Investors have been looking forward to the point when Pegasystems' (NASDAQ:PEGA) transformation into a cloud-based provider would begin to deliver steady sales growth and sustainable profits. That didn't happen in 2018, as the software giant undershot management's revenue targets because customers transitioned to subscription contracts at a faster pace than executives had planned.

This week, Pegasystems revealed continued robust demand for its cloud services, and the net impact was to limit sales growth and put further pressure on net income in the fiscal second quarter. Let's take a closer look at the latest metrics.

 Metric

Q2 2019

Q2 2018

Change

Revenue

$206 million

$197 million

4%

Net income (loss)

($32 million)

($10 million)

N/A

Earnings (loss) per share

($0.41)

($0.13)

N/A

Data source: Pegasystems' financial filings. N/A = not applicable.

What happened this quarter?

Pegasystems' sales rose to mark a rebound from the prior-quarter's decline. Losses widened, meanwhile, as expense growth far outpaced revenue gains.

A customer service representative talks on a headset.

Image source: Getty Images.

Here are a few highlights from the quarter

  • Revenue increased 4% compared to a 10% decline last quarter. That growth was powered by sharp increases in its cloud and subscription-based contracts that was almost completely offset by declines in term license sales. Pegasystems has been shifting away from the license-selling model in favor of subscriptions, and the move hurts short-term sales and profits by extending their recognition over a longer period.
  • Annual contract value (ACV) is the metric that management says best captures Pegasystems' growth rate during this transition in its selling model. That figure rose 21% after accounting for currency exchange-rate shifts, or about equal to its expansion rate over the last few quarters.
  • Gross profit margin held steady at 62.5% of sales, but operating expenses shot up to $181 million (or 87% of sales) from $146 million (or 74% of sales) last year. That shift was the main factor behind Pegasystems' move to a $32 million loss, compared to a $10 million loss in the prior-year period.
  • Backlog, or the value of reserved contracts that have yet to be booked, rose 45%, indicating healthy demand over the next few quarters.

What management had to say

Executives said the company was building momentum in its bid to capture market share in a quickly growing industry. "I'm pleased with how our strategy is working," CEO Alan Trefler said in a press release, "and we continue to gain traction in seizing the huge opportunity in front of us."

Management highlighted spiking demand for subscription sales, especially in its cloud business. "Pega Cloud ACV increased 65%, reaching $136 million," said CFO Ken Stillwell. "This strong growth reflects solid demand worldwide for digital-transformation solutions.

Looking forward

With reported sales down 3% over the last six months, Pegasystems remains on pace to notch modest growth for the full year, though its underlying ACV gains will be closer to 20%. From there, the negative impact of the shift toward subscription services should begin lessening through 2020 since this payment model accounts for over half of the company's revenue today.

As a result, investors will have a much better idea of the levels of sales growth and profitability they can expect from the software specialist beginning next year.