Progress Software Corporation — Q2 2014 Form 10-Q
Business context and period: Global business-software company focused on application development, data integration and analytics, and expanding its cloud Platform-as-a-Service offering, Progress Pacific. This unaudited report covers the quarter and six months ended May 31, 2014; comparisons are with the corresponding 2013 periods. The company operates as one reportable segment.
Financial performance
| Metric | Three months ended May 31 | Six months ended May 31 |
|---|---|---|
| Revenue | $80.8 million, down 1% reported (2% at constant currency) | $155.4 million, down 6% |
| Software license revenue | $28.0 million, down 5% | $50.3 million, down 15% |
| Maintenance and services revenue | $52.8 million, up 1% | $105.1 million, down 1% |
| Gross profit / margin | $73.4 million / 91%, versus 89% | $140.1 million / 90%, versus 89% |
| Operating income / margin | $20.3 million / 25%, versus $14.4 million / 17% | $34.3 million / 22%, versus $30.2 million / 19% |
| Continuing-operations net income | $12.8 million, versus $8.1 million | $23.9 million, versus $18.0 million |
| Diluted EPS from continuing operations | $0.25, versus $0.15 | $0.46, versus $0.31 |
| Operating cash flow | Not presented separately for the quarter | $42.5 million, versus cash used of $11.4 million |
For the six-month comparison, reported net income was $23.9 million versus $35.0 million in 2013; the earlier period included $17.1 million of income from discontinued operations, including a divestiture gain. No discontinued-operations income was reported in 2014.
Balance sheet, liquidity and cash flow
- At May 31, 2014, cash and cash equivalents were $202.0 million and short-term investments were $24.6 million, totaling $226.6 million, down from $231.4 million at November 30, 2013.
- Total assets were $673.3 million; shareholders’ equity was $518.5 million. No amounts were outstanding on the $150 million revolving credit facility; $0.8 million of letters of credit were outstanding. The company reported compliance with covenants by a significant margin.
- Six-month investing cash use was $9.6 million, including $12.5 million for the Modulus acquisition and $6.1 million for property and equipment, partly offset by investment maturities and $3.3 million of divestiture-related proceeds. Financing cash use was $31.3 million, including $35.0 million of share repurchases.
- Cash, cash equivalents and short-term investments held by foreign subsidiaries totaled $87.4 million; some earnings were considered permanently reinvested and not available for domestic operations without tax consequences.
- Additional $25.1 million of auction-rate securities were classified as long-term due to limited liquidity. Their fair value reflected $3.7 million of temporary impairment versus par value.
Material changes and management commentary
- License revenue remained the main weakness, particularly DataDirect in North America and, for the six-month period, DataDirect and OpenEdge in North America and EMEA. Management said sales-coverage changes for DataDirect and Corticon showed improvement in Q2, but could take time to affect results.
- Operating income improved as operating expenses fell, including lower sales and marketing and general and administrative costs after workforce reductions and restructuring. Product-development expense increased as the company invested in Pacific; it was 20% of revenue for the six months versus 17% a year earlier.
- On May 13, 2014, the company acquired PaaS provider Modulus for $15.0 million of stated consideration: $12.5 million cash and contingent consideration. The preliminary purchase-price allocation included $6.4 million goodwill and $7.3 million of purchased technology. Modulus results were not significant to the reported period.
- The company repurchased 1.6 million shares for $35.0 million in the first six months under a new $100 million authorization. Approximately $65.0 million remained available at quarter end.
- Revenue backlog was $112.5 million, down from $119.3 million a year earlier, including deferred revenue of $100.9 million and multi-year licensing arrangements of $11.6 million. Management cautioned that backlog is not a standardized or necessarily reliable indicator of future performance.
Outlook, risks and contingencies
- Management gave no specific numerical revenue or earnings guidance in the provided filing text. It expects cash, operating cash flows and available credit to fund operations and foreseeable cash requirements for at least the next 12 months.
- Management described the cloud/PaaS transition as early-stage, requiring continued investment in product development and cloud operations; sustainable revenue increases may not be foreseeable in the near term.
- Key stated risks include market acceptance of the strategy and products, competition and pricing pressure, successful transition to cloud and subscription models, acquisitions and realization of expected benefits, channel-partner execution, international operations and foreign-exchange movements, and uncertain economic conditions.
- A significant deterioration in the credit quality of auction-rate-security issuers or insurers could require an impairment charge. The company stated it believed it could hold the securities through the estimated recovery period.
- Routine legal proceedings and claims were disclosed; management did not believe their outcomes would materially affect financial position, results or cash flows. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
- New revenue-recognition guidance (ASU 2014-09) could affect the timing and amounts of recognized revenue; the company was evaluating its impact. Adoption was required for annual periods beginning after December 15, 2016, with early adoption prohibited.
Most important facts for investors to verify
- Whether license-revenue declines, especially in DataDirect and OpenEdge, stabilize and whether the Q2 sales-coverage changes produce sustained improvement.
- Whether Pacific, including the Modulus technology, gains market acceptance and generates revenue sufficient to justify continued development and operating investment.
- Whether margin and cash-flow improvements persist, noting that the year-over-year operating-cash-flow comparison was affected by unusually large prior-year tax and restructuring payments.
- The liquidity, valuation assumptions and potential impairment exposure of the $25.1 million auction-rate-security portfolio.
- Execution of the $100 million repurchase authorization, acquisition-related contingent obligations, and the effect of share repurchases on cash and share count.
- Trends in backlog, deferred revenue, maintenance renewals and foreign-exchange exposure, and the eventual effect of the new revenue-recognition standard.