Progress Software Corporation — Q2 FY2015 Form 10-Q
Reporting period: Three and six months ended May 31, 2015. Figures are in U.S. dollars; financial statement amounts below are in millions unless stated otherwise. The filing is unaudited.
Business context and results
Progress provides software for developing, deploying and managing business applications on-premises and in the cloud. Its strategy emphasizes next-generation application development and deployment, including cloud and Platform-as-a-Service offerings. The December 2014 Telerik acquisition expanded that portfolio; Telerik’s results are included from the acquisition date.
Second-quarter revenue rose 10% year over year to $88.8 million, or 19% on a constant-currency basis. Six-month revenue increased 10% to $170.2 million, or 17% on a constant-currency basis. Management attributed much of the increase to Telerik and BravePoint, while a stronger U.S. dollar weighed on reported international revenue.
Key financial metrics
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Revenue | $88.8 | $80.8 | $170.2 | $155.4 |
| Gross profit / margin | $73.1 / 82% | $73.4 / 91% | $136.8 / 80% | $140.1 / 90% |
| Operating income (loss) | $(2.7) | $20.3 | $(13.9) | $34.3 |
| Net income | $5.8 | $12.8 | $4.8 | $23.9 |
| Diluted EPS | $0.11 | $0.25 | $0.09 | $0.46 |
- Maintenance and services revenue was $60.1 million in Q2, up 14%; software license revenue was $28.7 million, up 3%. For the first six months, maintenance and services rose 11% to $116.2 million and license revenue rose 7% to $54.0 million.
- Operating cash flow for the first six months was $57.9 million, compared with $42.5 million. Investing cash outflow was $260.9 million, primarily reflecting $246.3 million of net cash paid for acquisitions. Financing cash inflow was $115.9 million, including $150.0 million of debt proceeds, offset in part by $32.9 million of share repurchases.
- At May 31, cash, cash equivalents and short-term investments totaled $199.1 million, down from $283.3 million at November 30, 2014. Total debt was approximately $146.3 million, including $7.5 million due within 12 months. The $150 million revolving facility was undrawn, apart from $0.5 million of letters of credit.
- Deferred revenue was $129.6 million; reported total revenue backlog, including multi-year licensing arrangements, was $148.6 million versus $112.5 million a year earlier.
Material changes versus prior period
- Despite higher revenue, operating results weakened substantially: the company recorded an operating loss in Q2 and for the six-month period. Higher acquisition-related amortization, maintenance and services costs, sales and marketing, product development and restructuring expenses contributed to the decline.
- Gross margin fell to 82% in Q2 and 80% for the six months, from 91% and 90%, respectively. Management cited acquired intangible amortization, higher service costs following BravePoint, and Telerik purchase accounting: acquired deferred revenue was reduced to fair value, while associated fulfillment costs continued to be incurred.
- The company recorded a $3.9 million impairment charge after deciding to replace its existing cloud-based mobile development technology with technology acquired from Telerik. Six-month restructuring expense was $6.2 million, including this impairment.
- Net income was supported by income tax benefits of $9.5 million in Q2 and $18.8 million for the six months, despite pretax losses. Management attributed the unusual effective tax rates to the geographic mix of earnings and Telerik-related purchase accounting losses in Bulgaria.
Outlook, risks and contingencies
- Management said existing cash, operating cash generation and available credit were expected to cover foreseeable cash needs for at least 12 months. It provided no quantified revenue or earnings guidance in the supplied filing text.
- Management warned that Telerik integration may disrupt FY2015 performance and said further 2015 restructuring costs, including facilities and potential asset impairments, may be incurred. The acquired deferred-revenue accounting effect is expected to ease as that balance is recognized.
- Key stated risks include acquisition integration and realization of expected benefits, competition and pricing pressure, execution in cloud and subscription markets, product acceptance, channel relationships, international operations and foreign-exchange movements. Approximately 40% of revenue is denominated in foreign currencies; management expected currency fluctuations to continue affecting results.
- The secured credit agreement matures December 2, 2019, includes financial covenants and restricts certain actions; the company reported compliance at May 31, 2015. Some $87.5 million of cash and investments held by foreign subsidiaries was considered permanently reinvested and unavailable for domestic operations without repatriation.
- Management did not believe pending ordinary-course legal matters would materially affect financial position, results or cash flows. Standard customer indemnifications were described as having historically insignificant costs.
Most important facts for investors to verify
- Whether Telerik integration produces the expected strategic benefits and improves the Application Development and Deployment segment’s performance; Telerik contributed $13.7 million of six-month revenue and $18.7 million of pretax losses, before acquired-intangible amortization.
- How much of the sharp operating-margin decline reflects acquisition accounting, acquired service costs and restructuring, and how those items trend as integration proceeds.
- The sustainability and composition of operating cash flow, including deferred-revenue growth, collection trends and the cash needs of restructuring and acquisitions.
- Debt repayment, covenant headroom and liquidity after the Telerik acquisition, share repurchases and the use of foreign-held cash.
- Exposure to currency movements, future restructuring or impairment charges, and the assumptions underlying reported backlog and its conversion to revenue.