Pegasystems Sales Shrink Following an Accounting Shift

Pegasystems (NASDAQ: PEGA) announced first-quarter results this week that paired a significant slowdown in sales growth with plummeting earnings. The declines were driven by a shift toward cloud-based revenue that had a more pronounced impact on the books because of the implementation of new accounting rules.

But the software specialist's management team was quick to point out that the business met its expectations and kept Pegasystems on track to reach its 2018 objectives.

More on that steady outlook in a moment. First, here's how the headline results stacked up against the prior year:

What happened this quarter?

Sales fell 8% to mark a dramatic shift from last quarter's 20% increase. But the drop was mainly due to an accounting shift, and Pegasystems' core sales growth was right in line with management's expectations.

Here are the operating and financial highlights from the quarter:

  • Revenue tied to both the term- and perpetual-license segments fell sharply thanks to two main drivers. First, new accounting standards led Pegasystems to recognize a large sale in the prior-year period that lifted those results by $35 million. And second, customers continued to migrate toward its cloud-based services, which reduces reported sales in the short term.
  • Annual contract value, the metric that executives believe best expresses Pegasystems' growth pace, rose 15% thanks to a 22% spike in cloud services and a 10% increase in maintenance revenue.
  • Overall gross profit margin fell to 68% of sales from 75% a year ago, but improved in the cloud business.
  • Cash flow surged to a record $56 million to mark a 72% improvement over the prior year. The strong operating cash flow was a consequence of the continued shift toward recurring revenue contracts.

What management had to say

Executives focused their comments on Pegasystems' move toward subscription-based contracts and the positive impact it is having on the business. "We're pleased to see our clients embracing our strategic shift to more recurring arrangements," CEO Alan Trefler said in a press release.

CFO Ken Stillwell added: "We are excited to see our term and cloud [annual contract value] grow 22%, year over year. We have discussed the importance of [annual contract value] as our most relevant performance metric of the growth and predictability of the future cash flows of our business, especially under the new revenue standard."

In a conference call with analysts, executives stressed that the sales results aren't nearly as weak as the headline numbers would suggest. "While our quarter-to-quarter comparison looks down relative to the recast Q1 2017 number," Trefler explained, "the first quarter 2018 actually represents about 25% of our revenue target for 2018."

Looking forward

Management had targeted sales growth of roughly 13% in 2018, but that forecast came before the latest accounting change. These new revenue recognition standards might help, or hurt, short-term results in a given quarter. Thus, investors can expect even more volatility as Pegasystems continues to migrate its customers over to a recurring-revenue billing approach.

Metrics such as annual contract value and operating cash flow, meanwhile, are now a bit more useful for investors to judge the strength of this business than are reported sales and gross profit figures.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool recommends Pegasystems. The Motley Fool has a disclosure policy.