Business Context and Reporting Period
Company: Progress Software Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three and six months ended May 31, 2009 (Fiscal Year 2009)
Business Overview: Progress Software develops and distributes software for application development, deployment, integration, and management. The company operates through three reportable segments: OpenEdge, Enterprise Infrastructure, and Data Infrastructure. The period reflects the impact of the global economic crisis, a strengthening U.S. dollar, and the integration of recent acquisitions (IONA, Mindreef, Xcalia).
Key Financial Metrics
| Metric (in thousands) | Three Months Ended May 31, 2009 | Six Months Ended May 31, 2009 |
|---|---|---|
| Total Revenue | $117,047 | $237,907 |
| Gross Profit | $94,454 | $190,936 |
| Income from Operations | $11,542 | $16,260 |
| Net Income | $6,907 | $10,558 |
| Diluted EPS | $0.17 | $0.26 |
| Cash and Equivalents (May 31, 2009) | $133,903 | - |
| Total Cash & Short-Term Investments | $148,735 | - |
| Long-Term Debt (less current portion) | $849 | - |
| Operating Cash Flow (Six Months) | - | $17,921 |
Margins (Six Months 2009): Gross Margin was 80%; Operating Margin was 7%; Net Margin was 4%.
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 9% ($10.9M) for the quarter and 5% ($11.6M) for the six-month period compared to the prior year. The decline was driven by a 23% drop in OpenEdge revenue and unfavorable foreign currency translation (strengthening U.S. dollar). Excluding currency effects, revenue would have increased 1% for the quarter and 5% for the six months.
- Profitability Compression: Net income fell 52% for the quarter and 61% for the six months. Operating income decreased 44% (quarter) and 57% (six months). This was primarily due to lower gross profit and increased operating expenses.
- Expense Increases: Operating expenses rose 5% for the six months, driven by a $5.4M restructuring charge, increased amortization of acquired intangibles (due to IONA and Mindreef acquisitions), and higher headcount-related costs.
- Segment Performance: While OpenEdge revenue declined significantly, Enterprise Infrastructure revenue grew 48% (quarter) and 68% (six months), largely due to the inclusion of IONA products. Data Infrastructure revenue remained relatively flat.
- Cash Flow: Net cash provided by operating activities decreased 62% to $17.9M for the six months, attributed to lower profitability and changes in working capital (specifically a $28.2M decrease in accounts payable and accrued expenses).
Outlook, Risks, and Unusual Items
- Management Commentary: Management cites the global economic crisis as a primary risk, noting customers are delaying or reducing investments. They expect license revenue for the remainder of 2009 to be below 2008 levels. The strengthening U.S. dollar continues to negatively impact reported results.
- Restructuring: The company incurred $5.4M in restructuring expenses in the first six months of 2009 related to severance and facility costs. Approximately $2.5M remains to be paid.
- Auction Rate Securities (ARS): The company holds $56.2M in ARS classified as non-current due to liquidity issues in the market. A temporary impairment of $8.8M was recorded in accumulated other comprehensive income. Management believes the impairment is temporary and does not expect it to affect operations.
- Executive Changes: A separation agreement was reached with former CEO Joseph W. Alsop, effective June 30, 2009. This includes the acceleration of vesting for 254,464 unvested options and an extension of the exercise period for 1.75M options, expected to result in approximately $5M of stock-based compensation expense in Q3 2009.
- Internal Controls: The company disclosed a material weakness in internal controls over financial reporting related to the accumulation of data for the statement of cash flows. An error was identified and corrected prior to filing, resulting in a $12.9M reclassification between operating and investing cash flows.
- Legal Proceedings: The SEC investigation into historical stock option granting practices was concluded with no enforcement action recommended. All related shareholder derivative lawsuits were settled in September 2008.
Investor Verification Checklist
- Revenue Quality: Verify the sustainability of the revenue decline in the core OpenEdge segment versus the growth in acquired segments (Enterprise Infrastructure).
- Cash Flow Accuracy: Review the remediation plan for the material weakness in cash flow reporting controls to ensure future data reliability.
- ARS Liquidity: Monitor the status of the $56.2M in Auction Rate Securities and any potential future impairment charges if credit ratings deteriorate.
- Executive Compensation Impact: Assess the impact of the $5M stock-based compensation charge related to the former CEO's separation agreement on Q3 2009 earnings.
- Foreign Exchange Exposure: Evaluate the sensitivity of future earnings to fluctuations in the Euro and British Pound, given that over 50% of revenue is generated outside North America.