Pegasystems Posts a Loss as Its Shift Toward the Cloud Accelerates

Pegasystems (PEGA 1.96%) investors have seen more-volatile earnings results from the software specialist lately thanks to its shift toward a cloud and subscription services selling model. The swings have become even more pronounced after a recent change in the way the company accounts for its revenue.

Yet, through the volatility, Pegasystems has made steady progress growing its customer base, and those bigger-picture trends held up in the most recent quarter, which was reported this week.

Let's take a closer look at the latest numbers:

Data source: Pegasystems.

What happened this quarter?

Revenue rose slightly thanks to a spike in demand for term licenses, whose sales are recognized over time rather than in a single up-front transaction. Higher costs, meanwhile, powered a modest loss in the period.

Image source: Getty Images.

Here are operating and financial highlights from the quarter: 

• Revenue growth returned, expanding 5% compared to an 8% decline in the prior quarter. The top line continues to be held back by the customer shift toward term-based licenses.
• Annual contract value, the metric executives believe best expresses Pegasystems' growth pace, saw a 20% increase. This growth was comprised of a 31% gain in the term- and cloud-based licenses, along with 11% higher maintenance sales.
• Gross profit was $123 million, or 62.4% of sales, compared to $119 million, or 63.8% of sales, a year ago.
• Sales and marketing expenses jumped, and that increase was the main reason Pegasystems posted a net loss during the period, compared to a slight profit a year ago.
• Operating cash flow dipped to $75 million from $86 million.
• Backlog, which represents sales that are contracted but not yet billed, was $477 million.

What management had to say

Executives celebrated the fact that customers are embracing the new sales offerings.

In a press release, CEO Alan Trefler said, "We're pleased to see the acceleration in our clients' move to the cloud and more recurring arrangements, which is a positive long-term trend for our business."

Management stressed annual contract value (ACV) as a more reliable demand indicator as "a natural consequence" of the business shift, CFO Ken Stillwell said, "is a reduction in reported revenue growth for the period."

ACV rose 20% this quarter to push cloud services up above 50% of sales for the first time. "I am very pleased to see our movement into recurring and cloud happen even faster than we anticipated," Stillwell said.

Looking forward

Management believes that over time, the business transition will generate higher profitability and more-predictable revenue streams. Still, the move is happening quicker than expected, with cloud services accounting for 50% of the business so far this year, compared to the 30% that executives had modeled.

That trend, and accounting changes that resulted in a temporary $35 million reduction in sales last quarter, are making reported revenue, which is down 2% in the last six months, a poor indicator of underlying growth. Instead, Pegasystems is highlighting the ACV metric, since it better correlates with cash flow potential during the business shift from one-time, perpetual licenses to a subscription-centered sales model.