PROGRESS SOFTWARE CORP /MA 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. However, actual results may differ from these estimates. The most significant estimates relate to revenue recognition and business combinations. For further information regarding the application of these and other accounting policies, see Note 1 to our Consolidated Financial Statements in Item 8 of our 2022 Annual Report. 19 Cautionary Note Regarding Forward-Looking Statements This Form 10-Q may contain information that are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended; Section 21E of the Securities Exchange Act of 1934, as amended; and the Private Securities Litigation Reform Act of 1995. Whenever we use words such as "believe," "may," "could," "would," "might," "should," "expect," "intend," "plan," "estimate," "target," "anticipate" and negatives and derivatives of these or similar expressions, or when we make statements concerning future financial results, product offerings or other events that have not yet occurred, we are making forward-looking statements. These forward-looking statements are based upon our present intent, beliefs or expectations, but are not guaranteed to occur and may not occur. Actual future results may differ materially from those contained in or implied by our forward-looking statements due to various factors which are more fully described in Part I, Item 1A. Risk Factors in our 2022 Annual Report. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized. We also cannot assure you that we have identified all possible issues that we might face. We undertake no obligation to update any forward-looking statements that we make. Use of Constant Currency Revenue from our international operations has historically represented a substantial portion of our total revenue. As a result, our revenue results have been impacted, and we expect will continue to be impacted, by fluctuations in foreign currency exchange rates. For example, if the local currencies of our foreign subsidiaries strengthen, our consolidated results stated in U.S. dollars are positively impacted. As exchange rates are an important factor in understanding period-to-period comparisons, we believe the presentation of revenue growth rates on a constant currency basis enhances the understanding of our revenue results and evaluation of our performance in comparison to prior periods. The constant currency information presented is calculated by translating current period results using prior period weighted average foreign currency exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Overview Progress is the trusted provider of the best products to develop, deploy and manage high-impact applications. We enable our customers to develop the applications and experiences they need, deploy where and how they want, and manage it all safely and securely. Progress helps customers drive faster cycles of innovation, fuel momentum and accelerate their path to success. The key tenets of our strategic plan and operating model are as follows: Be the Trusted Provider of the Best Products to Develop, Deploy and Manage High Impact Applications . A key element of our strategy is centered on building and maintaining the best products and tools enterprises need to build, deploy, and manage modern, strategic business applications. We offer these products and tools to both new customers and partners, as well as our existing partner and customer ecosystems. Focus on Customer and Partner Retention to Drive Recurring Revenue and Profitability . Our organizational philosophy and operating principles focus primarily on customer and partner retention and success, and a streamlined operating approach to drive predictable and stable recurring revenue and high levels of profitability. Follow a Total Growth Strategy through Accretive M&A. We are pursuing a total growth strategy driven by accretive acquisitions of businesses within the infrastructure software space, with products that appeal to both IT organizations and individual developers. These acquisitions must meet strict financial and other criteria, which help further our goal to provide significant stockholder returns by providing scale and increased cash flows. In April 2019, we acquired Ipswitch, Inc.; in October 2020, we acquired Chef Software, Inc.; in November 2021, we acquired Kemp Technologies; and in February 2023, we acquired MarkLogic. These acquisitions met our strict financial criteria. In recent years, our total growth strategy, described above, has resulted in the rapid expansion of our product portfolio. As our portfolio evolves, we continuously evaluate our organization for additional synergies and efficiencies. In connection therewith, we are working to realign our go-to-market, product, and operational teams and to increase centralization of shared services and functions across our company. We believe that these changes will improve collaboration among the teams that develop, sell, and support our products; enhance our ability to integrate acquired businesses; and lead to greater system uniformity and increased operating efficiency. 20 Employ a Multi-Faceted Capital Allocation Strategy . Our capital allocation policy emphasizes accretive M&A, which allows us to expand our business and drive significant stockholder returns. We also utilize dividends and share repurchases to return capital to stockholders. We intend to continue to repurchase our shares in sufficient quantities to offset dilution from our equity plans and to continue to return a portion of our annual cash flows from operations to stockholders in the form of dividends. We expect to continue to pursue acquisitions meeting our financial criteria that are designed to expand our business and drive significant stockholder returns. As a result, our expected uses of cash could change, our cash position could be reduced, and we may incur additional debt obligations to the extent we complete additional acquisitions. However, we currently believe that existing cash balances, together with funds generated from operations and amounts available under our Credit Facility, will be sufficient to finance our operations and meet our foreseeable cash requirements, including quarterly cash dividends and stock repurchases to Progress stockholders, as applicable, through at least the next twelve months. Results of Operations Revenue Three Months Ended % Change (In thousands) February 28, 2023 February 28, 2022 As Reported Constant Currency Revenue $ 164,226 $ 144,922 13 % 15 % Total revenue increased as compared to the same period last year primarily due to increases in our DataDirect product offerings, as well as our acquisition of MarkLogic in the first quarter of fiscal year 2023. These increases were partially offset by decreases in our OpenEdge product offerings, as well as the negative impact of foreign exchange on license and maintenance revenue in our EMEA region. Software License Revenue Three Months Ended % Change (In thousands) February 28, 2023 February 28, 2022 As Reported Constant Currency Software licenses $ 57,568 $ 42,750 35 % 36 % As a percentage of total revenue 35 % 29 % Software license revenue increased as compared to the same period last year primarily due to an increase in our DataDirect product offerings, as well as our acquisition of MarkLogic in the first quarter of fiscal year 2023. These increases were partially offset by a decrease in our OpenEdge product offerings, as well as the negative impact of foreign exchange in our EMEA region. Maintenance and Services Revenue Three Months Ended % Change (In thousands) February 28, 2023 February 28, 2022 As Reported Constant Currency Maintenance $ 92,513 $ 89,963 3 % 4 % As a percentage of total revenue 56 % 62 % Services 14,145 12,209 16 % 17 % As a percentage of total revenue 9 % 9 % Total maintenance and services revenue $ 106,658 $ 102,172 4 % 6 % As a percentage of total revenue 65 % 71 % Maintenance revenue increased as compared to the same period last year primarily due to our acquisition of MarkLogic and increased maintenance revenue from our Chef product offerings. Services revenue increased as compared to the same period last year primarily due to increased services revenue from our acquisition of MarkLogic. The maintenance and services increases were partially offset by the negative impact of foreign exchange in our EMEA region. 21 Revenue by Region Three Months Ended % Change (In thousands) February 28, 2023 February 28, 2022 As Reported Constant Currency North America $ 98,828 $ 78,093 27 % 27 % As a percentage of total revenue 60 % 54 % Europe, the Middle East and Africa ("EMEA") $ 53,405 $ 53,702 (1) % 4 % As a percentage of total revenue 32 % 37 % Latin America $ 4,189 $ 3,883 8 % 5 % As a percentage of total revenue 3 % 3 % Asia Pacific $ 7,804 $ 9,244 (16) % (15) % As a percentage of total revenue 5 % 6 % Total revenue generated in North America increased $20.7 million as compared to the same period last year. The increase was primarily due to increases from our DataDirect product offerings and our acquisition of MarkLogic. The decrease in revenue generated in EMEA was primarily due to a negative impact of foreign exchange, partially offset by our acquisition of MarkLogic and increased revenue from our Chef product offerings. The increase in revenue in Latin America was primarily due to increases in our OpenEdge product offerings. The decreases in revenue generated in Asia Pacific was due to decreases in our OpenEdge product offerings. In the first three months of fiscal year 2023 revenue generated in markets outside North America represented 40% of total revenue compared to 42% of total revenue on a constant currency basis. In the first three months of fiscal year 2022 revenue generated in markets outside North America represented 46% of total revenue compared to 47% of total revenue on a constant currency basis. Cost of Software Licenses Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Change Cost of software licenses $ 2,452 $ 2,609 $ (157) (6) % As a percentage of software license revenue 4 % 6 % As a percentage of total revenue 1 % 2 % Cost of software licenses consists primarily of costs of inventories, royalties, electronic software distribution, duplication, and packaging. Cost of software licenses as a percentage of software license revenue varies from period to period depending upon the relative product mix. Cost of Maintenance and Services Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Change Cost of maintenance and services $ 17,501 $ 15,145 $ 2,356 16 % As a percentage of maintenance and services revenue 16 % 15 % As a percentage of total revenue 11 % 10 % Components of cost of maintenance and services: Personnel related costs $ 13,143 $ 10,804 $ 2,339 22 % Contractors and outside services 2,700 2,968 (268) (9) % Hosting and other 1,658 1,373 285 21 % Total cost of maintenance and services $ 17,501 $ 15,145 $ 2,356 16 % Cost of maintenance and services consists primarily of costs of providing customer support, consulting, and education. The increase year over year was primarily due to increased headcount and hosting costs resulting from our acquisition of MarkLogic, partially offset by decreased contractors and outside services costs. 22 Amortization of Intangibles Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Amortization of intangibles $ 6,264 $ 5,458 15 % As a percentage of total revenue 4 % 4 % Amortization of intangibles included in costs of revenue primarily represents the amortization of the value assigned to technology-related intangible assets obtained in business combinations. The increase year over year is due to the acquisition of MarkLogic. Gross Profit Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Gross profit $ 138,009 $ 121,710 13 % As a percentage of total revenue 84 % 84 % Our gross profit increased primarily due to the increase in revenue and the decrease in costs of software licenses, offset by the increases in costs of maintenance and services and the amortization of intangibles, each as described above. Sales and Marketing Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Change Sales and marketing $ 33,754 $ 33,469 $ 285 1 % As a percentage of total revenue 21 % 23 % Components of sales and marketing: Personnel related costs $ 29,994 $ 28,395 $ 1,599 6 % Contractors and outside services 695 820 (125) (15) % Marketing programs and other 3,065 4,254 (1,189) (28) % Total sales and marketing $ 33,754 $ 33,469 $ 285 1 % Sales and marketing expenses increased primarily due to increased personnel related costs associated with our acquisition of MarkLogic, offset by decreases in marketing and sales events costs and contractors and outside services costs. Product Development Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Change Product development costs $ 30,438 $ 28,673 $ 1,765 6 % As a percentage of total revenue 19 % 20 % Components of product development costs: Personnel related costs $ 29,603 $ 27,479 $ 2,124 8 % Contractors and outside services 673 1,018 (345) (34) % Other product development costs 162 176 (14) (8) % Total product development costs $ 30,438 $ 28,673 $ 1,765 6 % Product development expenses increased primarily due to increased personnel related costs associated with our acquisition of MarkLogic, partially offset by decreased contractors and outside services costs. 23 General and Administrative Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Change General and administrative $ 18,786 $ 16,991 $ 1,795 11 % As a percentage of total revenue 11 % 12 % Components of general and administrative: Personnel related costs $ 16,135 $ 14,051 $ 2,084 15 % Contractors and outside services 2,387 2,067 320 15 % Other general and administrative costs 264 873 (609) (70) % Total cost of general and administrative $ 18,786 $ 16,991 $ 1,795 11 % General and administrative expenses include the costs of our finance, human resources, legal, information systems and administrative departments. General and administrative expenses increased primarily due to higher personnel costs associated with our acquisition of MarkLogic, as well as an increase in contractors and outside services costs, partially offset by a decrease in other general and administrative costs. Amortization of Intangibles Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Amortization of intangibles $ 13,611 $ 11,722 16 % As a percentage of total revenue 8 % 8 % Amortization of intangibles included in operating expenses primarily represents the amortization of value assigned to intangible assets obtained in business combinations other than assets identified as purchased technology. Amortization of intangibles increased due to the addition of MarkLogic intangible assets, as discussed above. Cyber Incident Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Cyber incident $ 2,692 $ — * As a percentage of total revenue 2 % — % *not meaningful As previously disclosed on December 19, 2022, following the detection of irregular activity on certain portions of our corporate network, we engaged outside cybersecurity experts and other incident response professionals to conduct a forensic investigation and assess the extent and scope of the cyber incident. Cyber incident costs relate to the engagement of external cybersecurity experts and other incident response professionals. 24 Restructuring Expenses Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Restructuring expenses $ 1,397 $ 511 173 % As a percentage of total revenue 1 % — % Restructuring expenses recorded in the first quarter of fiscal year 2023 relate to the restructuring activities that occurred in the first and fourth quarters of fiscal years 2023 and 2020, respectively, resulting from the acquisitions of MarkLogic and Chef, respectively. Restructuring expenses recorded in the first quarter of fiscal year 2022 are comprised mostly of costs related to the acquisition of Kemp and the Chef restructuring action of 2020. See the Liquidity and Capital Resources section of this Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Acquisition-Related Expenses Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Acquisition-related expenses $ 1,743 $ 912 91 % As a percentage of total revenue 1 % 1 % Acquisition-related costs are expensed as incurred and include those costs incurred as a result of a business combination. These costs consist of professional service fees, including third-party legal and valuation-related fees. Acquisition-related expenses increased due to our acquisition of MarkLogic, as well as our pursuit of other acquisition opportunities. Acquisition-related expenses in the same periods of fiscal year 2022 were primarily related to the acquisition of Kemp as well as our pursuit of other acquisition opportunities. Income from Operations Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Income from operations $ 35,588 $ 29,432 21 % As a percentage of total revenue 22 % 20 % Income from operations increased in the first quarter of fiscal year 2023 due to increased revenue, offset by an increase in costs of revenue and operating expenses as shown above. Other (Expense) Income, Net Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Interest expense $ (5,848) $ (3,703) 58 % Interest income and other, net 515 589 (13) % Foreign currency loss, net (331) (366) (10) % Total other expense, net $ (5,664) $ (3,480) 63 % As a percentage of total revenue 3 % 2 % Other expense, net, increased in the first quarter of fiscal year 2023 as compared to the same period last year primarily due to increased interest expense on our term loan and our revolving line of credit, which we drew on to fund part of our acquisition of MarkLogic. Interest income and other, net, decreased slightly due to the timing of grant income recognition. Foreign currency loss decreased in the first quarter of fiscal year 2023. 25 Provision for Income Taxes Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Provision for income taxes $ 6,250 $ 5,498 14 % As a percentage of income before income taxes 21 % 21 % Our effective tax rate was 21% in the first fiscal quarter of both 2023 and 2022. There were no significant discrete tax items in the first fiscal quarter of either 2023 or 2022. Net Income Three Months Ended (In thousands) February 28, 2023 February 28, 2022 % Change Net income $ 23,674 $ 20,454 16 % As a percentage of total revenue 14 % 14 % Select Performance Metrics: Management evaluates our financial performance using a number of financial and operating metrics. These metrics are periodically reviewed and revised to reflect changes in our business. Annual Recurring Revenue (ARR) We are providing an ARR performance metric to help investors better understand and assess the performance of our business because our mix of revenue generated from recurring sources has increased in recent years. ARR represents the annualized contract value for all active and contractually binding term-based contracts at the end of a period. ARR includes maintenance, software upgrade rights, public cloud and on-premises subscription-based transactions and managed services. ARR mitigates fluctuations due to seasonality, contract term and the sales mix of subscriptions for term-based licenses and SaaS. ARR is not calculated in accordance with GAAP. ARR does not have any standardized meaning and is therefore unlikely to be comparable to similarly titled measures presented by other companies. ARR should be viewed independently of revenue and deferred revenue and is not intended to be combined with or to replace either of those items. ARR is not a forecast and the active contracts at the end of a reporting period used in calculating ARR may or may not be extended or renewed by our customers. We define ARR as the annual recurring revenue of term-based contracts from all customers at a point in time. We calculate ARR by taking monthly recurring revenue, or MRR, and multiplying it by 12. MRR for each month is calculated by aggregating, for all customers during that month, monthly revenue from committed contractual amounts, additional usage and monthly subscriptions. The calculation is done at constant currency using the current year budgeted exchange rates for all periods presented. Our ARR was $569.0 million and $472.0 million as of February 28, 2023 and 2022, respectively, which is an increase of 20% year-over-year. The growth in our ARR is primarily driven by the acquisition of MarkLogic. Net Retention Rate We calculate net retention rate as of a period end by starting with the ARR from the cohort of all customers as of 12 months prior to such period end ("Prior Period ARR"). We then calculate the ARR from these same customers as of the current period end ("Current Period ARR"). Current Period ARR includes any expansion and is net of contraction or attrition over the last 12 months but excludes ARR from new customers in the current period. We then divide the total Current Period ARR by the total Prior Period ARR to arrive at the net retention rate. Net retention rate is not calculated in accordance with GAAP. Our net retention rates have generally ranged between 101% and 102% for all periods presented. Our high net retention rates illustrate our predictable and durable top line performance. 26 Liquidity and Capital Resources Cash, Cash Equivalents and Short-Term Investments (In thousands) February 28, 2023 November 30, 2022 Cash and cash equivalents $ 107,981 $ 256,277 Short-term investments 14,944 — Total cash, cash equivalents and short-term investments $ 122,925 $ 256,277 The decrease in cash, cash equivalents and short-term investments of $133.4 million from the end of fiscal year 2022 was due cash outflows of $355.8 million for cash paid for acquisitions, net of cash acquired, repurchases of common stock of $15.0 million, dividend payments of $8.0 million, payments of debt obligations of $1.7 million, and purchases of property and equipment of $0.4 million. These cash outflows were offset by proceeds from the issuance of debt of $195.0 million, cash inflows from operations of $46.8 million, $4.5 million in cash received from the issuance of common stock, and the effect of exchange rates on cash of $1.2 million. Except as described below, there are no limitations on our ability to access our cash, cash equivalents and short-term investments. As of February 28, 2023, $75.5 million of our cash, cash equivalents and short-term investments was held by our foreign subsidiaries. Foreign cash includes unremitted foreign earnings, which are invested indefinitely outside of the U.S. As such, it is not available to fund our domestic operations. If we were to repatriate these earnings, we may be subject to income tax withholding in certain tax jurisdictions and a portion of the repatriated earnings may be subject to U.S. income tax. However, we do not anticipate that this would have a material adverse impact on our liquidity. Share Repurchase Program In January 2023, our Board of Directors increased our share repurchase authorization by $150 million, to an aggregate authorization of $228.0 million. In the three months ended February 28, 2023 and February 28, 2022, we repurchased and retired 0.3 million shares for $15.0 million and 0.6 million shares for $25.0 million, respectively. The shares were repurchased in both periods as part of our Board of Directors authorized share repurchase program. As of February 28, 2023, there was $213.0 million remaining under the current authorization. Dividends On March 17, 2023, our Board of Directors declared a quarterly dividend of $0.175 per share of common stock, which will be paid on June 15, 2023 to stockholders of record as of the close of business on June 1, 2023. Future declarations of dividends and the establishment of future record and payment dates are subject to the final determination of our Board of Directors. Restructuring Activities See Note 12 to the condensed consolidated financial statements. Long-term Debt and Credit Facility See Note 7 to the condensed consolidated financial statements. Cash Flows From Operating Activities Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Net income $ 23,674 $ 20,454 Non-cash reconciling items included in net income 27,687 31,774 Changes in operating assets and liabilities (4,594) (8,135) Net cash flows from operating activities $ 46,767 $ 44,093 In the first three months of fiscal year 2023, operating cash flows increased as a result of higher billings and collections, partially offset by higher operating expenses as compared to the same period in 2022. Our gross accounts receivable as of 27 February 28, 2023, increased by $4.5 million from the end of fiscal year 2022 and our days sales outstanding (DSO) in accounts receivable decreased to 42 days from 52 days in the first fiscal quarter of 2022 due to the timing of billings and collections. Cash Flows From Investing Activities Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Net investment activity $ (14,862) $ 300 Purchases of property and equipment (385) (831) Payments for acquisitions, net of cash acquired (355,821) — Net cash flows from investing activities $ (371,068) $ (531) Net cash outflows and inflows of our net investment activity are generally a result of the timing of our purchases and maturities of securities, which are classified as cash equivalents or short-term securities. In the first quarter of fiscal year 2023 had payments for acquisitions net of cash acquired of $355.8 million. We also purchased $0.4 million of property and equipment in the first three months of fiscal year 2023, as compared to $0.8 million in the first three months of fiscal year 2022. Cash Flows From (Used in) Financing Activities Three Months Ended (In thousands) February 28, 2023 February 28, 2022 Proceeds from stock-based compensation plans $ 9,357 $ 4,094 Repurchases of common stock (15,000) (25,000) Proceeds from the issuance of debt 195,000 7,474 Payment of debt issuance costs — (1,957) Payment of principal on long-term debt (1,719) (1,719) Dividend payments to stockholders (8,023) (7,784) Other financing activities (4,817) (3,139) Net cash flows from (used in) financing activities $ 174,798 $ (28,031) During the first three months of fiscal year 2023, we received $195.0 million in net proceeds from the issuance of debt. During the first three months of fiscal year 2022, we received $7.5 million in net proceeds from the issuance of debt in connection with our amended term loan. We received $9.4 million from the exercise of stock options and the issuance of shares under our employee stock purchase plan as compared to $4.1 million in the first three months of fiscal year 2022. Further, we repurchased $15.0 million of our common stock under our share repurchase plan compared to $25.0 million in the same period of the prior year. We also made payments on our long-term debt of $1.7 million in the first three months of both fiscal year 2023 and 2022. Finally, we made dividend payments of $8.0 million to our stockholders during the first three months of fiscal year 2023 and $7.8 million in the first three months of fiscal year 2022. Liquidity Outlook Cash from operations in fiscal year 2023 could be affected by various risks and uncertainties, including, but not limited to, the effects of various risks detailed in Part I, Item 1A. Risk Factors in our 2022 Annual Report which have led to increased disruption and volatility in capital markets and credit markets that could adversely affect our liquidity and capital resources in the future. However, based on our current business plan, we believe that existing cash balances, together with funds generated from operations and amounts available under our Credit Facility, will be sufficient to finance our operations and meet our foreseeable cash requirements through at least the next twelve months. We do not contemplate a need for any foreign repatriation of the earnings which are deemed invested indefinitely outside of the U.S. Our foreseeable cash needs include capital expenditures, acquisitions, debt repayments, quarterly cash dividends, share repurchases, lease commitments, restructuring obligations and other long-term obligations. Legal and Other Regulatory Matters See discussion regarding legal and other regulatory matters in Part II, Item 1. Legal Proceedings. 28 Recent Accounting Pronouncements Refer to Note 1 - Nature of Business and Basis of Presentation (Part I, Item 1 of this Form 10-Q) for further discussion.