Progress Software Corporation (NASDAQ:PRGS) Q3 2023 Earnings Call Transcript

Progress Software Corporation (NASDAQ:PRGS) Q3 2023 Earnings Call Transcript September 26, 2023

Progress Software Corporation beats earnings expectations. Reported EPS is $1.08, expectations were $1.

Operator: Good day and welcome to the Progress Software Corporation Q3 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. [Operator Instructions] 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, sir.

Michael Micciche: Oka, great. Thank you, Sherry. Good afternoon, everyone, and thanks for joining us for Progress Software’s third quarter 2023 financial results conference call. On the line with me this afternoon are Yogesh Gupta, President and Chief Executive Officer; and Anthony Folger, our Chief Financial Officer. Before we get started, let’s go over our Safe Harbor statement. During this call, we will discuss our outlook for future financial and operating performance, corporate strategies, product plans, cost initiatives and other information that might be considered forward looking. Such 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 the Risk Factors section in our most recent Form 10-K and 10-Q for the quarter ended May 31, 2023. Progress Software assumes no obligation to update the forward-looking statements included in this call. And additionally, please note that all the financial figures that we are going to reference on this call today are non-GAAP measures unless otherwise indicated. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP figures in our financial results press release, which was issued after the market close today. The document contains additional information related to our financial results for the third quarter of 2023.

And I recommend you reference that for specific details. We have also prepared a presentation that contains supplemental data for our third quarter 2023 results, providing highlights and additional financial metrics. Both the earnings release and the supplemental presentation are available on the Investor Relations section of our website and the address is investors.progress.com. As Sherry mentioned today’s conference will be recorded in its entirety and will be available via replay on the Investor Relations section of our website. And so with that out of the way, Yogesh, I’ll turn it to you.

Yogesh Gupta : Thank you, Mike. Good afternoon, everyone. Thank you for joining us. We’re delighted to have a chance to discuss our fiscal third quarter ‘23 results, share some details about our business and provide our outlook for the remainder of fiscal year ‘23. As you’ve probably seen, Progress delivered another excellent performance in our third quarter during which we hit or exceeded all of our targets. And we have raised our guidance for FY23. So let’s jump right in. Our strong performance in Q3 was driven once again by sustained demand for our products across all geographies, and solid execution from all of our teams, build attention to expenses and total management of our cost structure in an environment of pervasive inflation allowed us to meet our operating margin part.

OpenEdge continues to provide significant splint as our workhorse product while our digital experience products also performed extremely well. In addition, our digital experience products received Gartner’s highest customer choice distinction in the 2023 Voice of the Customer report, evaluating digital experience platforms, which was published at the end of August. MarkLogic is performing in line with our expectations, integration of the businesses on plan. And going forward, we expect MarkLogic to meet the timeline we laid out when the deal closed. This quarter’s out performance again demonstrates that our customers continue to rely on Progress technology to run their mission critical businesses, especially as the level of economic uncertainty increases.

Our employees remain highly engaged and motivated. Our ability to attract and retain top talent remains at industry leading levels. And during this quarter, our employee retention rates improved even further. Anthony will break out all the numbers for you in a minute. But I’m very pleased with our execution on the top and the bottom line, as well as the growth in ARR and our net retention rates which once again came above 100%. Now if you recall back to January of ‘22 on our Q4 ‘21 earnings call, we listed several ways in which progress will show strength through what was then becoming a much different environment than the prior two years, which were broadly dominated by super low interest rates, nonexistent inflation, and Pandemic driven spending.

We discussed the reliability and cost effectiveness of our products and the value they deliver to our customers, especially in more difficult economic circumstances. We also talked how the culture at Progress enables market leading employee retention, which helps us keep our high quality, highly skilled and experienced people who focus intensely on customer success and drive our high customer retention rates. Because of our continued focus on our employees, Progress once again received numerous awards in Q3, including another Stevie for our achievements in corporate social responsibility, and recognition by b2b Media Business Awards for equality, and employees care. Driven by employees efforts, our business has remained largely remarkably steady.

While the overall economy and market has changed significantly. We will continue to stay focused on our execution and remain extremely vigilant in managing expenses in every part of our business. As for M&A, we still believe that the market for great acquisitions is favorable and improving for us. And we’re as busy as ever sourcing and assessing potential acquisitions. Among the trends in the M&A market, the number of private equity deals continued to fall in the quarter, along with the valuations of the companies acquired. And with VC backed companies down grounds are becoming more common, capital invested is shrinking, and leverage is becoming scarce. VC deal sizes have trended down hard in 2023 especially for late stage rounds. And deal counts are even lower than they were in 2017.

So while infrastructure software valuations remain somewhat high, which speaks to the value of the sticky install base and high recurring revenue that comes with good infrastructure products, our corporate development team continues to bat a very encouraging pipeline of targets. In the meantime, we continue to focus on integrating MarkLogic, paying down debt and maintaining adequate financing as we look for the next deal. We’ve been very active and aggressive throughout the year, and we’re ready to pull the trigger again, operationally and financially when we find the right asset. As previously mentioned, for MarkLogic, specifically, the integration remains on track and is nearing completion on our planned timeline. As in every other acquisition, we’ve done so far, we’ve learned some new things and had some new challenges to overcome with MarkLogic.

And we’re extremely satisfied with the progress we’ve made. So all-in-all, the third quarter was right where it should be, and we continue to execute on our total growth strategy. While we aren’t immune to the effects of the current environment that other companies have felt more acutely, we are pleased once again to beat numbers and rate our guidance even in the face of growing macroeconomic uncertainty. Switching gears, after we reported our second quarter back in June, we received a number of questions on how we were using AI, which at that time was making daily headlines. As we know, AI and generative AI are technologies that capture many people’s imaginations, because they offer real potential for operational efficiency gains as well as opportunities for product advancement.

We at Progress have been working pragmatically to use AI, where we see potential tangible benefits to our business. AI has been actually near and dear to my own heart for decades, and I came to the US many years ago, to do a PhD in AI. I hold a patent in the field of neural networks. And while I was CTO at CA, we devoted significant energy to researching AI and used it in a network management product. Many progress products have been using AI long before I became the lead story on CNBC every morning. For example, Flowmon uses analytic AI to detect and predict network anomalies before they negatively impact the business of our customers. Our Sitefinity product, a key component of our digital experience offering offers AI driven customer engagement, and personalization of digital content to drive engagement and conversions.

And Smartlogic, which we recently acquired in our MarkLogic acquisition, perform semantic AI analysis of data. What is new is generative AI or GenAI and large language models or LLM, as they’re called. We view the gen AI opportunity in two broad categories. First developing ways to use GenAI to make progress more efficient, and to be able to grow our pipeline while controlling costs. We started using GenAI to help our people do their jobs more efficiently in many functions, such as finding new customers, providing support, benefits administration, talent management and recruiting, legal and contract management just to name a few. Second, we’re leveraging market opportunities created by GenAI. For example, one of the challenges facing businesses when using GenAI is to augment the large language models with proprietary data in a secure manner to make the output of GenAI specific to that business.

Our data platforms combined with MarkLogic products directly addresses this challenge. Our products make it possible for businesses to augment the genetic LLM so they own information so the output is contextual, and relevant to their specific business, while keeping their proprietary information secure. Another example is to help application developers build applications more easily. Developers in our digital experience business have been recently working on building a conversational interface tool that uses GenAI to automatically generate forms such as a mortgage application say from textual prompts. In both the operational and product categories, our efforts in AI are fueled by the excitement and creativity of our teams. But we will only invest where we believe we can drive real tangible benefits for our business, whether it is product innovation, or efficiency improvement.

Lastly, let me take a moment to discuss the current status of MOVEit. As we detailed in our last earnings call, at the end of May threat actors exploited a zero-day, which is a previously unknown vulnerability in MOVEit to attack the MOVEit environment of our customers. Upon learning of the attack, we quickly patched MOVEit Cloud and created a patch for our on-prem MOVEit transfer customers. Several third party organizations, including cybersecurity experts and industry publications have given Progress high marks for our rapid response. As we indicated in our 8-K filing, MOVEit transfer and MOVEit Cloud represent less than 4% of our revenue. And while we’re incurring expenses related to legal responses and the investigation of this attack, there was minimal impact to our business in the third quarter.

It is too early to assess the impact of any litigation. We will continue to provide updates in our Form 10-Q filing as we did last quarter. I am very proud of our teams for all their efforts in responding to the vulnerability and helping our customers while still delivering great results across the business. Going forward, as always, we will continue to focus on our customers and keep taking steps to help mitigate risks throughout the company. So to wrap it up, our third quarter was an excellent quarter for Progress. We’re moving ahead with our total growth strategy meeting our goals in the overall business while nearing the full integration of MarkLogic. We remain well capitalized and continue to hunt aggressively for the next right M&A deal.

With that, let me turn it over to Anthony for detailed financial review and outlook. Anthony?

Anthony Folger: Thanks Yogesh. Good afternoon, everyone, and thanks for joining our call. As Yogesh mentioned, the third quarter was another strong one for Progress, further demonstrating the strength and durability of our business. Jumping right into the numbers, I’d like to start with ARR, which we believe provides the best view into our underlying performance. We closed Q3 with ARR of $577 million, which represents approximately 18% growth on a year-over-year basis, and 2% pro forma growth on a year-over-year basis. To be clear, the pro forma results include MarkLogic in both periods. The growth in ARR was driven by multiple products, and was again bolstered by strong net retention rates just under 101%. In the past, we’ve talked about our R&D investments, our focus on customer success, and the strength and stability of customer demand for our products.

We believe our Q3 net retention rates reflect a healthy mix of all these factors. In addition to our solid ARR performance for the quarter, revenue for the quarter of $176 million was at the high end of the Q3 guidance range we provided back in June, and represents approximately 15% growth on a year-over-year basis. Our strong revenue performance in the quarter was driven by multiple products, including OpenEdge, which continues to perform ahead of our expectations. On a year-over-year basis, our revenue growth was driven by the addition of MarkLogic and stability in the rest of our business, which again this quarter showed slight growth on a year-over-year basis. Turning now to expenses. Our total costs and operating expenses were $107 million for the quarter, an increase of $14 million compared to Q3 of 2022.

The year-over-year increase was driven entirely by the addition of MarkLogic to our business. Operating income was $68 million from the quarter, up $8 million compared to the year ago quarter. And our operating margin was 39%, the same as in the year ago quarter. On the bottom line, our earnings per share of $1.08 for the quarter were $0.06 above the high end of our guidance range. This over performance relative to our expectations was driven by strong 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’ll achieve all our synergy targets by the end of this fiscal year. Moving on to a few balance sheet and cash flow metrics.

We ended the quarter with cash, cash equivalents and short-term investments of $138 million and debt of $763 million for a net debt position of $625 million. This represents net leverage of approximately 2.3x using our forecasted fiscal year 2023 adjusted EBITDA. I’d also like to mention that during the third quarter, we paid down $30 million against the revolving line of credit that we use to partially fund the acquisition of MarkLogic, bringing the outstanding balance on our revolving line of credit to $140 million at the end of the quarter. Our DSO for the quarter was 49 days, or approximately flat compared to the year ago quarter. Deferred revenue was $280 million at the end of the third quarter down slightly from the second quarter reflecting normal seasonality in our business.

Adjusted free cash flow was $48 million for the quarter, an increase of over $8 million or 21% from the year ago quarter. During the third quarter, we did not repurchase any shares of Progress stock. So at the end of Q3, we had $198 million remaining under our current share repurchase authorization. Okay, now I’ll turn to our outlook. Despite news of a more challenging macroenvironment, we continue to see strength in the demand for our solutions. With that, starting with the full year 2023. We are increasing our revenue guidance by $1 million at the midpoint and expect revenue to be between $692 million and $698 million. We’re maintaining our outlook for operating margin for the year of approximately 38% to 39%. We’re maintaining our outlook for adjusted free cash flow and are tightening the range to be between $177 million and $183 million.

And we are increasing our outlook for earnings per share to be between $4.20 and $4.26, an increase of $0.03 at the midpoint. Our guidance for full year EPS assumes a tax rate of approximately 20% and approximately 45 million shares outstanding. For the fourth quarter of 2023, we expect revenue between $171 million and $177 million and earnings per share of between $0.87 and $0.93. In closing, we’re excited to deliver another strong quarter of financial results across the board, a continuation of the trend that we saw for much of 2022 and the first half of 2023. We’re thrilled to see the MarkLogic integration progressing. And we believe we’re on track to deliver a strong Q4 and position ourselves well for our fiscal 2024. With that, I’d like to open the call for questions.

Operator: [Operator Instructions] Our first question will come from the line of Ray McDonough with Guggenheim Securities.

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Q&A Session

Ray McDonough: Great, thanks for taking the questions. Maybe you guess for you, given the nature of solutions that you guys provide, the Progress provides, it’s not surprising that OpenEdge has exhibited strength throughout the weak macroenvironment, but it seems like the whole business as you highlighted has been stable. And MarkLogic, again, it makes sense. Some of the other products makes sense. But is there any area of your portfolio where you’re actually seeing a macro related impact? And if so, how might that be manifesting? And how should we think about the difference in buying behavior? Maybe between some of your more stable install bases?

Yogesh Gupta : Hey, Ray, thanks, good question. It’s, we’re actually not seeing challenges in any aspect of our business on the product lines, to be honest, we are hearing from our field organization that they’re noticing that large projects that maybe customers were looking at they might be looking at them more closely. But really from our perspective our business continues to be strong, we are seeing strength across the board. And that is really delightful and wonderful to see, as Ray, right our products are truly about making organizations more effective, more efficient, run their business better. They underpin mission critical environments. So it just — it is a wonderful business to be in. And I think the strength of the Progress business comes through in our results.

Ray McDonough: That all make sense, and I guess you were pretty clear, Yogesh that you’re kind of on the hunt for your next acquisition or your next target. If we kind of think through the size of targets, or the size of an acquisition that you might be willing to do, should we be thinking that there’s probably room to do a larger acquisition, maybe like MarkLogic, or a couple more smaller acquisitions? I guess the question is, how should we be thinking about the size of future acquisitions? And then in light of the increasing cost of capital, just with interest rates rising, how do you think about the hurdle rate for a future acquisition in terms of the returns? I know, you guys are very focused on return on invested capital. So I’m assuming your weighted average cost of capital is changing a little bit as interest rates rise, but just wondering, how are you thinking about those two things together?

Yogesh Gupta : Absolutely. Happy to happy to answer those. And maybe Anthony can help with the second part of — the second aspect of the question with respect to hurdle rate. On the first part, Ray, as we have said, right we, our ideal sweet spot is to buy companies that are, let’s say, in the 10% to 20%- 25% of our revenue size, right, and that’s, and that goes up every time we buy another company, because our overall our base goes up, right. So our goal is over the long haul is to double our business in five years. And so effectively we might find a business that is 10%, in which case, we might find two of them, or maybe even slightly less than 10%. And we might find two of them, we might find something that is closer to 20% or even 25%.

Some of it is, in fact, a lot of it depends on what comes to market, right. So the size of assets coming to market often range from even sub $50 million, which we look at, sometimes not as much as we used to, given our current size. But really, the $50 million to $150 million right now is our sweet spot. So in terms of revenue of the target, but that doesn’t mean that we don’t look at somewhat smaller, that doesn’t mean that we don’t look at somewhat bigger. The goal they’re raised for is more operational, rather than the financial side for my perspective, can we bring in a business and integrated easily, can we do it in a way that our culture survives? Can we do it in a way that people realize that we’re going to do things to Progress way going forward, which becomes really hard if you do like whatever it’s called merger of equals or some nonsense like that.