Progress Software Corp /Ma Q2 FY2022 Earnings Call

Welcome to the Progress Software Corporation Q2 2022 Earnings Call. My name is Darryl, and I will 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 Mike Micciche. Mike, you may begin.

Okay. Thanks, Darryl. Nice to have you back with us this quarter. Good afternoon, everybody, and thanks for joining us for Progress Software's second 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 outlook for future financial and operating performance, corporate strategies, product plans, cost initiatives, our acquisition of Kemp, the impact on our business of the COVID-19 pandemic, and the sanctions against Russia 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 and 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 second quarter of 2022, and I recommend you reference it for specific details. We also have prepared a presentation that contains supplemental data for our second 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 is being recorded in its entirety and will be available via replay on the Investor Relations section of our website. With that out of the way, I'll now turn it over to Yogesh.

Thank you, Mike. Good afternoon, everyone, and thank you for joining our second quarter 2022 earnings conference call. I'm extremely pleased to share with you the details of another great quarter for Progress, where we again exceeded expectations across the board. Our results were driven by our Total Growth Strategy, which layers accretive M&A upon a highly profitable and predictable business, with strong recurring revenues and very high retention rates. Our disciplined execution of this strategy over the past several years has resulted in the consistent performance that is delivering meaningful returns to our shareholders. Against a challenging macro backdrop, our second quarter performance was strong and our outlook for the remainder of fiscal '22 and beyond remains healthy. A very important aspect of our business is its predictability and stability during times of economic turbulence. Demand for our product remains steady and positive as Progress products are mission-critical for most of our customers. Even when post-COVID demand helped to deliver upside to our guidance in the recent quarters, the reliable recurring revenues from our large installed base of global customers still form the foundation of our business. This, combined with the mission-critical nature of our products, leads to a high-visibility business model and provides a natural hedge against uncertainties that may impact the budgets of other types of projects. The results of our second quarter speak to this strength. Revenues and earnings again finished above expectations and exceeded the top end of our guidance, thanks to the continuation of strong sales performance and the stickiness of our products. Total revenues during the quarter grew 19% year-over-year at constant currency. And operating margins came in at 41%, driven by the strong execution of our total growth model and healthy expense management. Annual recurring revenues continue to grow, up 13% on an as-reported basis and 3.5% year-over-year on a pro forma basis to $486 million. Net retention rate was again over 100%, coming in at 100.9%, and continues to be a key driver for the business overall. Free cash flow was also ahead of plan, and our balance sheet continues to strengthen. The develop, deploy, and manage software ecosystem we serve is vital to our customers, especially as they scrutinize their investments in new projects and other technologies. So it is increasingly important for Progress to continue innovating our products and remain relevant to our customers. As an example, we recently launched a new Progress Chef cloud security product, designed to help organizations around the world ensure that their native cloud, multi-cloud, and hybrid environments are safe and secure. This product builds on our commitment to deliver a unified and scalable platform that enables our clients to accelerate the delivery of secure and compliant application releases in any kind of environment. We also launched MOVEit 2022, with advanced capabilities to further secure and simplify the movement of mission-critical data across cloud and on-prem infrastructures. And we delivered Telerik UI for .NET MAUI on the same day that Microsoft made the .NET MAUI framework generally available. The impact of our ongoing drive to invest in our products and in customer support and success efforts is reflected in our retention rates and increasing recurring revenues. While we remain judicious with our investments in these line item costs, we invest where needed because we know that it is much more expensive to replace a customer than it is to retain one. Let's talk a bit about inflation. First, inflation has created an opportunity to increase effective prices wherever possible. A significant portion of Progress’s revenue comes from over 1,700 ISVs, who embed our products in their offerings and have either revenue sharing or some form of royalty arrangements with us. As many of these companies raise the prices of their products, we indirectly benefit. We also have a variety of contract agreements with our large numbers of customers and partners, which results in a variety of methods by which we pursue price increases. For example, in some cases, we may increase price at the time of renewal. And in other cases, a price increase may take the form of reduced discounts. We successfully began to implement this way we can and we continue to look for more opportunities. On the expense side, the labor market remains tight. Experienced personnel are harder to find and command a higher premium. We believe that it's significantly better for our business and less expensive to keep good employees instead of recruiting and training new ones. So we focus our energies on employee retention. We continue to be rewarded by a turnover rate, which has averaged about 1% per month over the past 12 months. This is well below the norm of 2% or more among many tech companies and we are proud of it. We are also proud of our amazing employee engagement, which is a key driver of strong retention and is demonstrated by the positive results of our broad employee surveys. Further, Progress has won 10 third-party awards for employee engagement and corporate social responsibility in the first 6 months of this year alone. Just last week, Progress was once again honored by the Boston Business Journal as one of the top 5 companies to work for in the Boston area, making this our second consecutive year of being included on this list. We were also selected by Forbes as one of America's Best Midsize Employers of 2022 for the second year in a row, and by Inc. Magazine for its 2022 Best Workplaces list. Further, we took home our second consecutive CV for achievements in diversity and inclusion and our third Executive International CSR Excellence Award. And we recently announced the winners of this year's Progress Women in STEM Scholarships, which went to 4 outstanding young ladies in Bulgaria, India, and the U.S. I'm incredibly proud of these awards and the work it took to achieve them, and I'm very grateful to the whole Progress team for their ongoing contributions to the success of our company. Before moving on to the impact of the changing macro environment on our M&A efforts, let me share that the integration of our latest acquisition, Kemp, which closed last October, is going well. Recall that Kemp acquired Flowmon in late 2020 and kept the two businesses largely separate. So our Kemp integration has essentially been two simultaneous integrations. And I'm happy to report that we've overcome some unique challenges with no major issues or setbacks. The integration is progressing according to plan, and we remain on track to complete it over the next several months. And our optimism continues to grow regarding M&A, the most significant driver of our Total Growth Strategy. Progress remains well positioned, both from a financial and strategic perspective. We're well capitalized with the vast majority of our current financing facilities fixed at very low rates. Our balance sheet continues to strengthen. Our base of recurring revenues is stable and growing. And our outlook for free cash flow is favorable. All this, combined with our prior successes integrating acquired companies, equips us well to remain active in the M&A market as an acquirer of choice. Further, as we shop for the right kind of infrastructure software businesses, we're seeing early signs of a shift towards a more buyer-friendly environment. The IPO window appears to be closed for now. Funding is getting more scarce and higher interest rates may negatively impact the ability of many of our competitors to leverage up. All of these factors will give us the ability to focus on acquisitions that meet our disciplined framework for financial returns, product compatibility, and overall fit. So we're happy to remain patient and be very selective in where and how we choose to allocate our capital. The strength of our capital allocation policy is that it is multifaceted, and we continually evaluate options to select those we believe will generate the highest return for our shareholders. I'm happy to say that compared to the broader market, Progress stock has done well. So we've had relatively few occasions to buy back shares opportunistically amid dramatic market turmoil. Even so, we bought back $26.5 million of our shares in the second quarter, and we'll continue to repurchase shares whenever buybacks produce compelling returns. In all, our second quarter was another solid one, and I'm very pleased with the results. I'm also optimistic about our outlook for the rest of 2022. Q3 is off to a good start, and despite a tumultuous market and an economy with increasing macro risks, I am confident that Progress is well positioned to deliver stable and predictable results. With that, I'll turn it over to Anthony to provide details on the numbers for Q2 and the forward outlook.

Thanks, Yogesh. Thanks, Mike. Good afternoon, everyone, and thanks for joining our call. As Yogesh mentioned, Q2 was another great quarter for Progress and our results reflect strong execution across our product portfolio, coupled with a strong and stable demand environment. Total revenue for the second quarter was $151 million or 17% growth over the year-ago quarter and was approximately $3 million above the high end of the guidance range we provided back in March. In constant currency, our second quarter revenue exceeded $154 million or 19% growth on a year-over-year basis. The addition of Kemp is the biggest contributor to our year-over-year growth. However, many of our other product lines also contributed to growth, most notably our DataDirect and DevTools products. In addition, we closed the second quarter with approximately $486 million in annualized recurring revenue, representing 13% growth on a constant currency basis and 3.5% growth on a pro forma constant currency basis. Consistent with prior quarters, our growth in ARR was driven by virtually all products in our portfolio, led by OpenEdge, DevTools, Sitefinity, and DataDirect. As we've mentioned many times before, the mission-critical nature of the applications we power and our consistent focus on improving the customer experience have resulted in a very stable and durable top line. At the end of Q2, our trailing 12-month net retention rate was approximately 101%, with improvements and strength evident across our entire product portfolio. Turning now to expenses. Our total costs and operating expenses were $89.6 million for the quarter, an increase of $10.1 million compared to Q2 of 2021. Virtually all of this year-over-year spend increase is driven by the addition of Kemp to our business. Operating income was $61.3 million for the quarter, up approximately 23% compared to Q2 of 2021. And our operating margin was approximately 41% compared to 38% in the year-ago quarter. On the bottom line, our earnings per share of $1.04 for the quarter was $0.08 above the high end of our guidance range and approximately 27% above our earnings per share of $0.82 in the year-ago quarter. Moving on to a few balance sheet and cash flow metrics. We ended the quarter with cash and short-term investments of $226 million. And having restructured our credit facilities during Q1, we also have approximately $300 million in untapped capacity under our revolving line of credit for total liquidity of approximately $526 million. Our DSO for the quarter was 39 days, an improvement of 5 days compared to Q2 of last year. Adjusted free cash flow was $68 million for the quarter, up $13 million or 23% from Q2 of last year. The increase in free cash flow was driven primarily from increased profitability and improved collections in the quarter. In the second quarter, we repurchased $26.5 million of stock and at the end of Q2, had $104 million remaining under our share repurchase authorization. I would now like to turn to our outlook for the full year and Q3. For the full year, we are maintaining our revenue guidance to be between $609 million and $617 million, and I'd like to highlight a few points about our annual revenue guide. First, it includes the negative impact of exchange rates on a year-over-year basis of approximately $12 million, with approximately $6 million of that negative impact spread across Q3 and Q4. Next, it does not assume any increase to revenue associated with the price increases that Yogesh mentioned earlier. Finally, as mentioned on our last call, our full year revenue guidance excludes $2 million to $3 million in revenue associated with previously forecasted business activity in Russia. I call out these points because they highlight the considerable strength of our business in light of the challenging macro environment that Yogesh referred to. Moving on, we expect an operating margin of between 39% and 40%, consistent with our prior guidance. We are projecting adjusted free cash flow between $185 million and $190 million, consistent with our prior guidance and we are increasing our guidance for earnings per share to be between $4.05 and $4.11. Our annual EPS estimate contemplates a tax rate of 20% to 21% and approximately 44.5 million shares outstanding, and does not assume any additional share repurchases in 2022. Turning now to our third quarter guidance, I'd like to start by reminding everyone that in the third quarter of 2021, we exceeded the midpoint of our revenue guidance by $22 million and a significant portion of this overperformance was the result of timing, specifically revenue shifting from Q4 into Q3. There was also increased contract durations in that $22 million overperformance. I would encourage everyone to review our Q3 2021 earnings materials when making year-over-year comparisons. With that, for the third quarter, we expect revenue between $147 million and $150 million and earnings per share of between $0.96 and $0.98. In closing, we are thrilled with our Q2 results and the execution across our business that drove those results. We are well positioned for the balance of 2022 and feel we're even better positioned to continue executing our Total Growth Strategy.

Congratulations on a strong quarter. You mentioned that the third quarter was a tough comparison to last year. Was there some revenue pulled into the second quarter from the third quarter? Could you elaborate on the revenue dynamics for this quarter?

No. So we...

Yes. Go ahead, Anthony.

No, I was just going to say, Anja, no, there was no pull-in from Q3 into Q2. I think we had solid performance across multiple products in the quarter. But I don't think there was anything specific to timing that we called out, but you Yogesh, I'll let you add to that.

Yes. No, I was going to say exactly to Anja. And really, the timing happened last year, not this year. So this year, we have had a very steady business and no timing shift.

And in terms of the M&A activity, what do you see there in terms of the valuations? And also, who do you compete against? You said you're the acquirer of choice with many of your targets. But who do you compete against mostly these days?

Yes. Anja, your question has two parts. First, regarding the current environment, public markets have undergone significant changes in valuation metrics, and we are starting to observe similar shifts in private markets. It's worth noting that in the first six months of this year, our M&A activity has been busier than in any previous six-month period. There is a lot of activity happening, and we are being very disciplined in our approach. We want to ensure that we identify the right assets and make appropriate investments that will provide the returns our shareholders expect. As for the competitive landscape, we often find ourselves competing against private equity-owned businesses, which are frequently also strategic players, but primarily it’s the private equity firms that are involved in these transactions on the opposite side.

And one last one. Given the ongoing economic climate, are you starting to see any change in behavior among your customers in your conversations with them? Or...

Interestingly, we remain confident. Our customers continue to invest in our businesses and the products we provide. Most of our revenue comes from recurring sources and customer retention, which gives us a strong foundation and allows us to feel optimistic about how this year is shaping up. We have not seen any significant changes from our customers recently. While the surge in demand from COVID has subsided since last year, there are no notable differences in this quarter compared to the previous ones.

You made some comments during your prepared remarks that you're seeing some customers pull back on other spending categories. I was wondering if you could elaborate on what those categories are and where you see customers kind of making the biggest cutbacks to spending?

Tyler, we may not be able to speak about other companies as much as we can about ours. From our perspective, most of our customers are currently concentrating on cost control measures. There is a strong emphasis on ensuring that technologies can assist in reducing costs or are areas where they are willing to maintain spending. Our Progress products are designed with this in mind, whether it's about enhancing developer productivity, creating exceptional digital experiences, or managing and deploying these experiences in both cloud and on-premises environments. Our focus is on promoting efficiency, effectiveness, and security. We are observing continued demand. However, there seems to be some hesitation in the customer base regarding new projects that may have been planned, particularly those linked to improving top-line growth. Our primary role is to help drive expense control and enhance organizational efficiency, which is why our products continue to perform well.

Great. And just a follow-up on the price increase commentary. Could you help quantify what percent of your business has seen price increases? And just give us a sense on maybe the blended ASP increase that you've seen?

Yes. So, Tyler, absolutely. So first of all, about 60% of our business is indirect, right? Whether it is to the ISVs or whether it is through the channel, the two-tier channel, right? So there, there isn't a direct increase that we can affect because we basically have relationships with these, which are, as I said, with ISVs around royalties or revenue sharing or with even the two-tier model, where there's a price that they basically get a discount from us and then they basically charge something different to their customers. And that's really not in our hand. So really, what we have is about 40% of our business is really possibly where we can affect change. The other interesting thing to realize is that those changes only happen when there is a contract that comes up. So, when the renewals come up and in many of our products, we have 3-year contracts. So, it isn't something that happens instantly, Tyler. It is something that we will see the benefit of over time, which is why we have not included that in our guidance for the remainder of 2022. Usually, the price increases are rather modest. They might be 3% to 5% a year. But again, as I said, because a small percentage of them get touched every year, and it's a small percent of a 40% pool to begin with. The impact is not that significant.

This is Pinjalim. Thanks for taking the questions and congrats on the quarter. Yogesh, I want to ask you a high-level question. When I was looking back at Progress Software in 2008, 2009, how it did, I know the business has changed a lot. Is there a way to help kind of compare the business today versus during the Great Financial Crisis? And how resilient do you expect the core organic business to be going into any potential macro slowdown next year or in the future?

Absolutely, I can provide a high-level overview. I wasn't here 15 years ago, but back then, the Progress products were nearing the end of their life cycle in terms of market relevance. While they still served existing customers, their broader market relevance had significantly declined. Today, that's not the case. Over the past three years, particularly with our acquisitions and our investments over the last five years, we have cloud-enabled our products. We've acquired offerings like Chef that are highly relevant in the modern cloud DevOps landscape for deployment, configuration management, and secure infrastructure scalability. Our acquisitions of Ipswitch and Kemp enhance our capabilities in observability, high availability, and performance, ensuring our infrastructure remains robust and resilient. These offerings are not only relevant on-premises but also in the cloud. Presently, this business segment is approaching 40% of our overall operations. While we still have a legacy business, it has strengthened significantly, and our retention rates have improved, reaching 101%, a level we did not have back in 2008 or 2007, as far as I can recall. So, I believe we are in a very different position now, and I feel confident about our business. For instance, in March 2020, we were the first enterprise software company to announce results shortly after the pandemic began, predicting a 3% impact, but we only experienced a 1.5% impact. That 3% was a carefully considered estimate, not just a random guess. Since then, we've acquired Kemp, which has made us a stronger business overall. So, I remain confident about our future.

One for Anthony. The guidance for Q3 seems to suggest like an air pocket in Q3 and a big ramp in Q4. I understand what you're saying with respect to a year ago, maybe consensus got it wrong, but is that it? Are you baking in some extra level of conservatism as well, given where the environment is at today? Are you baking in some kind of an acquisition in Q4? Help us understand kind of unpack it a little bit.

Yes, that's a great question, and thank you for it. I would say that we're not really being overly conservative in our guidance. If you look at the various factors on a year-over-year basis, such as the impact of foreign exchange and considering the addition of Kemp, it seems to us that Q3 is steady and strong compared to Q3 of last year, which was somewhat unusual. When you take into account foreign exchange and normalize for those elements, our annual guidance has actually improved from Q1 to Q2. While foreign exchange is affecting our guidance, we have provided constant currency numbers and noted a $12 million foreign exchange headwind year-over-year. Observing the trends from one quarter to the next, it's clear that foreign exchange has consistently impacted the increase in our guidance. Despite these macro challenges, we have managed to maintain our guidance range for the year, which we believe demonstrates the resilience of the business. There's a lot to discuss here, but overall, we feel very optimistic about our outlook.

Should we move on to the next question?

Yes, please.

I wanted to ask about new customer acquisitions. Is OpenEdge still the main driver, or are other parts of the portfolio becoming more significant in attracting new customers?

So, definitely, we are seeing much more new customer adds on products like Chef, the Kemp products, the Ipswitch products such as MOVEit and WhatsUp Gold. OpenEdge itself doesn't land new customers directly for us. What it does land is the ISVs that use our products, use OpenEdge, and they have built their applications on top of OpenEdge. They go out and land additional customers for their offerings, those business applications. And so we indirectly benefit from that. But really, for us, the way we go out and win new customers ourselves, it's primarily around the DevTools business, the Chef business, the MOVEit and WhatsUp Gold businesses that we acquired from Ipswitch and the Kemp products, Loadmaster, and Flowmon.

Got it. And then just on Kemp, I know you said that most of the integration so far has still really been on the cost side, but have you begun to see any cross-selling materialize between Kemp and maybe WhatsUp Gold or any other parts of the portfolio?

So, that's another good question. When we model these acquisitions, we do not include any cross-sell synergies in those. We believe that those are not always realizable. And we know that we can realize the expense one, so we focus on the expense synergies. It's been the first 6 months. I think it's really still early. We are beginning to see a little bit, but not in any meaningful way of cross-sell between products like WhatsUp Gold and Kemp, like Flowmon. Really Flowmon is the main product that would go well with WhatsUp Gold. But I think as I said, it's rather early.

And we have no more questions at this time. I'll pass it back to the speakers for closing comments.

Thank you, Darryl. Thank you all for joining our call today. I look forward to speaking with you soon. Thanks again, and goodbye.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.