PROGRESS SOFTWARE CORP /MA 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 2023 Annual Report as well as the risk factors described in Part II, Item 1A of this Report on Form 10-Q. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what 21 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. Overview Progress provides enterprise software products for the development, deployment and management of high-impact business applications. 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, loss contingencies and the MOVEit Vulnerability, and business combinations. For further information regarding the application of these and other accounting policies, see Note 1: Basis of Presentation to our Consolidated Financial Statements in Item 8 of our 2023 Annual Report. There have been no significant changes to our critical accounting policies and estimates since our 2023 Annual Report. 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. Results of Operations Revenue Three Months Ended % Change (In thousands) February 29, 2024 February 28, 2023 As Reported Constant Currency Revenue $ 184,685 $ 164,226 12 % 12 % Total revenue increased as compared to the same period last year due to our acquisition of MarkLogic in February 2023, as well as increases in our OpenEdge product offering. MarkLogic revenue represents $26.7 million of the increase as the current period includes activity for the full quarter, whereas the prior period only included the month of February 2023. These increases were partially offset by a decrease in our DataDirect product offering as a result of the timing of renewals on multiyear subscription contracts. Software License Revenue Three Months Ended % Change (In thousands) February 29, 2024 February 28, 2023 As Reported Constant Currency Software licenses $ 64,100 $ 57,568 11 % 11 % As a percentage of total revenue 35 % 35 % Software license revenue increased by $6.5 million as compared to the same period last year primarily due to our acquisition of MarkLogic in February 2023, which accounts for $15.4 million of the increase. The increase is offset by a decline in revenue driven by the timing of multi-year subscription renewals. 22 Maintenance and Services Revenue Three Months Ended % Change (In thousands) February 29, 2024 February 28, 2023 As Reported Constant Currency Maintenance $ 102,025 $ 92,513 10 % 10 % As a percentage of total revenue 55 % 56 % Services 18,560 14,145 31 % 31 % As a percentage of total revenue 10 % 9 % Total maintenance and services revenue $ 120,585 $ 106,658 13 % 12 % As a percentage of total revenue 65 % 65 % Maintenance revenue increased by $9.5 million as compared to the same period last year primarily due to our acquisition of MarkLogic in February 2023. Services revenue increased by $4.4 million as compared to the same period last year due to increased services revenue from our acquisition of MarkLogic. Revenue by Region Three Months Ended % Change (In thousands) February 29, 2024 February 28, 2023 As Reported Constant Currency North America $ 107,282 $ 98,828 9 % 9 % As a percentage of total revenue 58 % 60 % Europe, the Middle East and Africa ("EMEA") $ 63,087 $ 53,405 18 % 17 % As a percentage of total revenue 34 % 32 % Latin America $ 4,668 $ 4,189 11 % 8 % As a percentage of total revenue 3 % 3 % Asia Pacific $ 9,648 $ 7,804 24 % 25 % As a percentage of total revenue 5 % 5 % Total revenue generated in North America increased $8.5 million in the first quarter fiscal year 2024. The increase was primarily due to our acquisition of MarkLogic and increased revenue from our OpenEdge product offerings, partially offset by decreases in our DataDirect and Chef product offerings. The increases in revenue over the period in EMEA was primarily due to our acquisition of MarkLogic, increased revenue from our OpenEdge and DataDirect product offerings, and a positive impact from foreign exchange in our EMEA region. The increases in revenue in Latin America were primarily due to increases in our OpenEdge product offerings. The increases in revenue generated in Asia Pacific were due to increases in our Kemp, MarkLogic, and Chef product offerings. In the first three months of fiscal year 2024 revenue generated in markets outside North America represented 42% of total revenue on an actual and constant currency basis. In the first three months of fiscal year 2023 revenue generated in markets outside North America represented 40% and 42% of total revenue on an actual and a constant currency basis, respectively. Cost of Software Licenses Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Change Cost of software licenses $ 2,731 $ 2,452 $ 279 11 % As a percentage of software license revenue 4 % 4 % As a percentage of total revenue 1 % 1 % 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 . 23 Cost of Maintenance and Services Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Change Cost of maintenance and services $ 22,219 $ 17,501 $ 4,718 27 % As a percentage of maintenance and services revenue 18 % 16 % As a percentage of total revenue 12 % 11 % Components of cost of maintenance and services: Personnel related costs $ 17,045 $ 13,143 $ 3,902 30 % Contractors and outside services 3,408 2,700 708 26 % Hosting and other 1,766 1,658 108 7 % Total cost of maintenance and services $ 22,219 $ 17,501 $ 4,718 27 % Cost of maintenance and services consists primarily of costs of providing customer support, consulting, and education. The increase was primarily due to increased personnel related costs, contractor and outside services costs, and hosting costs resulting from our acquisition of MarkLogic. Amortization of Intangibles Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Amortization of intangibles $ 7,859 $ 6,264 25 % 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 year over year is due to the acquisition of MarkLogic. Gross Profit Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Gross profit $ 151,876 $ 138,009 10 % As a percentage of total revenue 82 % 84 % Our gross profit increased due to the increases in revenue, offset by the increases in costs of software licenses, costs of maintenance and services and the amortization of intangibles, each as described above. 24 Sales and Marketing Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Change Sales and marketing $ 39,111 $ 33,754 $ 5,357 16 % As a percentage of total revenue 21 % 21 % Components of sales and marketing: Personnel related costs $ 33,093 $ 29,994 $ 3,099 10 % Contractors and outside services 593 695 (102) (15) % Marketing programs and other 5,425 3,065 2,360 77 % Total sales and marketing $ 39,111 $ 33,754 $ 5,357 16 % Sales and marketing expenses increased primarily due to increased personnel related costs associated with our acquisition of MarkLogic, as well as increases in marketing and sales events costs, partially offset by decreases in contractors and outside services costs. Product Development Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Change Product development costs $ 34,988 $ 30,438 $ 4,550 15 % As a percentage of total revenue 19 % 19 % Components of product development costs: Personnel related costs $ 33,596 $ 29,603 $ 3,993 13 % Contractors and outside services 1,082 673 409 61 % Other product development costs 310 162 148 91 % Total product development costs $ 34,988 $ 30,438 $ 4,550 15 % Product development expenses increased primarily due to increased personnel related costs associated with our acquisition of MarkLogic, as well as increases in contractors and outside services costs and other product development costs. General and Administrative Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Change General and administrative $ 21,344 $ 18,786 $ 2,558 14 % As a percentage of total revenue 12 % 11 % Components of general and administrative: Personnel related costs $ 17,963 $ 16,135 $ 1,828 11 % Contractors and outside services 2,575 2,387 188 8 % Other general and administrative costs 806 264 542 205 % Total cost of general and administrative $ 21,344 $ 18,786 $ 2,558 14 % 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, as well as increases in contractors and outside services costs and other general and administrative costs. 25 Amortization of Intangibles Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Amortization of intangibles $ 17,389 $ 13,611 28 % As a percentage of total revenue 9 % 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 and Vulnerability Response Expenses, Net Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Cyber incident and vulnerability response expenses, net $ 987 $ 2,692 (63) % As a percentage of total revenue 1 % 2 % As previously disclosed, following (i) the detection of irregular activity on certain portions of our corporate network that was disclosed on December 19, 2022, and (ii) the discovery of the MOVEit Vulnerability that was disclosed on June 5, 2023, in each instance, we engaged outside cybersecurity experts and other incident response professionals to conduct a forensic investigation and assess the extent and scope of these matters. Cyber incident and MOVEit Vulnerability costs relate to the engagement of external cybersecurity experts and other incident response professionals and are net of received and expected insurance recoveries. Restructuring Expenses Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Restructuring expenses $ 2,349 $ 1,397 68 % As a percentage of total revenue 1 % 1 % Restructuring expenses recorded in the first quarter of fiscal year 2024 relate to a facility closure in connection with the restructuring action from the first fiscal quarter of 2023. Restructuring expenses recorded in the first quarter of fiscal year 2023 relate to headcount reduction from the same action. Acquisition-Related Expenses Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Acquisition-related expenses $ 702 $ 1,743 (60) % As a percentage of total revenue — % 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 in the first quarter of fiscal year 2024 were primarily related to our pursuit of other acquisition opportunities. Acquisition-related expenses in the same periods of fiscal year 2023 were primarily related to our acquisition of MarkLogic. 26 Income from Operations Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Income from operations $ 35,006 $ 35,588 (2) % As a percentage of total revenue 19 % 22 % Income from operations decreased in the first quarter of fiscal year 2024 due to an increase in costs of revenue and operating expenses, offset by increased revenue, as shown above. Other (Expense) Income, Net Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Interest expense $ (7,344) $ (5,848) 26 % Interest income and other, net 624 515 21 % Foreign currency loss, net (679) (331) 105 % Total other expense, net $ (7,399) $ (5,664) 31 % As a percentage of total revenue (4) % (3) % Other expense, net, increased 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. We expect our annual interest expense to decrease for the remainder of 2024 due to the reduced contractual interest rate on the 2030 convertible notes, which were used to finance the term loan and the borrowings outstanding under the revolver. Interest income and other, net, was higher in fiscal year 2024, resulting from higher interest rates on our invested cash balance. We expect interest income to continue growing during fiscal year 2024. Foreign currency loss increased year over year due to rate volatility and timing of intercompany and hedge settlement activitie s. Provision for Income Taxes Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Provision for income taxes $ 4,968 $ 6,250 (21) % As a percentage of income before income taxes 18 % 21 % Our effective tax rate was 18% and 21% in the first fiscal quarter of 2024 and 2023, respectively. The primary reason for the decrease in the effective rate was due to discrete tax benefits related to stock-based compensation and the statute of limitations expiring on uncertain tax positions in the first fiscal quarter of 2024. There were no significant discrete tax items in the first fiscal quarter of 2023. Net Income Three Months Ended (In thousands) February 29, 2024 February 28, 2023 % Change Net income $ 22,639 $ 23,674 (4) % As a percentage of total revenue 12 % 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. 27 Annualized Recurring Revenue (ARR) We provide 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 and comprises the vast majority of our total revenue. 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, both public cloud instances 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 annualized 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 $571.0 million and $570.0 million as of February 29, 2024 and February 28, 2023, respectively, remaining constant year-over-year. 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 defined in accordance with GAAP. Our net retention rates have generally ranged between 99% and 102% for all periods presented. Our high net retention rates illustrate our predictable and durable top line performance. Liquidity and Capital Resources Cash and Cash Equivalents (In thousands) February 29, 2024 November 30, 2023 Cash and cash equivalents $ 133,222 $ 126,958 The increase in cash and cash equivalents of $6.3 million from the end of fiscal year 2023 was due to cash inflows from operations of $70.5 million, $1.7 million in cash received from the issuance of common stock. These cash inflows were offset by cash outflows of $30.0 million for the repayment of the revolving line of credit, repurchases of common stock of $22.5 million, dividend payments of $8.2 million, payments of debt obligations of $3.4 million, the effect of exchange rates on cash of $1.5 million, and purchases of property and equipment of $0.3 million. Except as described below, there are no limitations on our ability to access our cash and cash equivalents. As of February 29, 2024, $73.0 million of our cash and cash equivalents was held by our foreign subsidiaries. Foreign cash includes unremitted foreign earnings, which are invested indefinitely outside of the U.S. As such, the foreign cash 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. 28 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 29, 2024 and February 28, 2023, we repurchased and retired 0.4 million shares for $22.5 million and 0.3 million shares for $15.0 million, respectively. The shares were repurchased in both periods as part of our Board of Directors authorized share repurchase program. As of February 29, 2024, there was $171.5 million remaining under the current authorization. On March 1, 2024, the Company repurchased and retired 0.4 million shares for $25.0 million. Dividends On March 19, 2024, our Board of Directors declared a quarterly dividend of $0.175 per share of common stock, which will be paid on June 17, 2024 to stockholders of record as of the close of business on June 3, 2024. 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: Restructuring Charges to the condensed consolidated financial statements. Long-term Debt and Credit Facility See Note 7: Debt to the condensed consolidated financial statements. Cash Flows From Operating Activities Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Net income $ 22,639 $ 23,674 Non-cash reconciling items included in net income 41,335 27,687 Changes in operating assets and liabilities 6,530 (4,594) Net cash flows from operating activities $ 70,504 $ 46,767 In the first three months of fiscal year 2024, operating cash flows increased due to higher billings and collections. Our gross accounts receivable as of February 29, 2024, decreased by $36.6 million from the end of fiscal year 2023. Our days sales outstanding (DSO) in accounts receivable increased to 50 days from 42 days in the first fiscal quarter of 2023 due to the timing of billings. Cash Flows Used in Investing Activities Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Net investment activity $ — $ (14,862) Purchases of property and equipment (309) (385) Payments for acquisitions, net of cash acquired — (355,821) Net cash flows used in investing activities $ (309) $ (371,068) 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 three months of fiscal year 2024, we purchased $0.3 million of property and equipment. In the first quarter of fiscal year 2023 we had payments for acquisitions net of cash acquired of $355.8 million, and $0.4 million of purchases of property and equipment. 29 Cash Flows (Used in) From Financing Activities Three Months Ended (In thousands) February 29, 2024 February 28, 2023 Proceeds from stock-based compensation plans $ 7,583 $ 9,357 Repurchases of common stock (22,500) (15,000) Proceeds from the issuance of debt — 195,000 Repayment of revolving line of credit (30,000) — Principal payment on term loan (3,437) (1,719) Dividend payments to stockholders (8,171) (8,023) Other financing activities (5,890) (4,817) Net cash flows (used in) from financing activities $ (62,415) $ 174,798 We received $7.6 million from the exercise of stock options and the issuance of shares under our employee stock purchase plan as compared to $9.4 million in the first three months of fiscal year 2023. During the first three months of fiscal year 2024, we did not receive any proceeds from the issuance of debt, while in the same period in fiscal year 2023 we received $195.0 million in net proceeds from the issuance of debt to partially fund the acquisition of MarkLogic. Further, we repurchased $22.5 million of our common stock under our share repurchase plan compared to $15.0 million in the same period of the prior year. We also made payments on our long-term debt of $33.4 million (including a $30.0 million repayment on the revolving line of credit) in the first three months of fiscal year 2024 and $1.7 million in the same period in 2023. Finally, we made dividend payments of $8.2 million to our stockholders during the first three months of fiscal year 2024 and $8.0 million in the first three months of fiscal year 2023. Liquidity Outlook Cash from operations in fiscal year 2024 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 2023 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 MOVEit Vulnerability As previously reported, on the evening of May 28, 2023, our MOVEit technical support team received an initial customer support call indicating unusual activity within their MOVEit Transfer instance. An investigative team was mobilized and, on May 30, 2023, the investigative team discovered a zero-day vulnerability in MOVEit Transfer (including our cloud-hosted version of MOVEit Transfer known as MOVEit Cloud). A “zero-day vulnerability” is a vulnerability that has been publicly disclosed (e.g., by an independent researcher or threat actor) before the software vendor has an opportunity to patch it. The investigative team determined the zero-day vulnerability (the “MOVEit Vulnerability”) could provide for unauthorized escalated privileges and access to the customer’s underlying environment in both MOVEit Transfer (the on-premise version) and MOVEit Cloud (a cloud-hosted version of MOVEit Transfer that we deploy in both (i) a public cloud format, as well as (ii) for a small group of customers, in customer-dedicated cloud instances that are hosted, separate and apart from the public instances of our MOVEit Cloud platform). We promptly took down MOVEit Cloud for further investigation and notified all then-known current and former MOVEit Transfer and MOVEit Cloud customers in order to apprise them of the MOVEit Vulnerability and alert them to immediate remedial actions. In parallel, our team developed a patch for all supported versions of MOVEit Transfer and MOVEit Cloud, which was released on May 31, 2023, and allowed for the restoration of MOVEit Cloud that same day. We are subject to litigation and governmental investigations related to the MOVEit Vulnerability, for which we have incurred expenses and will incur future costs. We expect our exposure to such expenses and liabilities to be reduced by insurance. 30 Please refer to Note 15: Cyber Related Matters to the Consolidated Financial Statements included in Item 1, Financial Statements for additional details and updates regarding the MOVEit Vulnerability. Recent Accounting Pronouncements Refer to Note 1: Basis of Presentation (Part I, Item 1 of this Form 10-Q) for further discussion.