Progress Software Corporation — Q3 2018 Form 10-Q
Reporting period: Unaudited quarter and nine months ended August 31, 2018; comparisons are with the corresponding 2017 periods. Amounts below are in U.S. dollars.
Business context
Progress sells software licenses and related maintenance and services through three segments: OpenEdge, Data Connectivity and Integration, and Application Development and Deployment. Its strategy emphasizes “Cognitive Applications,” cloud offerings, and a streamlined operating model. More than half of worldwide license revenue is generated through indirect channel partners.
Financial performance and liquidity
- Q3 revenue: $95.7 million, down 2% reported and 1% at constant currency. Software license revenue fell 5% to $27.2 million; maintenance and services were essentially flat at $68.5 million.
- Nine-month revenue: $285.8 million, up 2% reported and flat at constant currency. Maintenance and services increased 2% to $206.8 million; license revenue increased 1% to $79.0 million.
- Profitability: Q3 gross profit was $79.0 million, with an 83% gross margin, versus $79.2 million and 81% a year earlier. Operating income rose 9% to $22.2 million (23% margin); net income rose 50% to $16.7 million, or $0.37 diluted EPS. For nine months, operating income increased 48% to $61.7 million (22% margin), and net income increased 115% to $45.1 million, or $0.97 diluted EPS.
- Segment trends: Q3 OpenEdge revenue was approximately flat at $68.0 million; Data Connectivity and Integration fell 15% to $7.6 million; Application Development and Deployment fell 1% to $20.1 million. Nine-month OpenEdge revenue grew 3%, while Data Connectivity and Integration declined 8% and Application Development and Deployment grew 1%.
- Cash flow: Nine-month operating cash flow was $97.0 million, versus $73.2 million. Investing activities provided $4.3 million, compared with $81.0 million used in 2017, when acquisitions required $77.1 million. Financing activities used $128.1 million, including $110.0 million of share repurchases, $19.5 million of dividends, and $4.6 million of debt principal payments.
- Cash and liquidity: Cash, cash equivalents, and short-term investments totaled $137.9 million at August 31, down from $183.6 million at November 30, 2017. Management believes cash, operating cash flow, and available credit are sufficient for foreseeable needs for at least 12 months. $36.8 million of cash and investments was held by foreign subsidiaries and intended to remain permanently invested abroad.
- Debt: Term-loan principal was $119.1 million; $6.2 million was due within 12 months. The $150 million revolving facility had no borrowings and $1.3 million of letters of credit outstanding. The facility rate was 3.63%; the company reported compliance with its financial covenants. Cash and investments exceeded reported debt principal by approximately $18.8 million.
- Other indicators: Total revenue backlog was $158.5 million, down from $160.5 million a year earlier. Total deferred revenue was $144.8 million. Accounts-receivable DSO improved to 43 days from 48 days in Q3 2017.
Material changes versus prior periods
- Q3 revenue declined, primarily reflecting lower license sales and the stronger U.S. dollar; nine-month reported growth was driven partly by favorable currency effects, while constant-currency revenue was flat.
- Operating income improved substantially, reflecting the 2017 workforce and cost-reduction actions and, for the nine-month comparison, higher revenue and much lower restructuring expense ($2.4 million versus $18.7 million).
- Lower effective tax rates materially contributed to net-income growth: 17% in Q3 and 21% for nine months, versus 41% and 44%, respectively, in 2017.
- The company repurchased $110.0 million of stock in the first nine months, versus $43.9 million in the prior-year period; outstanding shares declined year over year.
Outlook, commentary, risks, and unusual items
- No specific revenue or earnings guidance is provided in the supplied filing text. Management targets returning approximately 50% of annual operating cash flow through repurchases and 25%–30% through dividends. It expected approximately $10 million of additional repurchases in the remainder of FY2018 and the remaining $100 million authorization in FY2019, subject to market conditions and management discretion.
- After quarter-end, the board approved an 11% dividend increase, from $0.14 to $0.155 per share, payable December 17, 2018. The company may change or discontinue dividends or repurchases.
- The company recorded provisional tax benefits related to U.S. tax reform: $1.4 million in Q1 and a further $0.6 million in Q3 for deferred-tax remeasurement, plus a $0.9 million Q3 discrete benefit related to tax credits and deductions. Its accounting for the law was not complete; estimates could change.
- Fiscal 2017 restructuring reduced the workforce by more than 20%. Management expected additional facility-related costs through FY2019 but did not expect them to be material. The remaining restructuring accrual was $0.6 million.
- Management plans to adopt the new revenue standard (ASC 606) on December 1, 2018 using the full retrospective approach. It anticipates earlier recognition for certain license arrangements, including perpetual licenses sold with maintenance and term licenses with extended payment terms; the complete financial impact was still being assessed.
- Key risks include revenue and license-sales volatility, reliance on OpenEdge and indirect channel partners, currency movements, competition and product-development execution, cloud/subscription transition risks, cybersecurity and privacy exposure, acquisition execution, and debt covenant or cash-flow constraints. Q3 foreign-currency losses were $0.9 million; nine-month losses were $2.0 million, though derivative results substantially offset related exposures.
- Ordinary-course legal claims were disclosed; management did not expect them to materially affect financial position, results, or cash flows. Disclosure controls were judged effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether license revenue stabilizes, particularly in Data Connectivity and Integration, and whether OEM renewal timing explains the segment decline.
- Underlying operating and cash-flow trends after separating restructuring savings, foreign-exchange effects, share-based compensation, and tax benefits.
- The final tax-reform accounting and the actual transition-tax/deferred-tax consequences.
- The quantified effect of ASC 606 adoption on reported revenue, deferred revenue, and comparability, once disclosed.
- Repurchase and dividend execution relative to operating cash generation, alongside scheduled debt repayments and covenant headroom.
- Progress on cloud/subscription and Cognitive Applications strategies, and the conversion of reported backlog into recognized revenue.