Progress Software Corporation
Q1 2019 Earnings Call Transcript

Published: 28 Mar 2019

[Operator:]

Good day, and welcome to the Progress Software Corporation Q1 2019 Investor Relations Conference Call. At this time, I'd like to turn the conference over to Mr. Brian Flanagan, please go ahead, sir.

[Brian Flanagan:]

Thank you, Michael. Good afternoon, everyone, and thanks for joining us for Progress Software's fiscal first quarter 2019 earnings call. With me today is Yogesh Gupta, President and Chief Executive Officer; and Paul Jalbert, our Chief Financial Officer. Before we get started, I'd like to remind you that during this call, we will discuss our outlook for future financial and operating performance, corporate strategies, product plans, cost initiatives and other information that might be considered forward-looking. We will also discuss our just announced acquisition of Ipswitch Inc. This forward-looking information represents Progress Software's outlook and guidance only as of today and is subject to risks and uncertainties. Please review our Safe Harbour statement regarding this information, which is available in today's press release and press release regarding Ipswitch as well as in the Investor Relations section of our website at progress.com. Progress Software assumes no obligation to update the forward-looking statements included in this call whether as a result of new developments or otherwise. Additionally, on this call, the revenue, operating margin, diluted earnings per share and adjusted free cash flow amounts we will refer to are on a non-GAAP basis. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers in our earnings release issued today. Today, we published our financial press release on our website. This document contains the full details of our financial results for the fiscal first quarter 2019, and I recommend you reference it for specific details. Today's conference call will be recorded in its entirety and will be available via replay on our website in the Investor Relations section. And with that, I'll now turn it over to Yogesh.

[Yogesh Gupta:]

Thank you, Brian, and good afternoon everyone. Welcome to our first quarter conference call. As you've seen in this afternoon’s press releases, we announced solid first quarter results as well as an exciting acquisition, which is what I will spend most of my time talking about today. We also recently announced OpenEdge 12, an important major release of our flagship product, and I'll also talk more about that. Before we turn to those two topics, however, let me first address a few highlights of our Q1 financial results. We’re off to a good start for the year with revenue and EPS both well above the high end of our guidance ranges. Our revenue and EPS overachievement was primarily due to OpenEdge, which had better than expected license sales from both our ISV partners and direct enterprises during the quarter. OpenEdge also again achieved maintenance renewal rate well over 90% in Q1, a key indicator of the ongoing strength and stability of that business. Our overall expenses were essentially flat to Q1 of last year reflecting our disciplined management approach as we continue to strive for operational efficiencies. We also continue to execute on our capital allocation strategy, returning $32 million to shareholders during the quarter through share buybacks and dividends. Paul will review our Q1 performance in more detail in his remarks. I'm excited to now turn to the acquisition we announced earlier today. We've been saying for more than a year now that accretive M&A is an important part of our strategy. Ipswitch is exactly the type of acquisition we've been targeting and we'll continue to target going forward in order to deliver increased scale and cash flows. As stated, acquisitions must first be complementary to our business with similar products, audiences and growth profiles. From a financial standpoint, they must bolster our recurring revenue and be accretive with margins of at least 35% after cost synergies. This acquisition will be immediately accretive to both non-GAAP EPS and cash flow and it meets all of our disciplined acquisition criteria. Like Progress, Ipswitch has been successful in providing software solutions to small and mid-sized businesses and enterprises, enabling them to solve mission-critical business challenges. Their data file transfer and network management products are easy to use and powerful, consistent with Progress’ product philosophy of making difficult tasks as easy as possible for both developers and IT professionals. Ipswitch’s annual revenues are around $75 million with a growth profile and high levels of recurring revenue that are similar to those of Progress. It also has solid maintenance renewal rate. Importantly, we have identified areas where we can leverage our operating model and infrastructure to achieve approximately $15 million of annualized cost synergies within 12 months, while maintaining Ipswitch’s longstanding business and healthy renewal rate. By doing so, we expect Ipswitch to contribute over 40% operating margins post synergies well above the 35% margin target we’ve established. Ultimately, this acquisition will generate returns for our shareholders in excess of our weighted average cost of capital and beyond what we could achieve with other uses of our capital. Let's review the financial terms of the deal. It's a $225 million all cash transaction funded with a combination of existing cash and $185 million of incremental term debt. Our leverage following the transaction will be approximately 1.8 times pro forma EBITDA well within our capacity and very manageable given our strong consistent cash flows. Pending required regulatory approvals, we expect to close the transaction in late April and begin operations with Ipswitch as part of Progress in May, now for some background on Ipswitch’s products, people and operations. First of all, if Ipswitch employees listening on the call, I'd like to welcome you and tell you how excited we are to have you become part of Progress. I believe the cultures of our two companies are very similar and we look forward to meeting all of you in the coming weeks. Ipswitch is based in Burlington, Massachusetts, just five miles from our Bedford headquarters and has two core products

[Paul Jalbert:]

Thank you, Yogesh and good afternoon everyone. As a reminder, all financial results I'll be referring to in my remarks are on a non-GAAP basis. Also, please note that all 2018 amounts have been adjusted to reflect ASC 606 which we adopted effective December 1, 2018 using the full retrospective method. Our first quarter total revenue was $89.5 million, $1.5 million above the high-end of our guidance range. The overachievement was primarily driven by better than expected license sales within our OpenEdge segment. Our earnings per share was $0.50 for the quarter, $0.03 above the high-end of our guidance range due to the higher revenue. Looking at consolidated revenue for the quarter as compared to Q1 of last year total revenue of $89.5 million was 6% lower at actual exchange rates and 4% lower on a constant currency basis. The year-over-year impact of exchange rates on our first quarter revenue was a negative $2.3 million consistent with our expectations. License revenue of $22.8 million decreased by 12% from a year ago at actual exchange rates and 10% on a constant currency basis. The expected decrease was primarily due to the timing of revenue recognition under ASC 606 from our DCI segment due to the higher number of multiyear term licenses that renewed in Q1 2018 as compared to this quarter. Maintenance and services revenue was $66.7 million a decrease of 4% year-over-year at actual exchange rates and 2% on a constant currency basis. Turning now to our revenue by segment with all comparisons at constant currency OpenEdge revenue was $67.5 million for the first quarter up 1% versus Q1 2018. We had a particularly strong quarter from direct enterprises and our ISV partners also delivered better than expected results with some transactions closing earlier in the year than we had expected. License sales from our partner channel continues to be solid including SaaS related billings of $6.6 million for the quarter, which represents a year-over-year growth of 3% now this is lower year-over-year growth in our recent trends in part due to the timing of reporting from our ISVs and also due to a difficult comparison to a strong Q1 2018 when we reported a 23% increase. OpenEdge maintenance revenue was down slightly compared to last year on a constant currency basis. Despite the lower revenue, we once again achieved renewal rates of well over 90% for both ISV partners and our direct enterprise customers. As expected, DCI revenue was $6 million for the quarter, a decrease of 37% compared to Q1 of last year. With the performance in Q1 that was on tract our view for the full year has not changed. During our Q4 conference call, we introduced the new metric for DCI to provide clarity on the underlying economics of this segment. This metric is the annual contract value or ACD of the DCI maintenance contracts and the OEM term license contracts. We continue to expect ACV to be $32 million to $33 million for 2019, consistent with 2018. Since the value of our DCI OEM contracts is very steady and predictable, we do not expect ACV to fluctuate materially going forward. Turning to our AD&D segment, revenue was $18.3 million for the quarter, down 5% compared to Q1 of 2018. The decrease was due to lower license sales, partially offset by a slight increase in maintenance. Total bookings were $16.9 million for the quarter, down 12% versus Q1 of last year. The bookings decrease was primarily due to lower license and new maintenance bookings for DevTools. We were encouraged by the momentum we had created for DevTools in the second half of last year so our Q1 bookings results are disappointing. Our opportunities for new and expansion license sales are not at the level we anticipated coming into the year, so we have also moderated our expectations for the full year. That being said, we are watching our spending to protect margins and profitability. And as a result, the contribution margins for Q1 were slightly higher than last year, and we expect to preserve or improve the full year AD&D contribution margins as well. Total revenue by geography with our international regions at constant currency

[Brian Flanagan:]

Thank you, Paul. That concludes our formal remarks for today. So I'd now like to open up the call to your questions. I ask that you keep your remarks to your primary question and one follow-up. I will now hand over to the operator to conduct the Q&A session.

[Operator:]

Thank you. [Operator Instructions] And we’ll take our first question from Steve Koenig [Wedbush]. Please go ahead.

[Steve Koenig:]

Great, thank you very much. So congrats on completing the acquisition, I know you got some integration work ahead but looks like it will be accretive. I want to ask one question about the core business and then just come back to the acquisition. On OpenEdge on the outperformance there, was any of that due to those renewals, some of the slip deals that you had in Q3 and Q4? Did any of those come into play in terms of the Q1 outperformance or was it from a different set of customers?

[Yogesh Gupta:]

Steve, this is Yogesh. Thank you. The outperformance came from a different set of customers. The deals that didn't happen last year, we explained last time that some of those people were not renewing, et cetera. So these were different deals. They – some of them came in a bit early and some of them came in a bit larger than expected.

[Steve Koenig:]

Got it, okay. Great. Thank you, Yogesh. So then on the acquisition, if I may, one housekeeping and then more substantial question, I just want to make sure. Now on the revenue accounting, it doesn't sound like there's a write-down, you just – you'll be accounting for that at its normal run rate or will there be a write-down followed by more revenue coming in as contracts renew?

[Paul Jalbert:]

Yes, Steve. It’s Paul. So as I mentioned at the beginning of my comments, right, all the financial results on a non-GAAP basis. So we have preliminary purchase price allocation, right. But there would be a, because 75% of the total revenue is maintenance, there would be deferred revenue haircut on that. So we will be reporting on a non-GAAP basis, which will have the add-back of the deferred revenue haircut.

[Steve Koenig:]

Got it, okay. Thanks for that. And then if I may – one – my follow-up on the acquisition. It sounds like when I do the math in my head, the pre-acquisition operating margin was maybe on the order of 20%, which seems like there would be a target of opportunities if that’s kind of stable mature business. So with the $15 million in cost synergies, where are you finding those cost synergies? And do you anticipate – are there any revenue synergies or just predominantly more of a portfolio play?

[Yogesh Gupta:]

So I think you are right, Steve, on the way you're looking at it from a cost synergies perspective. We are – our intention is to make sure that the product and the sales and marketing functions are kept stable so that we can continue to retain the customers and retain the healthiness of the business. That said, we are finding opportunities and expect to find opportunities basically on other aspects of the operations, including other functions as well as infrastructure and so on. So our synergies are coming from those functions that don't directly impact customers and product roadmaps.

[Steve Koenig:]

Got it. And any opportunities for revenue synergy or should we think about it as more like an addition to your portfolio?

[Yogesh Gupta:]

I think we should think about it at this point as an addition to the portfolio. There's always some possibility that we might be able to cross-sell and do get some additional revenues. There are obviously the OpenEdge customers and the core customers of ours can be candidates for the products from Ipswitch as well as the Ipswitch customers can potentially be prospects for our core products from Progress. But that said, I want to be very clear, none of our modeling, none of our expectation are based on any revenue synergies.

[Steve Koenig:]

Got it, fantastic. Great. Well, thank you very much for the answers and good luck.

[Yogesh Gupta:]

Thank you. Thanks Steve.

[Operator:]

We'll take our next question from Mark Schappel with Benchmark.

[Mark Schappel:]

Hi, thank you for taking my question. And a nice job on the quarter and congrats on the Ipswitch deal.

[Yogesh Gupta:]

Thank you, Mark.

[Paul Jalbert:]

Thanks Mark.

[Mark Schappel:]

Let me just start with the existing business. Yogesh, could you just discuss a little bit about the ramp in your go-to-market activities with Kinvey and DataRPM this quarter? And I think the quarter before that, you were ramping up activities in those areas. Just wondering if you could just give us little more color?

[Yogesh Gupta:]

Yes. So we ramped up – we are continuing to ramp and we ramped up, as you said, our sales and marketing efforts, and we continue to see steady pipeline growth and new customer wins in Q1. What consistent with that we’ve seen in the past few quarters. So as I’ve said previously, we will disclose bookings for our new business when they become meaningful which we’re hoping to be later this year.

[Mark Schappel:]

Okay, great. Thanks. And then with respect to potential new metrics around Kinvey and DataRPM, are you getting any closer in your view to introducing new metrics for those businesses?

[Yogesh Gupta:]

Yes. So as I said, we continue to see the customer activity and pipeline growth. And once bookings become meaningful, we will provide them. So I think bookings is the metric that we expect to provide first.

[Mark Schappel:]

Okay, great. Thank you. And then moving on to the Ipswitch deal, Steve asked most of the questions I had, but I do have one. With respect to the 40% margin target that was called out on the call, how long do you think it’ll take to get to those gross margins?

[Yogesh Gupta:]

Yes. So our expectations are one year, 12 months, so we expect to get there within 12 months from now – from when we close.

[Mark Schappel:]

Okay, great. Thank you. That’s all I have. Thanks.

[Yogesh Gupta:]

You’re welcome.

[Operator:]

And our next question comes from Matthew Galinko, National Securities.

[Matthew Galinko:]

Hey, good afternoon guys. Thanks for taking my questions. Maybe just, I hate to beat the dead horse here but just back to Kinvey for a quick moment. And I think when we talked last quarter, the goal was to start seeing some acceleration and uptake in the pipeline in Q2. And so I guess, I’m just wondering if kind of the – it sounds like it was a more linear build and sort of a exponential build, let’s say, in the pipeline. But can you just maybe elaborate a little bit more on what you’re seeing there in terms of the pipeline build. Are you getting the traction that you are expecting? Are there delays around features that you need to rollout or you are still trying to find your foot in that just want to, I guess, little bit more color?

[Yogesh Gupta:]

So Matt, we continue to see steady pipeline growth, right. And, the new customer wins in Q1 we’re very consistent with what we’ve seen over the past several quarters. So as I said previously, we will disclose our bookings for this business as they become meaningful. We’re hoping that, that will be later this year. So there is no more additional at this point to share.

[Matthew Galinko:]

Okay. And I guess then on to Ipswich a little bit – I guess, why – what does Ipswich, it sounds like it’s probably a flattish mature business. What’s their motivation for selling at this point? And, maybe as a follow-on to that, are you seeing that the tide turned a little bit in terms of converting more of your M&A pipeline to transactions. And do you have capacity to – or additional capacity to work and close on additional deals as you work to integrate this one? Thank you.

[Yogesh Gupta:]

Yes. So Matt, I think that why the folks at Ipswitch wanted to sell is probably a question better answered by them. It is a mature business. It is a founder-owned and founder-led business. And so I think at some point people go, you know, it’s been awhile and maybe I ought to do something else. So I think, there are lots of different reasons why people do that. What is interesting to us is that we were able to source this internally, and we were able to do this deal with a company that was local to us, and I think it makes a lot of things much better for us in terms of integration and opportunities and bringing the people on board and so on. In terms of future acquisitions and pipeline and so on, as you know, this is a sizable acquisition for us. And of course, until we get the integration done, also the focus for the remainder of 2019 and early 2020 will be on the successful integration of Ipswitch and realization of the financial goals that we’ve identified. So accretive acquisitions like Ipswitch are a key element of our corporate strategy, so we’ll continue to pursue them in 2020. But I don’t expect that we will do another one in 2019 given that we have the integration of Ipswitch ahead of us.

[Matthew Galinko:]

Got it. All right. Thank you.

[Operator:]

This concludes our Question-and-Answer session. I’ll turn the conference back to you, Mr. Flanagan.

[Brian Flanagan:]

Thank you all for joining the call today. For your reference, we have also posted a slide presentation in the Investor Relations section of our website that provides an overview of the Ipswitch transaction. As a reminder, we plan on releasing financial results for our fiscal second quarter of 2019 on Thursday June 27th, 2019 after the financial markets close and holding the conference call at the same day at 5

[Yogesh Gupta:]

Thank you, Brian. And we’re off to a strong start in 2019 with solid Q1 results led by our OpenEdge segment. The Ipswitch acquisition is an important step for us, adding scale and cash flow and generating real value for our shareholders. As we integrate Ipswitch, we’ll continue to focus on keeping our business strong and running it efficiently and our bookings and pipeline growth for our high productivity platform. Thank you again for your continued support and for joining us on our call today. Thank you.

[Operator:]

This concludes today’s conference. Thank you for your participation. You may now disconnect.