Progress Software Corp (PRGS) Q2 2023 Earnings Call Transcript

Good day and welcome to the Progress Software Corporation Q2 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker Mr. Mike Micciche, Vice President of Investor Relations. Please go ahead.

Thank you, Mike, and good afternoon, everyone. Welcome to our second quarter 2023 earnings conference call. As you saw in our press release, Progress had a strong quarter with earnings, revenues, and operating margins all exceeding estimates. Consequently, we have raised our full year 2023 outlook, which Anthony will detail shortly. In the quarter, revenues increased 19% year-over-year to $179 million, driven by robust demand for our products and excellent performance from our teams in the field. Our customers and partners remain dedicated to using Progress products to support their businesses, particularly during these challenging economic times. We are committed to providing them with exceptional value and ensuring their success. Earnings per share reached $1.06, significantly surpassing estimates due to strong top-line revenue and effective execution on the MarkLogic integration alongside careful expense management by all our teams. Operating margins exceeded targets, finishing the quarter at 38%, compared to a consensus of approximately 35%. ARR grew in the second quarter to $569 million, representing a 19% year-over-year increase, driven by the MarkLogic acquisition and a net retention rate exceeding 101%. These impressive results were achieved across nearly all product lines and regions, with significant contributions from MarkLogic. Our product portfolio demonstrated broad strength this quarter, particularly in OpenEdge, Loadmaster, Chef, Sitefinity Cloud, and MarkLogic offerings. The growth in OpenEdge stemmed from customer win-backs and their need to modernize applications, reaffirming the platform's value for mission-critical applications moving forward. Loadmaster, acquired through Kemp, continues to win new customers via the Dell Channel, enhancing Dell's cloud storage offerings. We also witnessed new customer acquisitions and expansions within our Chef product line, as customers experienced greater benefits from our DevOps and DevSecOps solutions. Sitefinity Cloud continues to grow as customers in various industries appreciate its ease of use, improved engagement, and marketing effectiveness. There were new customer wins and expansions among existing Sitefinity Cloud customers. Our MarkLogic business also showed strength as we engaged customers and shared our vision. As you know, the MarkLogic acquisition closed on February 7th, just weeks before the end of our fiscal first quarter. Since then, we have welcomed our MarkLogic colleagues, connected with customers globally, and made significant progress on integrating all aspects of the company into Progress. As with every acquisition, we’ve gained valuable insights, and our integration playbook keeps us on track as we merge the two companies. We expect to achieve all our synergy targets by the end of this fiscal year. MarkLogic's financial contribution has been strong in FY23, significantly impacting our ARR in the most recent quarter. As noted in our Q1 earnings call, the full-year revenue contribution from MarkLogic will become evident next year in fiscal 2024. In summary, we are very pleased with the continued strong performance of our field operations and the integration of MarkLogic. We are excited to reflect these excellent Q2 results in our updated guidance for the remainder of the year. Alongside our strong financial results and the progress made with MarkLogic in Q2, we also hosted our first Investor Day in seven years in early April. During my session, I provided an overview of the company and highlighted successes from our total growth strategy. I discussed our long-term plan to create shareholder value and shared insights on our products, employees, customers, and culture. Anthony provided a comprehensive financial review with details on our longer-term model, followed by our Head of Corporate Development, Jeremy Segal, who covered our M&A and integration strategies, detailing everything from deal sourcing to our integration methodology. If you haven't seen it, the webcast and slide decks are available on the Investor Relations section of our website. The key theme in all our discussions has been our commitment to our total growth strategy, which includes: investing in our products, systems, and processes to maintain relevance and operational efficiency; acquiring and integrating strong businesses that enhance our capabilities and create sustained shareholder value; and maintaining an unwavering focus on customer success to drive excellent retention rates. This approach is supported by a prudent capital allocation strategy aimed at maximizing shareholder returns. Our acquisition model is disciplined and straightforward. We seek solid infrastructure companies with complementary technology, the right size and scale, a robust customer base, strong recurring revenues, high retention rates, and achievable synergies to ensure our return on invested capital exceeds our WACC. We acquire at reasonable prices, improve customer retention, and maximize cash flows and margins to deliver sustained shareholder value. We have consistently demonstrated our ability to execute M&A following this disciplined approach, and we plan to continue doing so. From a broader M&A perspective, we maintain our belief that the market is shifting in our favor. We believe this remains true as capital becomes scarcer in the private market, and the unfavorable economic cycle persists in the coming years, prompting more attractive companies to seek exit strategies or alternatives to going public. Jeremy and his team are actively exploring potential targets, with many opportunities available as competitive dynamics favor us. Additionally, we have been institutionalizing the learning process that accompanies acquiring and integrating companies, allowing us to build on our successes with each acquisition. While we are very optimistic about our ability to identify and complete future acquisitions, including the potential for multiple deals in a year, we intend to remain as patient and disciplined as we have since we initiated our total growth strategy in 2019. Lastly, I want to address an issue our team has focused on in recent weeks. As many of you know from the 8-K that Progress filed on June 7th, we identified and patched a zero-day exploit in the MOVEit Transfer and MOVEit Cloud products. This is a serious matter, and we have consulted with industry-leading cybersecurity experts. Our priority throughout this process has been to support our customers in securing their environments. With issues like this, it's crucial to avoid speculation and concentrate on protecting our customers from ongoing cyber threats. Our commitment to customer success, which serves as a foundational principle of our strategy, has led to strong performance over the past few years, including in the latest quarter. In conclusion, we achieved better-than-expected financial results across the board and are confident in our business's strength, leading us to raise our guidance for the remainder of the year. The MarkLogic integration is progressing as planned, and MarkLogic is already making meaningful contributions to revenue, ARR, and profitability. Moreover, we believe the M&A market continues to improve for us as we enhance our capabilities to source, integrate, and execute deals. I'm incredibly proud of our teams for their outstanding work and grateful for their dedication and commitment to our success. With that, I'll turn it over to Anthony for the financial details and guidance.

Thanks, Yogesh. Good afternoon, everyone, and thanks for joining our call. As Yogesh mentioned, we're very pleased with our Q2 results, which again exceeded the high end of our guidance range on revenue and earnings per share. We're also very pleased to see some of this upside coming from MarkLogic, which is performing a bit better than our expectations thus far. Turning to the numbers. We'll start on the top line with ARR. We closed the second quarter with ARR of $569 million, which represents approximately 19% growth on a year-over-year basis and 3% pro forma growth on a year-over-year basis. To be clear, the pro forma results include MarkLogic in both periods. As Yogesh mentioned, the growth in ARR was again driven by multiple products across our portfolio including OpenEdge, MarkLogic, Sitefinity and DataDirect. A trend that continues to fuel our ARR growth is strong net retention with Q2 rates at just over 101%. In addition to our strong ARR growth, revenue for the quarter of $179 million was well above the high end of the guidance range we provided back in March and represents approximately 19% growth on a year-over-year basis. The better than expected revenue performance in the quarter was driven by stronger than expected demand from multiple products including OpenEdge, Loadmaster, Chef, MarkLogic, Sitefinity. For those of you who listened to our Q1 earnings call, you'll recall that our Q1 performance was aided slightly by timing. In that, some revenue we expected to recognize in the second quarter actually came in early and was recognized in the first quarter. I mentioned this only to highlight our exceptional top line performance in Q2, which punctuated a very strong first half of 2023. Turning now to expenses. Our total costs and operating expenses for the quarter were $112 million, up 25% compared to the prior year and in line with our expectations. The year-over-year increase was driven by the acquisition of MarkLogic and to a lesser extent an expected increase in compensation and benefit costs across the rest of our business, which we've detailed on previous calls. Operating income was $67 million, up $6 million compared to the prior year quarter and our operating margin was 38% compared to 41% in the second quarter of 2022. On the bottom line, earnings per share of $1.06 for the quarter is $0.14 above the high end of our guidance range. This overperformance relative to our expectations was driven by outstanding top line performance coupled with solid cost management across the business. Our outlook for the MarkLogic integration remains unchanged and we continue to expect that we will achieve all our synergy targets 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 $126 million and debt of $795 million for a net debt position of $669 million. This represents net leverage of roughly 2.5 times using our forecasted fiscal year 2023 adjusted EBITDA. And if we pro forma that EBITDA to consider MarkLogic synergies, our net leverage drops even further. I'd also like to mention that during the second quarter, we paid down $25 million against the revolving line of credit that we drew down to partially fund the acquisition of MarkLogic, bringing the outstanding balance on our revolving line of credit to $170 million at the end of the quarter. DSO for the quarter was 44 days, which is generally consistent with last quarter and in line with our expectations. Adjusted free cash flow was $48 million for the quarter, an increase of $1 million from Q1 and generally in line with our expectations. During the second quarter, we repurchased $15 million of Progress stock. And at the end of the quarter, we had $198 million remaining under our current share repurchase authorization. Okay. Now I'd like to turn to our outlook for Q3 and the full year 2023. When considering our outlook, we continue to see strength in the demand environment for our solutions despite the potential that the macro environment may become more challenging. With that, for the third quarter of 2023, we expect revenue between $172 million and $176 million and earnings per share of between $0.98 and $1.02. For the full year 2023, we expect revenue between $690 million and $698 million, an increase of $10 million from our prior guidance. We expect an operating margin of between 38% and 39%, generally consistent with our prior guidance, adjusted free cash flow between $175 million and $185 million, again consistent with our prior guidance, and earnings per share of between $4.16 and $4.24, an increase of $0.07 from our prior guidance. Our annual EPS estimate contemplates a tax rate of 20% to 21%, approximately 44.7 million shares outstanding, the impact of $30 million of share repurchases and the paydown of $85 million on our revolving line of credit, which we believe we can complete by the end of 2023. In closing, we're excited to deliver strong financial results across the board in the second quarter, a continuation of the trend that we saw from much of 2022 and the first quarter of 2023. We're thrilled to see the MarkLogic integration gaining momentum and we believe we're very well-positioned to deliver strong results for the remainder of 2023 and well beyond. With that, I'd like to open the call for Q&A.

Thanks, guys, and great execution. Maybe a couple of questions for you, Yogesh. First on the MOVEit issue in this past quarter. Can you, first of all, quantify how big of a product line that is for you from a revenue standpoint? And what has been the feedback from customers? I know it's not easy to move off something like this quickly. But what is the risk here down the road that customers are trying to find alternatives to this situation?

Hey, thank you, Ittai, for the nice feedback on the quarter. We had actually in our 8-K that we filed mentioned that the MOVEit file transfer, MOVEit transfer product and MOVEit cloud which are the two products that were impacted, were less than 4% of our overall annual revenue. So it's a rather limited impact so to speak. As far as customers are concerned, Ittai, we continue to engage with them. Our focus at this point is making sure that they get their environment secure and continue to get work done. We feel really good about the effort our team is putting in to help our customers. And at this point, it's really too early to speculate about potentially what kind of an impact we might have in terms of customers saying that they want to use something else. So right now, Ittai, we're just focused on making sure that our customers are back to running, back to feeling that their environment is secured, applying the patches that we've provided them, etc.

Very good. And maybe a follow-up for you on, I want to make sure I understand the commentary. Last quarter, clearly, there was some pull-forward element and some components. Help me understand to what degree do you have visibility whether the products or outperformance this quarter is also a pull forward from the third quarter perhaps or just pure expansion activity given specific needs of customers? How do you get your hands around this?

Yeah. So go ahead, Ittai. Go ahead, Anthony.

Yeah. I was just going to jump in there, Ittai, and say, yeah, in Q1 of this year, we did have a couple of deals that came in earlier than we anticipated. And I think they came in earlier and maybe they were a little bit bigger. In Q2, there really was none of that activity. So I don't think anything in this quarter, at least nothing material, is something that should have been recognized in Q3. And that's why I made the comment in my remarks because I think we felt really good about the performance in the quarter. And I think in light of the fact that some of the revenue got booked in Q1, it makes it even a stronger case for how good the performance was in Q2 on the top line. So it's continuing to acquire new customers, continuing to renew, continuing to expand with our existing customers. I think in a lot of areas we're performing well.

Excellent. Good stuff. Thank you very much. Keep it up.

Great. Thanks for taking the questions. Yogesh, maybe for you. You mentioned customer success is obviously core to your strategy and you opened up with statements regarding customers remaining committed to using Progress products. But I was wondering how conversations went outside of the MOVEit customer base regarding the vulnerability. Have customers outside of that installed base indicated any concern around using any other Progress products? Or just in general how have those conversations went?

So at this point, Ray, because the issue is limited to MOVEit, we really have not had other customers come to us and raise concerns. One point about the software industry is that vulnerabilities appear frequently. I think someone mentioned that over 10,000 vulnerabilities have been reported by software vendors in the last six months alone. Unfortunately, that is the reality we face with cybercriminals continuing their activities. So, no, we have not had customers of other products express any concerns at this point.

That makes sense. And then maybe a follow-up for you, Anthony. You guys beat non-GAAP operating margin guidance by a significant margin here and you're maintaining your full year guidance as it relates to margins. Do you expect to ramp spending in terms of OpEx in the back half of the year? And should we be thinking about incremental spending on cybersecurity for instance to move the needle in terms of OpEx spending? Any color there would be helpful.

Yeah. Sure, Ray. I don't think that we had I would say pretty significant investments in cyber coming into the year and we have for a couple of years ongoing now. And so I think with the top line beat if there is an opportunity to invest more where necessary, obviously, we would. But there are other costs in the business. Wage inflation continues to run and we talked about that from time-to-time and inflation generally seems to be pretty persistent. And so I think we are trying to give ourselves a little bit of latitude around the margin, on the operating margin as some of those costs may continue to escalate as the year goes on. I think that's really it.

Great. Thanks for taking the questions.

Great. Thank you so much and congrats on a great quarter. Yogesh on the MOVEit point or the issue, I guess, I'm wondering if you can actually take any proactive steps or are you taking any kind of proactive steps to look at the rest of the product portfolio, mainly the new acquisitions to Ipswitch kind of the customers from those using those products?

That is a really good question. We have a very robust security program at Progress and take product security very seriously, given the broad range of customers we serve. We are currently investigating this matter. Over the past four weeks, our focus has been on our customers, and I want to clarify that we are not neglecting other responsibilities. We are examining our product security to identify any areas where improvements are needed. Additionally, we are considering enhancements to our M&A process to ensure the security of products we acquire, including those obtained from Ipswitch in 2019. It's important to emphasize that we have always prioritized security. We utilize industry-leading code scanning software to detect vulnerabilities, and we invite hackers to test our software for potential flaws. Our approach is multi-faceted, and we have a strong response team ready to act if necessary. So, I want to assure you that we have consistently taken product security seriously, and this situation presents an opportunity for us to identify further improvements.

Got it. And one question on just the M&A front. I'm wondering if the wave of investments in generative AI companies could be good for you maybe as VCs kind of reprioritize their portfolio. Could that actually drag down the exit multiples for some traditional assets?

I think that this is always, Pinjalim, one of the fun things about being who we are, right? The VC world usually moves to the next shiny object. And so the workhorse businesses that got created over the last decade or last 15 years that become really, really strong, they then become not that interesting to VCs. And when that happens, that basically means that their valuations do change. And so, you're absolutely correct. I think that it will create an opportunity for us to pick up vendors just pick up other companies. I'll give you a very interesting example, Pinjalim, I'm sure you noticed this, right? When cloud became really, really exciting, on-prem software company valuations came down, even though we know that on-prem software companies have greater gross margins. And so from the kind of business we run, I think, we will find other companies that are really good companies in our industry, which are now less interesting to VCs who might say, you know what, the combination of capital being scarcer and there is some hot stuff going on with generative AI, let's put our money to work there. So I think that's a really astute observation, Pinjalim.

Got it. Thank you very much.

Thanks. I was curious if you could drive into the strength in the customer demand. You had mentioned strength, it sounded like it was no waiver in demand. Maybe if you could just unpack where you're seeing the strongest signals from your customers and excitement. And if I could also drill a little into MarkLogic. You mentioned that was a bit better. Can you remind us what revenue you recognized this quarter from MarkLogic and any other color that you can share? Thanks.

I will let Anthony discuss the MarkLogic segment and provide some figures related to that. Overall, I'm pleased to report that we’ve seen strong demand across the board. Customers are keen to leverage products they are already familiar with, which is why expansions are a significant part of our business. For example, we have a customer using OpenEdge who had spent the last five years contemplating a switch to a different platform after being convinced by someone that our competitor's platform would allow them to modernize their application. They invested over $50 million during this period but eventually realized they weren't making any progress. They decided to recommit to us, modernize using OpenEdge, and signed a seven-figure expansion deal. This reflects a broader trend where customers are questioning if they are wasting money and seeking solutions from what they already have. Additionally, we are gaining new customers for products like Loadmaster and Sitefinity Cloud, which solve issues related to efficiency and network performance. Loadmaster enhances the reliability of environments, while Sitefinity Cloud helps marketing teams work more effectively, offering great value. Currently, value is paramount in the market. Customers are looking for reliable products, and we have several references to showcase. This trend spans across various regions and includes our application development products, digital experience offerings like Sitefinity, as well as our DevOps and SecOps tools, and IT infrastructure management solutions. Anthony, would you like to address the MarkLogic question?

Yeah, sure. So we were right around $25 million for the quarter, Brent. And honestly, that was a bit ahead of our expectations. Maybe a few million dollars ahead to be honest. And there is a lot of seasonality in that business, we mentioned it on the last call. But we would probably expect Q2 and Q4 for this year to be the bigger quarters. I would expect Q3 to be seasonally a bit slower and so it might step down a few million bucks during the third quarter because of just seasonality. But overall we did come in a bit higher than expected both top line and bottom line on MarkLogic this quarter. So that was really encouraging.

Hi. Thank you for taking my question and congratulations on another great quarter and execution. You mentioned in a previous question that you expect expenses to creep up a bit due to inflation and wage inflation. Is there anything you can do to offset that?

So, thank you, Anja. We actually are looking to see like what we really can do. I mean I'll let Anthony talk about this more around expenses. But from our perspective, we continue to look for opportunities where we can control costs and reduce spend, but at the same time, there are some market factors that are really out of our control. Anthony, do you want to expand?

I agree, Yogesh. In previous years, we have made efforts in various areas of the business to streamline operations. An example of this is when we sold our corporate headquarters last year, which helped us reduce our balance sheet assets, boost our capital, and lower our operating expenses. We are currently exploring smaller opportunities, which is a continual part of our approach to business. I believe we can maintain and slightly improve our margins over the long run, as we discussed during Investor Day. Wage inflation, in particular, has been persistent for the last couple of years. So far, we have effectively offset it, and I believe we will continue to do so. However, it requires significant effort and a resourceful approach as we navigate the latter half of the year. There are definitely areas to explore, and that's been part of our history.

Okay. Great. Thank you. That's all for me.

Well, thank you, everyone for joining us. Once again, we're excited about where we're going and our second half of the year as well in addition to what we have delivered in the first half. We look forward to talking to you again soon. Have a good night.

Thank you all for participating. This concludes today's program. You may now disconnect.