $.01 par value (the "Common Stock"), of the Company. We are familiar with the Restated Articles of Organization of the Company, the corporate minute book and the Restated by-laws of the Company, and the Registration Statement. We have also made such further investigation as we have deemed necessary for the purposes of this opinion. Based upon and subject to the foregoing, we are of the opinion that the shares of Common Stock to be sold by the Company pursuant to the prospectus contained in the Registration Statement (the "Prospectus") have been validly authorized for issuance and, when issued against receipt of the purchase price described in the Prospectus, will be legally issued, fully paid and nonassessable. We understand that this opinion is to be used in connection with the Registration Statement. We consent to the filing of this opinion as an exhibit to the Registration Statement, the incorporation by reference of this opinion in any abbreviated registration statement in connection with the Common Stock pursuant to Rule 462(b) promulgated under the Securities Act, and the reference to our firm in the Prospectus under the caption "Legal Matters." Very truly yours, CHOATE, HALL & STEWART DS1/305140 EX-23.1 4 CONSENTS OF EXPERTS AND COUNSEL Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Experts" and "Selected Consolidated Financial Data" and to the use of our report dated May 6, 1996 (except for Note 10 as to which the date is July 10, 1996 and Note 11 as to which the date is November 19, 1996), in the Registration Statement (Form S-1) and the related Prospectus of Pegasystems Inc. for the registration of 2,581,750 shares of its common stock. Our audits also included the financial statement schedule of Pegasystems Inc. located at Exhibit 99.1. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Boston, Massachusetts November 19, 1996 EX-23.6 5 CONSENT OF THE ABERDEEN GROUP November 19, 1996 The undersigned hereby consents to the reference to its name and to the use of its report by Pegasystems Inc. (the "Company") in the Company's Registration Statement on Form S-1 and hereby agrees to the filing of this consent as an exhibit thereto. THE ABERDEEN GROUP, INC. By:___________________________ Name: Title: EX-27.1 6 ARTICLE 5 OF FDS FOR 3RD QUARTER OF 10-Q
5 This schedule contains summary financial information extracted from the consolidated balance sheet of Pegasystems Inc. as of September 30, 1996 and the related consolidated statement of income for the nine month period ended September 30, 1996 and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1996 SEP-30-1996 25,419 0 30,733 839 0 39,122 2,451 788 59,728 4,601 0 0 0 264 47,872 59,728 20,956 20,956 5,360 16,442 0 0 85 5,852 2,285 3,567 0 0 0 3,567 .14 .14
EX-99.1 7 VALUATION AND QUALIFYING ACCOUNTS Exhibit 99.1 PEGASYSTEMS INC. Schedule II Valuation and Qualifying Accounts
Additions Charged Balance at to beginning costs Balance at of and end of Description period expenses Deductions period - ------------------------------- ---------- -------- --------- ---------- Year ended December 31, 1995 Allowance for doubtful accounts $ 0 $793,310 $359,423(a) 433,887 Year ended December 31, 1994 Allowance for doubtful accounts 340,041 0 340,041(a) 0 Year ended December 31, 1993 Allowance for doubtful accounts 18,087 325,862 3,908(a) 340,041
(a) Deductions are related to accounts receivable write-offs -----END PRIVACY-ENHANCED MESSAGE-----