Progress Software Corp /Ma Q1 FY2022 Earnings Call

Welcome to the Progress Software Corporation Q1 202 Earnings Call. My name is Darryl and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to Michael Micciche. Mike, you may begin.

Okay. Thank you, Darryl. Good afternoon, everyone and thanks for joining us for Progress Software's first quarter fiscal 2022 financial results conference call. With us today is Yogesh Gupta, President and Chief Executive Officer, and Anthony Folger, our Chief Financial Officer. Before we get started, I'd like to remind you that during this call, we will discuss our future financial and operating performance, corporate strategies, product plans, cost initiatives, our acquisition of Kemp, the impact of the COVID-19 pandemic on our business and other information that might be considered forward-looking. This forward-looking information represents Progress Software's outlook and guidance only as of today and is subject to risks and uncertainties. For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular, the section captioned Risk Factors in our most recent Form 10-K. Progress Software assumes no obligation to update the forward-looking statements included in this call, whether as a result of new developments or otherwise. Additionally, on this call, all the financial figures we discuss are non-GAAP measures unless otherwise indicated. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers in our financial results press release, which was issued after the market close today and is also available on our website. This document contains the full details of our financial results for the fiscal first quarter of 2022 and we recommend you reference it for specific details. We also have prepared a presentation that contains supplemental data for our first quarter 2022 results, providing highlights and additional financial metrics. Both the earnings release and this presentation are available in the Investor Relations section of our website at investors.progress.com. Today's conference call will be recorded in its entirety and then will be available via replay on the Investor Relations section of our website. And so, with that, Yogesh, I will now turn it over to you.

Thank you, Mike. Good afternoon, everyone and thank you all for joining us. I'm pleased to be with you today to discuss Progress' first quarter fiscal 2022 earnings. We are extremely happy with our results, which continue to demonstrate the value-creating power of our total growth strategy. We have assembled an impressive product portfolio to develop, deploy, and manage high-impact applications and to help accelerate the digital transformation efforts of organizations. We started off fiscal 2022, continuing the robust momentum from FY 2021, which was our best year ever. We experienced strong demand for our products across the board, and we had outstanding execution across all regions. As you will see from our increased guidance, we expect the positive momentum from last year to continue in fiscal 2022. In fact, excluding the impact of the Russia embargo and the foreign exchange headwinds, our increase in revenue guidance is greater than the beat in our first quarter. More details from Anthony in his remarks. We are now four months into the integration of Kemp, which continues to be on track, and the business is performing very well. We remain confident about the synergies we expect to achieve and the resulting shareholder value this acquisition will create. Before I get into the details of the quarter, I think it's important to take a moment to talk about the situation in Ukraine. We are truly horrified by the humanitarian crisis caused by the Russian invasion. Thankfully, we have no employees in harm's way in the region. Our hearts and best wishes are with the friends and families of our employees, particularly those in Bulgaria and the Czech Republic. And we hope for a quick and peaceful end to the suffering of the people of Ukraine. Many of our employees around the world are directly helping with the refugee crisis in many ways. I couldn't be more proud of our Progress team members for the speed and generosity of their response. And as a company, we recently pledged $100,000 to the World Health Organization emergency appeal for Ukraine. From a business perspective, Progress has stopped doing business in Russia and Belarus in accordance with the U.S. government sanctions. And the impact is not material to our overall results or our longer-term outlook. Turning back to our first quarter results. As you probably have seen already from our press release, we again beat top and bottom line expectations. Revenue of $147.5 million exceeded our guidance of $139 million to $142 million. Earnings per share were equally strong at $0.97 versus guidance of $0.83 to $0.85. Annual recurring revenue and net dollar retention rates improved once more, with ARR up over 12% year-over-year to $479 million. And our net retention rate was again over 100%. The strength we saw in our first quarter was exhibited across products and geographies, driven by one, the impact of the first full quarter of revenue from Kemp. Two, sustained demand from the strong economy and fully funded IT budgets. And three, the ongoing trends towards digital transformation as companies and workers adapt to the new post-COVID paradigms. OpenEdge, once again proved itself as the mainstay of our product revenues, while virtually all of the products in particular DataDirect, Flowmon, Corticon, our File Transfer, and DevTools products contributed to the outperformance. In our OpenEdge ISV partner business, we saw several large deals around the world from a longtime partner QAD in North America, COINS in EMEA and Revolution in Asia-Pacific. Our DevTools business continues to do well with increasing customer accounts, strong retention rates, and increasing average deal sizes, as customers deploy these products more broadly within their organizations. DevOps and DevSecOps remain high priority among customers as they automate the deployment and management of cloud and on-prem infrastructures. And our Chef products continue to be the industry-leading choice to do so. WhatsUp Gold and our most recent additions from Kemp, the Flowmon and LoadMaster offerings present a sought-after set of full-stack observability products that help our customers deliver high-quality application experience. We are very pleased with the way these products have added robust capabilities to our offerings and furthered our goals as we continue to be the trusted provider of the best products to develop, deploy, and manage business applications. We achieved strong operating margins in the first quarter, thanks again to good expense control, the temporary dampening effect of Omicron on travel and return to office at the very end of the year, and the timely and seamless integration of Kemp. We expect that travel budgets and other expenses will not sustain the artificially favorable levels we saw over the last two years, as we again start seeing our customers, partners, and especially our employees face-to-face in the coming months. Closer to home, recent inflationary pressures present some new, but so far manageable challenges. The biggest challenge all companies are seeing is employee recruitment and retention across all geographies. To date, the inflationary impact has been manageable. And while we anticipate seeing more in the coming months, we are prepared to adapt, which includes the potential to raise prices on select products. We expect strong margins to continue to be one of our hallmarks. Turning now to our total growth strategy and our outlook for M&A. M&A is another area where for Progress, the spike in inflation and recent pullback in the capital markets is an advantage. We have mentioned in the past that rising interest rates could put Progress in a more competitive position in the market for deals. Other players are less likely to use leverage as heavily in a higher interest environment. We're seeing some signs of a more promising M&A environment. Infrastructure software companies in our target zone seek alternatives to public market exits or private funding strategies. At the same time, potential competitors who formerly were much more aggressive when money was cheaper are becoming more cautious. As a result, we expect our disciplined approach to bear more fruit in the future. Our radar scope remains dotted with many possible targets, and we are working daily to vet an increasing number of quality acquisition candidates. Progress remains well capitalized due to our strong and predictable cash flows, a sturdy balance sheet, and an ample ability to finance possible transactions. As we announced in January, we refinanced our existing credit facilities in a very favorable way, with over half of our current debt fixed at 1%. Our disciplined model of buying the right kinds of companies at the right price and the right multiple has served us well so far. We believe that doing smart accretive acquisitions has proven to be the best way to deploy our capital to create shareholder value. So, no matter how much the market for deals changes one way or the other, we have no plans to deviate from strict M&A criteria. We also see market pullbacks as an opportunity to buy back stock, as we did in our first fiscal quarter. All-in-all, I'm once again very proud of our results and grateful to the whole Progress team for another outstanding performance. We remain very positive about our outlook, even as we carefully watch the global events. As always, we thank our customers and investors for their continued loyalty. And I personally want to thank the whole Progress team for their commitment and efforts. I will now turn it over to Anthony to provide more detail on our results and guidance.

Thanks Yogesh. Good afternoon, everyone and thanks for joining our call. As Yogesh mentioned, we're very pleased with our Q1 results, which again exceeded the high-end of our guidance range on revenue and earnings per share. We're also pleased with our progress integrating Kemp, which delivered results in line with our expectations in the first full quarter since the acquisition closed. Turning to the numbers. Our revenue for the quarter of $147.5 million was well above the high-end of the guidance range we provided back in January and represents 12% growth on a year-over-year basis. The better than expected performance in the quarter was driven by multiple products, including OpenEdge, Corticon, and DataDirect. Consistent with our growth in revenue, we also saw growth in ARR to close the first quarter with $479 million in ARR to represent 12% growth on a year-over-year basis, and 3.5% growth on a pro forma year-over-year basis. To be clear, the pro forma results include Kemp in both periods. In addition to our strong ARR growth, our net retention rates continued to shrink in the first quarter, once again, exceeding 100%. Before moving on, I'd like to take a moment to highlight the fact that we report ARR in constant currency using our current year, updating exchange rates. And we apply those rates to all periods presented. As a result of updating exchange rates to our 2022 budgeted rates, the ARR reported after periods have changed slightly. However, the changes in alter the trend in ARR growth or the net retention that we've been reporting over the past several quarters. To illustrate this point, we include a slide in the supplemental presentation filed with our press release. Turning now to expenses. Our total cost and operating expenses for the quarter were $88.8 million, up 18% compared to the prior year and right in line with our expectations. The year-over-year increase was driven by the acquisition of Kemp and, to a lesser extent, an expected increase in compensation costs across the rest of our business. Operating income was $58.7 million, up $2 million compared to the prior year quarter. And our operating margin was 40% compared to 43% in the first quarter of 2021. On the bottom line, earnings per share of $0.97 for the quarter represents growth of $0.02 year-over-year and is $0.12 above the high-end of our guidance range. This overperformance relative to our bottom line expectations was driven by our strong top line performance, coupled with good cost management across the business, including Kemp, where our integration is running right on plan. Our outlook for the Kemp integration has not changed, and we expect to recognize all synergies by the end of this fiscal year. Moving on now to a few balance sheet and cash flow metrics. We ended the quarter with cash, cash equivalents, and short-term investments of $173 million and debt of $633 million or a net debt position of $460 million. I'd like to mention that during the first quarter, we amended our credit facility to expand liquidity, lower costs and provide greater flexibility to grow as we execute our total growth strategy. The amended facility provides an aggregate amount of $575 million in capital, including $275 million in senior secured term loans and an untapped $300 million revolving line of credit. This new credit facility replaces our 2019 facility and will mature on January 25th, 2027 subject to certain conditions. DSO for the quarter was 52 days, an improvement of eight days when compared to the fourth quarter of 2021 and an improvement of one day when compared to the first quarter of 2021. Adjusted free cash flow was $45 million for the quarter, a decrease of $2 million compared to the prior year quarter. This decrease in free cash flow was attributable to bonus and commission payments made to our employees in the first quarter of 2022 that were approximately $10 million higher than bonus and commission payments made in the prior year quarter. During the first quarter, we repurchased 551,000 shares of Progress stock at a total cost of $25 million. And at the end of the quarter, we had $130 million remaining under our current share repurchase authorization. I'd also like to mention that in the first quarter we adopted ASU 2020-06, the new convertible debt accounting standard using the modified retrospective method. On our balance sheet, the new standard simplifies the presentation of our convertible notes by increasing their carrying value to be equal to the principal value less any unamortized debt issuance costs. In our income statement, the new standard will have the effect of reducing our GAAP net interest expense, but will have no impact on our reported non-GAAP net interest expense, net income or cash flow from operations. Finally, I'd like to point out that we recently classified land and building assets, totaling $15.3 million as assets held-for-sale in our consolidated balance sheet. This classification reflects an active program to sell corporate office space in Bedford, Massachusetts, which is part of a broader initiative to consolidate office space and provide a more flexible work environment for our employees by supporting a mix of remote and in-office work. We expect the sale of our corporate offices to be complete in the first half of 2022, and expect net proceeds to exceed the carrying value of the assets held-for-sale on our balance sheet. Okay. Now, I'd like to turn to our outlook for Q2 and the full year 2022. For the second quarter of 2022, we expect revenue between $145 million and $148 million, and earnings per share of between $0.94 and $0.96. When considering our outlook for the full year, it's important to note that we continue to see strength in the demand environment for our solutions. As a result, we are increasing our full-year outlook on almost every metric and we expect revenue between $609 million and $617 million, and that's an increase of $3 million from the midpoint of our prior guidance. I'd like to highlight the fact that this $3 million increase to our revenue guidance includes the negative impact of movements in foreign exchange rates and the removal of previously forecasted business activity in Russia, which together totaled approximately $4 million. We expect an operating margin of between 39% and 40%, an increase of 50 basis points from our prior guidance. Adjusted free cash flow between $185 million and $190 million, consistent with our prior guidance; and earnings per share between $4.01 and $4.09, an increase of $0.05 from the midpoint of our prior guidance. Our annual EPS estimate contemplates a tax rate of 20%, approximately 44.5 million shares outstanding, and the impact of $50 million of share purchases we are aiming to complete by the end of 2022. And that's a total of $50 million, not an incremental $50 million. In closing, we're truly excited to deliver strong financial results across the board in the first quarter, a continuation of the trend that we saw from much of 2021. The integration of Kemp is tracking to plan, and we believe we're very well-positioned to deliver strong results for the remainder of 2022. With that, I'd like to open the call for Q&A.

And our first question comes from Ittai Kidron from Oppenheimer. Go ahead with your question.

Thanks. Great quarter, everyone. I wanted to ask about Kemp. It's encouraging to see the progress and that orders are on track. Could you elaborate on how much of the synergies from Kemp are currently more focused on increasing top line growth rather than bottom line? You've reached your 40% margin target, and I'm curious if there's still potential for further margin improvement with Kemp, or if it's more about top line growth from this point forward. If so, could you share the progress you've made in cross-selling Kemp to existing customers or up-selling your existing solutions to Kemp customers?

Ittai, thanks. Let me explain how we've approached acquisitions like Kemp. Our acquisition model focuses on creating shareholder value and does not factor in potential cross-selling opportunities, as we prefer to be conservative in that aspect. When we discuss synergies, we mostly refer to expenses, and we anticipate it will take about 12 months post-acquisition to fully realize the expense synergies. However, a considerable portion of those synergies was already accounted for as we concluded Q1. It's worth noting that the Kemp acquisition occurred just a month before the end of the year, which limited our time to gather the expense synergies in the first quarter. Anthony, did I overlook anything?

I think you're right, Yogesh. We have made significant progress on the integration and capturing synergies. There's still more work to do regarding systems and processes, but as you pointed out, we are on track. We believe we can complete this within the 12-month timeframe we mentioned earlier.

Okay. Maybe as a follow-up. Yogesh, you've talked about how Russia is not a material part of your business, and that's good to hear. But maybe you can talk about Europe as a whole, what percent of revenue does it account for? And there are already data points that show significant deceleration in macroeconomic activity in Germany, and it's starting to kind of move into other adjacent countries. So, I guess, the question is, what have you seen from a pipeline, from a renewal rate specifically in that region? Are there any signs of change in behavior in customers that are based in Europe?

So, Ittai, we currently feel positive about our performance in Europe. We continue to see strong results and are not experiencing the potential impacts that others may be encountering. I cannot comment on other companies. Europe performed really well in the first quarter, and our leaders and team in Europe are optimistic about the remainder of the year. Our business may be somewhat different, and I’m not sure if what we are experiencing applies to everyone else. Anthony, do you know what portion of our business comes from Europe? I know it's in the upper 30s, but I’m not certain of the exact figure.

As we review the entire year of 2022, I believe approximately 34% of our business comes from EMEA. Most of this percentage is from maintenance, which has a strong presence there. We are also seeing a significant number of subscription renewals from that region. Therefore, we generally expect stability in that area, with less reliance on acquiring new customers compared to some other companies.

Got it. And maybe last one for me. You talked about your intention to raise prices, just making sure, Anthony, that nothing in the guide includes that, but can you be a little bit more specific on timing and magnitude? And is it just across the portfolio or specific products or specific regions? Any color on that.

So, I can start and then Anthony can go ahead.

I want to clarify that our outlook does not account for any price increases. We need to analyze this on a regional, product, and sometimes channel basis to determine what is appropriate. There may be situations where contracts are up for renewal, whether for maintenance or subscription, and a price increase could be justified. We're looking into those possibilities. In other areas of our business, it might be more effective to reduce discounting as a way to achieve a price increase, and we are assessing those opportunities as well. Given our extensive product portfolio and various market approaches, it's not a straightforward task where we can just implement a blanket price increase. We will need to be selective and consider price increases carefully based on region, channel, and product type.

Very good. Appreciate it. Thanks.

And our next question from Pinjalim Bora from JP Morgan. Go ahead.

Great. Hey, guys. Thank you for taking the questions, and congrats on the quarter. I wanted to talk about OpenEdge. It seems like it was an outperformer in the quarter. Could you maybe update us on what is the OpenEdge mix at this point in time and what's driving the outperformance, is maintenance, renewals ticking higher? Are you seeing just the secondary variables of some of your ISV partners doing well, seems like?

Yeah. So, Pinjalim, thank you. The biggest driver for the OpenEdge business is and has always been the ISV business, right? So, our ISV partners are the lion share of that business and with them, we have these revenue share models where we get a piece of their business, and over time, they have continued to do well. They have modernized their applications on top of our OpenEdge platform. They have cloud-enabled their products and actually offer cloud offerings folks like QAD do. And so, as their business performs better, we get a piece of that business as well. So, when you look at some of the examples I gave in my prepared remarks, QAD, COINS, Revolution, et cetera, these folks are all seeing interesting increasing opportunities in the market, their businesses are doing well. And as a result of that, we are seeing increasing royalties from them. So, that's the primary driver within the OpenEdge business, Pinjalim.

And just, Pinjalim, I was just going to add to that. I think, thinking about the business for the full year 2022, OpenEdge is right around 40% of our total business. And then that, as you might expect, has come down over the past several years as we've seen a little bit of growth in other product lines. And we've acquired a bunch, the mix really has come down there, but the business nonetheless is very stable, but as a percentage of the whole, it's around 40%.

Got it. Very helpful. And last question for me. Yogesh, I think during the Kemp acquisition, you had highlighted an aspect of leveraging Kemp's go-to-market motion. I think you had said they had kind of a two-tier sales motion, and you were looking to kind of expand that to other parts of Progress' portfolio. What have you learned so far? It's been six, seven months; have you started rolling that out towards some other parts of the business yet?

So, Pinjalim, we spent the first few months primarily making sure that things were on track with the business in the Kemp business itself and making sure that we got our cost synergies in place and so on. We have begun to see what products we can actually place through the two-tier channel. But I think we are early, Pinjalim, to speak to it at this point. So, I would not conclude anything meaningful at this point about us leveraging that channel for other products. There is definitely that opportunity, but we have not made significant progress in that area at this point.

Understood. I'll get back in the queue. Thank you.

Thanks, Pinjalim.

Our next question comes from Tyler Radke from Citi. Go ahead, Tyler.

Yeah. Thanks for taking the question. I wanted to just clarify your comments on some of the challenges you're seeing on the inflation side. Is that just kind of the general observation on the macro environment? Or is this manifesting itself through specific headwinds, either in customer negotiations or on certain costs or payments that you're having to make? Just help expand on that a little bit. Thank you.

Sure. I'll begin, and Anthony can add his thoughts as well. From the customers' standpoint, we aren't seeing any negative effects at all. In fact, we believe there could be some chances for us in this inflationary environment to raise prices with certain clients, depending on when their contracts are up for renewal. That's not where we're facing challenges. The real challenge comes from managing our employees. Retention is an essential issue for software companies and businesses of all sizes right now. Wage pressures are the main challenge we are observing and closely monitoring. However, we feel confident about our current position. We believe this will be manageable, and so far, we are handling it well while staying vigilant. We just wanted to emphasize that this is an area we are closely watching. Anthony, would you like to add anything?

No, I would say that we haven't seen a significant impact in our Q1 numbers from inflation. We have accounted for additional impact for the rest of the year. Even with that, we believe it's a manageable issue right now, but it's definitely something we are monitoring closely.

Great. As a follow-up, the margin performance this quarter and the guidance appear strong. If wage pressure exceeds your expectations, will you be balancing that by cutting other areas of the budget? Also, I have another question regarding the M&A strategy.

Yes, we are committed to maintaining our best-in-class operating margins, which is a core aspect of our business. We will be careful in managing expenses to ensure we support our employees, retain talent, and remain competitive in the market. This is definitely a priority for us.

Okay. Great. Regarding the M&A environment, you mentioned that the declining valuations are making it more favorable. How should we think about this in relation to your M&A strategy, particularly in terms of pace and the types of deals you're pursuing? Will you be opportunistic and possibly look to accelerate your M&A activities in the near term to benefit from the improved environment?

Yes, Tyler, the short answer is yes. Opportunities arise when they do, and we need to facilitate these deals effectively. We definitely have the capacity to take advantage of this from both an operational and financial standpoint. I've always considered what we can manage and integrate efficiently after completing a transaction. Therefore, we are indeed looking to speed up our M&A activities in light of the current market conditions.

Thanks.

Thanks, Tyler.

Our next question comes from Anja Soderstrom from Sidoti. Go ahead.

Hi. Thank you for taking my questions. A lot of my questions have been asked and answered already. But can you just speak a bit to the organic growth you see? It seems like that has picked up a little bit in the past quarters. How did you see that in this quarter? And how do you expect that to play out in the coming quarters?

Thank you, Anja. The business has picked up and is performing well. In this quarter, the primary driver of our outperformance came from organic growth, which accounted for the vast majority of our success. We have a strong confidence in our organic business. Our annual recurring revenue increased by 3.5% year-over-year over the past 12 months, which gives you an idea of our business performance. We are optimistic about our 40% operating margin and have seen consistent organic growth in our annual recurring revenue, achieving a 3.5% increase for two consecutive periods, steadily improving over the last couple of years. We remain confident in our strong business with solid market demand.

Thank you. I also wanted to ask about how you plan to manage inflationary pressures through price increases. What has been your history with price increases?

So, Anja, interestingly enough, there's a part of our business that is royalty-based, and I mentioned this in response to an earlier question as well. When you look at the royalty-based businesses, there really isn't an opportunity to change prices because it's a percentage of their revenue. That only changes if we can introduce more products with that specific ISV partner. However, with everyone else, historically, we haven't raised prices in quite some time. We've actually done well in that regard for our customers. I believe if we identify the right products and opportunities to raise some prices, we wouldn't face any significant resistance. We are considering this, and as Anthony pointed out, we will need to be selective regarding the opportunities, geographies, products, and channels. This isn’t a blanket decision to increase prices by a certain percentage across the board.

Okay. Thank you. That was all for me.

Thank you, Anja.

We have no more questions at this time. I'll turn it back to Yogesh for closing comments.

Well, thank you everyone for joining our call, and we look forward to speaking with all of you again. Thank you.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may all disconnect.