Progress Software Corporation — Q1 FY2013 10-Q
Reporting period: Three months ended February 28, 2013; comparisons are with the three months ended February 29, 2012. Amounts are in U.S. dollars. Results reflect the shift to a single continuing business after divesting non-core product lines; prior-period operating results were reclassified to discontinued operations.
Financial performance
| Metric | Q1 FY2013 | Prior period | Change/comment |
|---|---|---|---|
| Revenue | $89.3 million | $87.2 million | Up 2% reported; up 3% constant currency |
| Software license revenue | $32.7 million | $31.9 million | Up 2% |
| Maintenance and services revenue | $56.6 million | $55.3 million | Up 2%; maintenance rose 3%, professional services declined 1% |
| Gross profit / margin | $77.9 million / 87% | $76.6 million / 88% | Gross profit up 2%; margin down 1 percentage point |
| Operating income / margin | $14.7 million / 16% | $19.2 million / 22% | Down 23%; margin down 6 points |
| Continuing-operations income | $9.1 million; $0.16 diluted EPS | $12.0 million; $0.19 diluted EPS | Down 24% |
| Net income | $31.1 million; $0.53 diluted EPS | $7.5 million; $0.12 diluted EPS | Includes $22.0 million from discontinued operations, substantially reflecting divestiture gains |
| Operating cash flow | $(25.1) million | $38.5 million | Primarily affected by divestiture-related tax payments and bonus payments |
| Cash, equivalents and short-term investments | $321.4 million | $355.2 million at Nov. 30, 2012 | Down $33.8 million during the quarter |
Continuing-operations results exclude the divested product lines. Q1 discontinued operations included $5.6 million of revenue and a $35.1 million pretax gain on sales; the reported net contribution was $22.0 million after tax and other discontinued-operation results. Accordingly, reported net income is not a direct measure of recurring operating performance.
Balance sheet, liquidity and capital allocation
- Total assets were $780.4 million and shareholders’ equity was $595.8 million at February 28, 2013. The filing reports no outstanding borrowings under the $150 million revolving credit facility and $0.5 million of letters of credit.
- The company said it expected cash, operating cash flows and available credit to fund foreseeable needs for at least 12 months. It reported compliance with credit-facility covenants by a significant margin.
- Q1 cash decreased by $22.6 million. Investing cash flow was $83.3 million, including $73.4 million of net divestiture proceeds; financing cash flow was $(80.0) million, including common-stock repurchases.
- The company repurchased 4.783 million shares for $106.3 million during the quarter. It had repurchased 9.3 million shares for $194.7 million under the 10b5-1 plan through quarter-end, and reported $219.5 million of plan repurchases through March 28, 2013.
- Cash, cash equivalents and short-term investments held by foreign subsidiaries totaled $142.1 million; some earnings were considered permanently reinvested and not available for domestic operations without repatriation.
- Auction-rate securities had a $26.4 million fair value and $4.2 million of accumulated temporary impairment. They lacked short-term liquidity; management said it could hold them through the estimated recovery period.
Material changes and management commentary
- All ten identified non-core product-line divestitures were completed by the end of Q1 FY2013, for aggregate purchase consideration of approximately $130 million. The strategy centers investment on OpenEdge, DataDirect and Decision Analytics and a planned cloud application-platform-as-a-service offering.
- North American revenue increased 10%; EMEA rose 2% reported; Latin America declined 10% reported (1% constant currency); and Asia Pacific declined 24%. Management cited a sales-leadership transition as an additional factor in Asia Pacific.
- Operating expenses rose 10%. Product development increased 29%, partly from investment in product development and costs previously supporting divested lines; sales and marketing rose 8%, also reflecting absorbed support costs. Management said these transitional costs were pressuring margins and could persist until costs are reduced or absorbed.
- The 2012 restructuring generated $1.4 million of Q1 charges. Management expected approximately $4.4 million of additional costs through the rest of FY2013; excess-facilities payments may continue through FY2016.
- Management stated that sustainable revenue increases might not be foreseeable in the near term while product investments take time to affect performance. It cited customer deal delays associated with strategic-plan uncertainty and weaker macroeconomic conditions, particularly in Europe.
- Revenue backlog was $141.7 million versus $185.7 million a year earlier, but the filing cautions that the comparison is not comparable because prior-period deferred revenue included divested businesses. Some backlog is off-balance-sheet and not subject to the same accounting controls as reported financial-statement data.
Risks, contingencies and unusual items
- Disclosure-control material weakness: Controls over documenting customer and partner contractual terms were not effective, resulting in improper revenue timing on certain transactions that management said were immaterial to the financial statements. Disclosure controls were judged ineffective at the reasonable-assurance level. Remediation was underway but the weakness was not yet considered remediated.
- Divestiture indemnity: An indemnification obligation related to the Artix, Orbacus and Orbix sale was recorded at $1.0 million; the maximum obligation is $11.3 million. The term is indefinite, though management expected substantial resolution within 12 months.
- Foreign exchange: Q1 included a $1.1 million net foreign-currency loss, primarily from exchange-rate movements affecting intercompany balances. International operations represented 54% of revenue.
- Restructuring and execution: The company identified risks from executing its strategic shift, disruption to customers and employees, absorbing retained overhead after divestitures, product acceptance, competition, pricing and economic conditions.
- Other matters: Management reported ordinary-course legal proceedings with no expected material effect. It also noted that deterioration in ARS issuer or insurer credit could require an impairment charge.
Key facts for investors to verify
- Whether the revenue-recognition control weakness is fully remediated and whether subsequent filings disclose any further affected transactions.
- Continuing-business revenue, operating margins and cash generation, separating recurring results from divestiture gains and restructuring costs.
- Progress on reducing or absorbing costs retained after the divestitures, and actual restructuring charges and cash payments versus estimates.
- The status and potential exposure of the $11.3 million maximum divestiture indemnity and the liquidity or valuation of auction-rate securities.
- Share-repurchase pace and funding relative to operating cash flow, covenant requirements and the company’s liquidity outlook.