Three months ago, I suggested that software maker Pegasystems (NASDAQ:PEGA) might finally be on the mend. I based that suggestion on the enticing gap (a chasm, really) between the company's reported earnings under generally accepted accounting principles and its true year-to-date cash generation -- its free cash flow.

Back in Q1, Pegasystems had racked up less than $100,000 worth of profits under GAAP -- but $11.6 million worth of free cash flow. With the books on Q2 now closed, Pegasystems reports more of the same. Six months into fiscal 2005, the company now has just $429,000 in profits to its name -- but has generated over $15.2 million in free cash flow. Nice.

It's also heartening to note that Pegasystems has become more conservative about projecting its future fortunes. Like a curious foal shocked one time too many by the wire surrounding its paddock, Pegasystems is shying away from a field of promises that it might not be able to keep.

For example, last quarter I highlighted Pegasystems' prediction that it would generate $12 million to $20 million in cash from operations. I observed that it might well do that -- especially considering that the company had already hit the low end of that target.

Pegasystems' pattern of cautious forecasting continued this quarter. The company raised its estimate for fiscal 2005 cash from operations to $16-22 million, but again, it's already got the low end of $16 million tucked under its saddle girth. With six more months to work with and not much need for capital expenditures, there can be little doubt that Pegasystems will more than fulfill its promise of cash generation.

Meanwhile, on the GAAP front, Pegasystems faces a tough row to plow. The most recent quarter shows part of the company's problem: Revenues continued to decline both sequentially and year over year. What's worse, the share of the company's revenue earned from profitable licensing fees also declined sequentially and year over year, while the proportion of less profitable "services" revenue climbed -- a trend that Pegasystems' CFO warned would continue throughout the rest of 2005. Put it all together, and the company expects fiscal 2005 to culminate in per-share earnings of $0.15 at most.

Track this company's flight in progress:

Fool contributor Rich Smith has no position, short or long, in Pegasystems.