Progress Software Corporation — Q2 FY2019 Form 10-Q
Reporting period: Three and six months ended May 31, 2019. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise stated. Prior-year comparisons reflect retrospective adoption of ASC 606.
Business context
Progress sells software licenses and related maintenance and services through direct and channel-partner relationships. Its three segments are OpenEdge, Data Connectivity and Integration, and Application Development and Deployment. On April 30, 2019, Progress acquired Ipswitch, adding network-management and secure file-transfer products; Ipswitch results are included in OpenEdge from the acquisition date.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $100.0 | $92.9 | $189.5 | $188.3 |
| Gross profit / margin | $82.4 / 82% | $76.2 / 82% | $155.9 / 82% | $154.7 / 82% |
| Operating income / margin | $14.7 / 15% | $18.6 / 20% | $30.2 / 16% | $37.7 / 20% |
| Net income / margin | $8.2 / 8% | $12.9 / 14% | $17.6 / 9% | $26.6 / 14% |
| Diluted EPS | $0.18 | $0.28 | $0.39 | $0.57 |
| Operating cash flow | — | $65.1 | $73.7 |
Q2 revenue increased 8% year over year (10% at constant currency); six-month revenue increased 1% (3% at constant currency). Software-license revenue rose 32% in Q2 and 8% for six months, while maintenance and services were flat in Q2 and down 2% for six months. Q2 Data Connectivity and Integration revenue rose sharply to $12.9 million from $3.4 million, primarily due to OEM renewal timing. OpenEdge and Application Development and Deployment revenues declined in the six-month period.
Net income declined 37% in Q2 and 34% for six months. Management attributed lower operating income primarily to higher operating expenses, acquisition-related amortization, restructuring and acquisition costs; higher interest expense also reflected acquisition debt. The effective tax rate was 34% in Q2 and 32% for six months, versus 25% and 23%, respectively, in the prior-year periods.
Balance sheet, cash flow and capital allocation
- At May 31, 2019, cash, cash equivalents and short-term investments totaled $128.6 million, down from $139.5 million at November 30, 2018. Cash and cash equivalents were $103.2 million.
- Long-term debt had a $301.0 million principal balance; the balance-sheet carrying amount was $298.2 million, including current and long-term portions. The term loan bears variable interest; the reported rate was 4.06%. The facility matures April 2024. No revolving loans were outstanding; $1.8 million of letters of credit were outstanding.
- Operating cash flow was $65.1 million, versus $73.7 million in the prior-year half. Investing cash outflow was $211.3 million, including $225.3 million paid for Ipswitch, partly offset by $6.1 million of property-sale proceeds. Financing cash inflow was $145.6 million, including $185.0 million of debt proceeds.
- Progress repurchased $25.0 million of shares and paid $13.9 million in dividends in the first half. Repurchases were suspended for the remainder of FY2019; management expected to resume them in FY2020. A quarterly dividend of $0.155 per share was declared for payment in September 2019.
- Management said available cash, operating cash flows and credit-facility availability should be sufficient for foreseeable needs for at least 12 months. Foreign subsidiaries held $29.7 million of cash and investments, which management did not expect to need to repatriate.
Material changes, outlook and risks
- Ipswitch acquisition: Purchased for approximately $225 million in cash, funded with existing cash and new borrowing. Ipswitch contributed $3.3 million of reported revenue after closing. Purchase accounting is preliminary; recorded goodwill was $117.7 million, and acquired identifiable intangible assets were approximately $109.3 million. The seller also received approximately $2.0 million in restricted stock tied to a three-year non-compete agreement.
- Restructuring: Acquisition-related restructuring generated $2.7 million of Q2 expense. Progress expected further employee and facility-consolidation costs in FY2019 and FY2020; $2.3 million of the related reserve remained at May 31.
- Accounting: ASC 606 was adopted retrospectively from December 1, 2018, changing the timing of some license revenue recognition and increasing unbilled receivables. The filing states adoption did not affect total cash flows. ASU 2016-16 adoption reduced opening retained earnings by $3.4 million.
- Outlook: The filing provides no specific quarterly or full-year revenue or earnings guidance. Management cited continued acquisition evaluation and stated that future cash uses could change if additional transactions are completed.
- Risks and contingencies: Management highlighted revenue forecasting and quarterly variability, foreign-exchange exposure, reliance on OpenEdge and channel partners, competition and product-development execution, cloud-transition risks, cybersecurity and privacy, and Ipswitch integration and acquisition risks. The company reported compliance with credit-facility financial covenants. Ordinary-course legal proceedings were not expected by management to have a material effect. Disclosure controls were assessed as effective.
Most important facts for investors to verify
- Whether Ipswitch integration delivers expected growth and benefits, and how preliminary purchase-price allocations change.
- Whether license growth and Data Connectivity and Integration renewal timing persist, given declines in other segments and maintenance revenue.
- Whether operating profitability and cash generation recover as acquisition, restructuring and amortization costs develop.
- Debt repayment, variable-rate exposure, covenant headroom and liquidity after the $225 million acquisition.
- Actual restructuring costs and timing, and whether share repurchases resume as management expected in FY2020.