Progress Software Corp. (PRGS) Q3 2020 Earnings Call Transcript

Progress Software Corp  (NASDAQ: PRGS) Q3 2020 earnings call dated Sep. 29, 2020

Corporate Participants:

Anthony Folger — Chief Financial Officer

Yogesh Gupta — Chief Executive Officer

Analysts:

Anja Soderstrom — Sidoti — Analyst

Mark Schappel — Benchmark — Analyst

Ittai Kidron — Oppenheimer — Analyst

Presentation:

Operator

Good day and welcome to the Progress Software Corporation Q3 2020 Investor Relations Conference Call. Today’s call is being recorded.

At this time, I’d like to turn the conference over to Anthony Folger. Please go ahead.

Anthony Folger — Chief Financial Officer

Thank you Al. Good afternoon everyone and thanks for joining us for Progress Software’s fiscal third quarter 2020 financial results conference call. With me today is Yogesh Gupta, President and Chief Executive 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, our acquisition and integration of Chef, the impact of the COVID-19 crisis on our business and other information that might be considered forward-looking. 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 harbor statement regarding this information, which is available in today’s financial results press release 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, all the financial figures we discuss are non-GAAP measures, unless it is stated that the measure is a GAAP number. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers in our financial results press release issued today.

Today, we published our financial results press release on our website. This document contains the full details of our financial results for the fiscal third quarter 2020 and I recommend you reference it for specific details. We have also published a presentation that contain supplemental data for our third quarter 2020 results, providing highlights and additional financial metrics. This presentation is available in the Investor Relations section of our website at investors.progress.com. Today’s conference call will be recorded in its entirety and will be available via replay on our website in the Investor Relations section.

With that, I’ll now turn it over to Yogesh.

Yogesh Gupta — Chief Executive Officer

Thank you, Anthony, and good afternoon everyone. On today’s call, I’d like to recap our strong third quarter results and provide some more color on why we’re so excited about our pending acquisition of Chef. We reported strong Q3 financial results with revenue and EPS, both meaningfully exceeding the high end of our guidance. Against the backdrop of a major global pandemic, our continued strong performance demonstrates the durability of our business, our relationships with our customers and partners and the discipline and commitment of our employees. I am very happy with our results. The strength of our business enabled us to raise our 2020 outlook for revenue and EPS. The improved outlook reflects our increased confidence in the continued momentum in our business through the fourth quarter and the contribution from shares. And consistent with our shareholder-friendly capital allocation policy, for the third year in a row, we have increased our quarterly dividend. A reflection of our continued ability to generate strong cash flow.

I’d like to spend the bulk of my time discussing our pending acquisition of Chef, which represent another important milestone in the execution of our total growth strategy. We recently received antitrust clearance for the deal, integration planning has been well underway and we hope to close the transaction very shortly. Chef Business has continued to perform very well throughout this period. During the roughly one month since we announced the transaction, the reaction from customers has bolstered our view. It is as following on the heels of Ipswitch that will be another successful demonstration of our strategy to complement our stable businesses with accretive M&A in the infrastructure software space.

As we discussed during our Investor Call on September 8, Chef is an amazing company and has been a true pioneer in the growing DevOps and DevSecOps market enabling things to build, deploy and manage secure applications in modern multi-cloud on-prem and hybrid environments. As the leader in continuous automation software Chef’s innovation will extend Progress’ offering in an ecosystem which has become increasingly important. Chef technology enables organizations to rapidly develop and deploy consistent, reliable, high impact business system that meet the ever-increasing demand for performance and security in today’s complex environment. This enables IT organizations to be agile and proactive instead of slow and deactive. What excites us most is the impressive caliber of Chef’s 700 plus customers, which include numerous Fortune 500 companies across diverse end markets and verticals. With a talented group of employees focused on innovation and customer success, Chef has continuously grown its business to approximately $70 million in revenue. This growth has also lead to stability and their relentless focus on customer success and retention that has resulted in verified net retention rates in a business that is approximately 95% recurring in nature.

Going forward, we will align this business with our objective to drive a high mix of revenues from predictable recurring streams and as a result, we expect the addition of Chef to increase Progress’ overall recurring revenue mix by approximately 2 percentage points. In addition, Chef’s net retention rate has consistently run well north of 95% and with our own focus on customer success, Chef will contribute a very stable recurring revenue stream. From the perspective of Chef’s customers, employees and communities it serves, we are the ideal acquirer. Like Chef’s, we have a longstanding track record of outstanding customer satisfaction. I’ve spoken at length on our drive to maximize customer success and how that has enabled us to retain our loyal customers and partners for decades. In the case of OpenEdge and DataDirect products, and at the same time to build a massive developer network with Telerik DevTools.

You’ve also heard me extol [Phonetic] the mission critical nature of our products and how tens of thousands of businesses have benefited from our technologies. Similarly, with more than 40 million product downloads over the years, hundreds of thousands of organizations have benefited from Chef’s offerings. A critical factor in why we make sense for Chef and its customers is that we will build on Chef’s impressive platform and longstanding record of outstanding customer satisfaction. As a public company with a 40 year track record of customer success, we will leverage progress assistance, processes and additional resources to further enhance the success of Chef’s customers. And we will continue to support Chef’s vibrant open source community, which is another key ingredient of its success.

In addition to meeting our M&A criteria from a technology and product point of view, we believe the Chef acquisition is also in complete alignment with our objectives to scale our business through accretive M&A. Once the acquisition is complete, we will immediately begin to implement our integration plans. Based on anticipated synergies, we expect the transaction to turn accretive in the first quarter of 2021 and that Chef’s operating margin contribution will increase through the course of 2021 reaching more than 35% at the end of the year.

To summarize, the acquisition of Chef, squarely supports our strategy to grow through accretive M&A and checks all of the boxes of our rigorous acquisition criteria. However, we aren’t sitting on our laws. We intend to continue to grow through accretive acquisitions. We are focused on building our accretive M&A pipeline and as previously mentioned, have bolstered our internal team to enable us to do so, and to be opportunistic as acquisitions present themselves, particularly in an uncertain market like we are living in today. With Ipswitch and Chef and continued execution of our long-term strategy, we can double the size of our business over a five-year period. We look forward to updating you on the success as we move forward.

In summary, we are excited with our strong third quarter performance and the subsequent progress we have made on our strategy with our pending Chef acquisition. We are confident that Chef will close as another proof point that illustrates the potential of our total growth strategy to expand our business through accretive M&A to the benefit of all our stakeholders.

With that I’d like to turn the call over to Anthony to provide more details on our financial results and our outlook.

Anthony Folger — Chief Financial Officer

Thank you Yogesh. Good afternoon everyone and thanks for joining our call. As Yogesh noted, we are very pleased with our strong third quarter performance and we’re also very excited about our pending acquisition of Chef, which we think is a perfect fit with our longer term strategy.

For the quarter, total revenue was $110.9 million or $1.9 million above the top end of the guidance range we provided in June. And was primarily driven by better than expected performance of our OpenEdge product. The durability and stability of our revenue even in the backdrop of a major global pandemic, demonstrates just how mission critical our products are to the tens of thousands of businesses who have benefited from our technologies. The high and increase in mix of recurring [Technical Issues] maintenance revenue retention rate well over 90% reflect the investments we’ve made in our products and our customers’ success and position us well for the future.

On a year-over-year basis, total revenue decreased by 4% in both actual and constant currency. The year-over-year decrease is driven by a decline in DCI revenue resulting from the timing of multiyear term license renewals as we anticipated. As we’ve previously discussed, the timing of DCI contract renewals with certain OEM partners can cause fluctuations in revenue recognition under ASC 606, which can significantly affect our top line in any given quarter. This timing benefited us in fiscal year 2019 and in Q1 of 2020. But caused our DCI revenue to decline year-over-year in both Q2 and Q3 of 2020. Because the timing of renewals can materially impact revenue recognition, we believe that annual contract value or ACV more closely reflects longer term trends in our DCI business than reported revenue. We continue to expect ACV to be $32 million to $33 million for 2020, consistent with our actual performance in 2019.

Turning now to expenses. Our total cost and operating expenses were $63.8 million for the quarter, down 8% compared to a year ago. This year-over-year decline is primarily the result of a reduction in travel and in person events, both of which were driven by restrictions put in place to combat the spread of COVID-19 and cost reductions we made as part of our restructuring in the fourth quarter of 2019 aimed to driving greater operating efficiency and margin expansion. As a result of the decline in total cost and operating expenses, operating margin for Q3 came in at 42%, an increase of 200 basis points on a year-over-year basis. We recognize that some of this margin improvement is the result of better than expected performance during the quarter. However, it’s important to highlight that a significant portion of the margin improvement was driven by reduced expenses resulting from the restrictions put in place to combat the spread of COVID-19. As a result, we reiterate our view of sustainable operating margins in the high 30s. On the bottom line, our earnings per share of $0.78 for the quarter exceeded the high end of our guidance range and increased $0.03 from the year ago.

Moving on now to a few balance sheet and cash flow metrics. We ended the quarter with cash, cash equivalents and short-term investments of $230 million and debt of $288 million. DSO for the quarter was 49 days within recent historical ranges. Deferred revenue was $171 million at the end of the third quarter, up almost $11 million from a year ago, and down slightly from the second quarter, reflecting normal seasonality. Adjusted free cash flow was $30 million for the quarter, up from $27 million a year ago. We did not repurchase any stock during the third quarter. As a result, at the end of Q3 we had $230 million remaining under our current share repurchase authorization. We’re also pleased to announce our Board of Directors recently declared a quarterly dividend of $0.175 per share which represents a 6% increase. Dividends remain an important element of our balanced and shareholder-friendly capital allocation strategy, and our strong performance in 2020, along with an improved outlook and healthy balance sheet enables such an increase.

Note that our pending acquisition of Chef is announced after the end of the fiscal third quarter and we anticipate the closing to occur shortly, roughly one month into our fiscal fourth quarter. The purchase price for Chef is $220 million and will be funded with a combination of cash on hand and by drawing down our existing $100 million revolving credit facility. With the high recurring revenue and strong net dollar retention rates that Yogesh mentioned earlier, we anticipate Chef’s business to grow in the low single-digits as we move forward. This growth rate is consistent with some of our other products and reflects our focus on customer retention. We expect the transaction to be slightly dilutive to net income in the fourth quarter, but to become accretive in the first quarter of 2021, with increasing synergies being realized throughout 2021, and exiting the year with an operating margin of more than 35% for the Chef business.

I would now like to turn to our outlook for Q4 and for the full year 2020, which reflects the combination of our better-than-expected third quarter performance, our ongoing business momentum and the impact of the Chef acquisition. As we’ve mentioned, while the impact of the COVID pandemic on our business thus far has been less than originally anticipated, our outlook continues to assume some headwinds, resulting from the economic challenges brought on by the pandemic. For the fourth quarter of 2020, we expect revenue between $125 million and $129 million. This includes approximately a $10 million to $12 million contribution from Chef and earnings per share of between $0.76 and $0.79 including the impact of Chef during the quarter, which we anticipate in between breakeven and a loss of $0.04. For the full year fiscal 2020, we are increasing our revenue guidance to be between $452 million and $456 million, consistent with updated guidance we provided with our preliminary third quarter results. This increase reflects the impact of our better-than-expected third quarter performance, healthy business trends and the $10 million to $12 million contribution from Chef. Also incorporated in this guidance is the impact of $8 million to $11 million from the COVID-19 pandemic, including what we have realized to date.

We anticipate operating margin for the year of approximately 40% with a slight Q4 headwind from the Chef acquisition. We are projecting adjusted free cash flow to be between $135 million and $140 million, an increase from our prior outlook. We expect earnings per share to be between $2.94 and $2.97, also consistent with the updated guidance provided with our preliminary third quarter results. When comparing our current EPS guidance to the 2019 results, it’s important to note that we’ve included a $0.02 reduction for the anticipated negative impact of foreign exchange on a year-over-year basis. Our guidance for full year EPS assumes a tax rate of 20% and approximately 45 million shares outstanding. Although we will provide guidance for fiscal 2021 on our next financial results conference call, our comments today, and those made previously should provide a helpful gauge.

To summarize a few directional measures for fiscal 2021, we anticipate double-digit revenue growth to be driven by a full year’s contribution from Chef, while our remaining businesses continue to demonstrate their stability and net out roughly flat on a year-over-year basis. In addition, we believe we can maintain an operating margin in the high 30s. With respect to operating margin, there will be some pressure from Chef early in the year which will diminish during the year as we drive synergies. In addition, we assume that some of the restrictions put in place to combat the spread of COVID-19 maybe relaxed in 2021, resulting in a pickup in travel and related expenses.

In closing, we’re very excited about our third quarter results that exceeded our original guidance ranges. We’re also pleased to be reaching another milestone in the execution of our longer term growth strategy with the pending acquisition of Chef.

With that I’d like to open the call for Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And we will take our first question from Anja Soderstrom from Sidoti. Please go ahead.

Anja Soderstrom — Sidoti — Analyst

Hi Yogesh and Anthony. Congratulations on a great quarter and the acquisition of Chef, seems a good fit for you.

Yogesh Gupta — Chief Executive Officer

Thank you.

Anja Soderstrom — Sidoti — Analyst

I wanted to ask — I wanted to ask you about the fluctuations in DCI. You have spoken about that before and I remember you held last year about that flow in of contracts there. What are you seeing in terms of content fluctuations there? Are there any — will that — are any larger contracts coming in, in the near term or was it a matter of pressure or what are you seeing in terms of renewals for the DCI?

Yogesh Gupta — Chief Executive Officer

So, I’ll speak to sort of the — first of all to the fact that by the way the renewals that are coming up are going really well. Right. I mean it is a very, very sticky product. The DataDirect business is a business that is largely an OEM business with over 200 different software vendors who embedded in their products and those that come up they’ve renewed. In fact, I think we’ve talked about this before that we’ve not had ISVs, any ISV actually churn in a decade or more. So I think it’s a really, really sticky business.

In terms of what comes up when, our guidance includes in it, the expectation of bookings from the renewals that are coming in any given period. Anthony, would you like to add more?

Anthony Folger — Chief Financial Officer

No, no. I think that’s right Yogesh. I mean, I think, the reality as we — the renewals tend to move around and they tend to be lumpy and that will obviously drive a little bit of lumpiness in our revenue recognition. But ultimately, when you look at the business on an annual basis, when you look at the net new revenue that we’re generating from an ACV basis, it’s been in that $32 million to $33 million range for a couple of years now. So it’s been very stable, adding to Yogesh’s point.

Anja Soderstrom — Sidoti — Analyst

Okay. And just in terms of renewal, you said you haven’t had any churn, but how should we think about pricing in terms of the DCI as it relates to…

Yogesh Gupta — Chief Executive Officer

Anja we’re expecting it to continue to be very stable. They continue to be stable. We expect them to continue to be stable, which is why the annual contract value stays stable at the $32 million to $33 million range, right. So if somebody had a — previously had a three year contract that was $1 million a year, they will most likely renew it and we don’t see any reason why they don’t. In fact, we have not seen any difference this year that they renew at the same price.

Anja Soderstrom — Sidoti — Analyst

Okay. Thank you. That was all from me for now. I’ll get back in the queue.

Yogesh Gupta — Chief Executive Officer

Thank you Anja.

Anthony Folger — Chief Financial Officer

Thanks, Anja.

Operator

We’ll now take our next question from Mark Schappel from Benchmark. Please go ahead.

Mark Schappel — Benchmark — Analyst

Hi. Good afternoon. Thank you for taking my questions.

Yogesh Gupta — Chief Executive Officer

Hey Mark.

Mark Schappel — Benchmark — Analyst

Starting off with — hey, guys. So starting off with a couple of questions on Chef. How much international business did they do?

Yogesh Gupta — Chief Executive Officer

So their international business is, Mark, significantly smaller as a percentage than for our business overall. Right. So they are over three quarters of their revenues are US. Anthony is that correct? I sorry, I just want to make sure [Speech Overlap]

Anthony Folger — Chief Financial Officer

Yes. That majority is US based, Mark, and even more so than the Progress business.

Mark Schappel — Benchmark — Analyst

Okay, great. And then with respect to the geographic business, where is that focused overseas? Is it mostly in Europe?

Yogesh Gupta — Chief Executive Officer

So yes, so, I mean, again pretty much EMEA is a place where they have customers as well as some parts of APAC. But as I said, it is way more focused on North America than any of the other geographies.

Mark Schappel — Benchmark — Analyst

Okay, thanks. And Yogesh I know it’s only been a few weeks since the acquisition, particularly any potential touch points or sales synergies between your Telerik business and Chef?

Yogesh Gupta — Chief Executive Officer

So I mean, Mark, as you know, there are some potentially impacting things there, not just on the Telerik side but other sides as well. But what we have done is that, we have modeled the business going forward very much focused around no additional cross-sell, no additional dying to find revenue synergies between businesses. Our goal, to be honest, is to stay very focused and make sure that the customer base is stable, that the recurring revenue from those customers and the retention is very, very high, and that we focus on making sure that the business continues to as Anthony said, grow in the low single-digit. And so we are not contemplating nor are we are pushing for cross-sell across product portfolios.

Mark Schappel — Benchmark — Analyst

So is the integration plan to let Chef operate as a kind of standalone entity for the most part, at least for the first year?

Yogesh Gupta — Chief Executive Officer

No. We are actually intending to rapidly integrate it as we did with Ipswitch. We are going to bring it under one of our GMs and then we are going to basically — our integration plan gets basically our G&A structure put in place very quickly and start putting our various other structures in place as well including technical support and so on. Obviously part of the consideration with any acquisition as we did with Ipswitch as well, Mark, was just to make sure, you don’t do so fast that you rock the boat, but you do it as fast as possible. So we are — we do not intend to run it as a separate business. We do not intend to run it as a separate standalone entity. We are integrating it into our business.

Mark Schappel — Benchmark — Analyst

Okay, great. And then turning to the core business. Yogesh, could you just summarize real quick which parts of your business actually drove the upside in the quarter?

Yogesh Gupta — Chief Executive Officer

Really primarily the OpenEdge product. I mean in a nutshell, Mark. The DCI, we knew was going to happen from year-to-year. So we had the decline year-over-year, but it was as expected. But the OpenEdge business did well and you know it is actually a testament to the strength of the product right, that even in times like these, it continues to perform well.

Mark Schappel — Benchmark — Analyst

Is it fair to say that it was the kind of core ISV channel on the OpenEdge side?

Yogesh Gupta — Chief Executive Officer

Yes, yes. That is correct. And as you know, mark, we had even — when we had in — at the end of Q1, when we had provided guidance, we have talked about the fact that part of our contemplating the headwind of COVID were around new business acquisition. And as you know our primary new business acquisition is in the DevTools products as well as in the Ipswitch portfolio, right, WhatsUp Gold and MOVEit. So whatever little we are seeing that’s where we’re seeing the primary stuff, the OpenEdge business has been really strong and ISVs have been really strong.

Mark Schappel — Benchmark — Analyst

Great. Thank you. That’s all.

Yogesh Gupta — Chief Executive Officer

Thanks, Mark.

Operator

We’ll now take our next question from Ittai Kidron from Oppenheimer. Please go ahead.

Ittai Kidron — Oppenheimer — Analyst

Hey, guys. Yogesh and Anthony, congrats again on the Chef deal. Looks very attractive. Yogesh can you talk about…

Yogesh Gupta — Chief Executive Officer

Thank you Ittai.

Ittai Kidron — Oppenheimer — Analyst

Yes. The asset itself Chef, I mean, are there other things out there in the marketplace that you think you can kind of build around and add to Chef to kind of add a little bit more meat around the bone on that one?

Yogesh Gupta — Chief Executive Officer

I think it has a lots of assets that exist in the market. As you know with M&A it is opportunistic right, and we have both sides have to agree that now is a good time or whenever is a good time to do a deal, right. But yes, absolutely, I mean if you think about the whole opportunity around deploying, managing, operating, doing it in a extremely complex model environment, right, there are tremendous challenges that face there. And there is a whole portfolio of solutions that are needed by enterprises to do that successfully and do that well. And Chef is a market leader in one aspect of it, but I think there is a whole DevOps cycle and a whole set of products and capabilities in the DevOps area that that we do not participate in today. So, yes, I think there is tremendous opportunity.

Ittai Kidron — Oppenheimer — Analyst

That’s great. And then as a follow-up Anthony, on the financial side of the deal. Correct me if wrong. I think you mentioned 35% — to get to 35% margin on that business exiting ’21, did I get that right. And if so, are we looking at about a $5 million to $7 million increase on the operating profit side on a quarterly basis. Am I thinking about this right?

Anthony Folger — Chief Financial Officer

Yes, Ittai, you’re correct in that we’re certainly projecting to get north of 35% operating margin as we exit ’21. It will build gradually through the course of the year for the Chef business. So it will be a little bit compressed as we work through Q1, Q2, Q3. But yes, I think in terms of the quarterly operating margin that you might see from that, yes, I think you’re right out there.

Ittai Kidron — Oppenheimer — Analyst

Got it. Excellent. All right. Good stuff. Congrats guys.

Yogesh Gupta — Chief Executive Officer

Thank you Ittai.

Anthony Folger — Chief Financial Officer

Thank you.

Operator

And we have no further questions. That does conclude our question-and-answer session. I would now like to turn the call back over to Yogesh for any closing remarks.

Yogesh Gupta — Chief Executive Officer

Thank you, Alie. Thank you all for joining us on this call today. I’m very pleased with our Q3 performance and the continued strong momentum in our business going forward. We are also excited looking forward to closing the Chef deal and getting to work on our integration plan. Our company is financially strong and healthy, and we will continue to execute aggressively on our total growth strategy to drive long-term value through accretive M&A in the infrastructure software space. Thank you again for joining us today and I look forward to speaking with you next during our FY 2020 full-year conference call. Bye-bye.

Operator

[Operator Closing Remarks]