Foolish Forecast: Pegasystems Ready to Ride?

It's been a while since we last checked in on business process management software maker and ex-Motley Fool Hidden Gems recommendation Pegasystems (Nasdaq: PEGA  ) . Back in August, and again in November, the company predicted profits through the end of the year of $0.15 a share -- at most. Tomorrow, we get to learn how close the company came to that high mark. Pegasystems reports Q4 and full-year 2005 earnings after market-close.

Wall Street Wisdom:

• General consensus. Only two analysts follow Pegasystems these days. One says "buy it;" the other says to hold.
• Revenues. Analysts believe that Pegasystems boosted its quarterly revenues 7% year over year, to $28.1 million.
• Earnings. Profits, in contrast, are believed to have fallen 38% to $0.05 per share. If correct, that will bring the company to $0.10 for the year -- well above the low range of its guidance at $0.03, but far short of the $0.15 at the top.

Margin watch:
Long after the firm has ceased to be able to blame its subpar operating performance on its parting of ways with First Data (NYSE: FDC  ) , Pegasystems' gross and operating margins continue to contract. Net margins consistently come out looking better than operating margins because the firm depends heavily on interest income from its cash hoard to save the day. Over the past 18 months, Pegasystems has earned $5.7 million from its business -- and $7.7 million from interest on its cash.

Margins %	6/04	9/04	12/04	3/05	6/05	9/05
Gross	72	71.9	72.5	71.5	69.3	68.1
Op.	8.6	4.7	6	4.1	0.8	2.8
Net	11.2	8.7	7.8	6.1	4.3	4.7

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

Foolish forensics:
As lousy as Pegasystems' GAAP numbers look, however, they don't necessarily tell the whole picture. Behind the scenes, the company has already generated $16.7 million in free cash flow year to date -- nine times its reported profits. If the analysts are right and Pegasystems earns a dime per share for the year, that will bring its accounting profits up only to $3.6 million. In contrast, if free cash keeps flowing at its current rate, the company could generate as much as $22.3 million in cash profits. Pegasystems' business is more profitable than it appears. Keep an eye on free cash flow tomorrow, but don't send this horse to the glue factory just yet.

Fool contributorRich Smithdoes not own shares of either company named above.