Pegasystems (NASDAQ:PEGA) just closed out a fiscal year that was warped by a dramatic shift in its business model. The stampede by the software specialist's clients toward cloud-based and subscription services pressured reported sales and profits. But it also put the company in a good position to generate predictable, growing cash flow in the years to come.

Let's look at the latest quarterly numbers:

 Metric

Q4 2018

Q4 2017

Year-Over-Year Growth (Decline)

Revenue

$256 million

$255 million

1%

Net income

$16 million

$41 million

(60%)

EPS

$0.20

$0.49

(59%)

Data source: Pegasystems' financial filings.

What happened this quarter?

Pegasystems' sales growth was a meager 1% for the quarter, leading to flat results for the full year. Yet judging by management's preferred growth metric, which accounts for the negative impact of clients moving to subscription-based contracts, revenue gains sped up in the year's final months.

A customer service representative at work in front of a computer.

Image source: Getty Images.

Here are a few highlights from the quarter:

  • There were lots of changes among the company's revenue streams despite the roughly steady sales result for the quarter. Cloud-based revenue spiked higher by 66% to $25 million, which helped offset double-digit declines in term licensing contracts.
  • Annual contract value, the metric that management says best expresses Pegasystems' underlying growth pace, accelerated to a 23% increase from 20% in each of the prior two quarters.
  • Gross profit margin held roughly steady and operating margin fell as the company spent more on its sales and marketing infrastructure. Overall, operating income fell to $15 million, or 6% of sales, from $39 million, or 15% of sales, a year ago.
  • Pegasystems paid higher taxes than in the prior-year period, and so its reported net income fell at a steeper 60% rate.
  • Backlog, which includes contracted but not yet charged orders for the next few years, rose to $631 million from $522 million last quarter.

What management had to say

Executives said they were happy with the quick shift in demand toward subscription-based and cloud software services, even though the move hurt sales and earnings. "We had a strong Q4 capping off a terrific year," CEO Alan Trefler said. CFO Ken Stillwell added that "the significant acceleration in the shift to subscription [sales] ... will increase the ongoing predictability of our revenue and cash flow."

Management went into more detail about its operating wins in a conference call with analysts, highlighting the company's double-digit growth in new customer commitments. "We believe we're building a business that can grow profitably as we scale and achieve better visibility to future recurring cash flow," Stillwell said.

Check out all our earnings call transcripts.

Looking forward

Management's outlook for 2019 calls for sales to improve to $965 million from $891 million, an impressive return to solid revenue growth. The company expects to lose money on a GAAP basis, to the tune of about $0.22 per share, versus a $0.13-per-share profit in 2018.

Executives believe the subscription-model shift will pressure 2019 sales and margins, just as it did this past year. For that reason, the company says its key growth metrics for investors to follow will be annual contract value and backlog. Success in both these areas should translate directly into increasing, and more predictable, cash flows. From there, it's an open question as to where Pegasystems' profit margins will eventually settle under the new selling approach.