Q2 2023 Progress Software Corp Earnings Call
Participants
Anthony Folger; Executive VP & CFO; Progress Software Corporation
Michael Micciche; VP of IR; Progress Software Corporation
Yogesh K. Gupta; CEO, President & Director; Progress Software Corporation
Anja Marie Theresa Soderstrom; Senior Equity Research Analyst; Sidoti & Company, LLC
Brent John Thill; Equity Analyst; Jefferies LLC, Research Division
Ittai Kidron; MD; Oppenheimer & Co. Inc., Research Division
Pinjalim Bora; Analyst; JPMorgan Chase & Co, Research Division
Raymond Michael McDonough; Research Analyst; Guggenheim Securities, LLC, Research Division
Presentation
Operator
Good day, and welcome to the Progress Software Corporation Q2 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. (Operator Instructions). Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. Mike Micciche, Vice President of Investor Relations. Please go ahead.
Michael Micciche
Great. Thank you, Sheri. Good afternoon, everyone, and thanks for joining us for Progress Software's Second Fiscal Quarter 2023 Financial Results Conference Call. With us today is Yogesh Gupta, our President and Chief Executive Officer; and Anthony Folger, our Chief Financial Officer.
Before we get started, let's go over our safe harbor statement. During this call, we will discuss our outlook for future financial and reporting performance, corporate strategies, product plans, cost initiatives, our integration of MarkLogic, and other information that must be considered forward-looking. Such forward-looking information represents Progress Software's outlook and guidance only as of today and is subject to risks and uncertainties. For a description of the risk factors that may affect our results, please refer to the Risk Factors section in our most recent Form 10-K.
Progress Software assumes no obligation to update the forward-looking statements included in this call. Additionally, on this call, all the financial figures we discuss are non-GAAP measures unless otherwise indicated. You can find a reconciliation of those non-GAAP financial measures to the most directly comparable GAAP numbers in our financial results press release, which was issued after the market closed today. This document contains additional information related to our financial results for the second quarter of 2023, and I recommend you reference it for specific details. We have also prepared a presentation that contains supplemental data for our second quarter 2023 results, providing highlights and financial metrics.
Both the earnings release and the supplemental presentation are available in the Investor Relations section of our website at investors.progress.com. Today's conference will be recorded in its entirety and will be available via replay on the Investor Relations section of our website. And with that, I'll turn it over to Yogesh.
Yogesh K. Gupta
Thank you, Mike, and good afternoon, everyone. Welcome to our second quarter 2023 Earnings Conference Call. As you saw in our press release, Progress had another great quarter, with earnings, revenues, and operating margins, all ahead of estimates. As a result, we have raised our full-year 2023 outlook, which Anthony will detail for you in a few minutes.
In the quarter, revenues were up 19% year-over-year to $179 million, thanks to continued strong demand for our products and a fantastic performance again from our teams in the field. Our customers and partners remain committed to using Progress products to run their businesses, especially in these more challenging economic times. And we remain committed to providing them with great value and ensuring their success. Earnings per share came in at $1.06, well ahead of estimates, driven by strong top-line revenue and helped by excellent execution on the MarkLogic integration as well as prudent expense management from all of our teams. Operating margins exceeded targets, ending the quarter at 38% versus consensus of around 35%.
ARR grew in the second quarter to $569 million, an increase of 19% year-over-year and driven by the acquisition of MarkLogic and a net retention rate that was again above 101%. These outstanding results were achieved across virtually all product lines and geographies, with a strong contribution from MarkLogic, which I'll talk more about in a minute. Our product portfolio saw broad strength this quarter led by OpenEdge, Loadmaster, Chef, Hiponia Cloud, and MarkLogic offerings. Strength in OpenEdge was driven by customer win-backs as well as their need to modernize their applications, once again demonstrating the value that this platform provides for the mission-critical applications of the future.
Loadmaster, which we acquired Tuchen, continues to see new customer wins through the Dell channel because our product bolsters Dell's cloud storage offerings. We also saw new wins as well as expansions with our Chef's line as customers continued to reap greater DevOps and detect benefits from our products. And our SisNet Cloud offering continues to grow as customers across the industry realize the value it delivers through ease of use, improved engagement, and marketing effectiveness. We saw new customer wins as well as expansions by existing SisNet Cloud customers.
And last but not least, our MarkLogic business also saw strength as we engaged with the customers and began to share our vision with them. As you know, the MarkLogic acquisition closed on February 7, a few weeks prior to the end of our fiscal first quarter. Since then, we have welcomed our MarkLogic colleagues, connected personally with customers around the globe, and made significant progress on integrating all facets of the company into progress. As with every acquisition we have done, we'll learn a few new things along the way, and our integration playbook is keeping us on track as we combine the 2 companies. We expect to achieve all our synergy goals by the end of this fiscal year.
MarkLogic's financial contribution has been strong in FY '23, with a meaningful impact on our ARR evident in the most recent quarter. And as we shared in our Q1 earnings call, the full-year revenue contribution from MarkLogic will hit next year in fiscal 2024. So to sum up Q2, we couldn't be happier with the continued strong performance of our operations in the field as well as the integration of MarkLogic, and we're thrilled that we were able to roll these excellent Q2 results through our updated guidance for the remainder of this year. In addition to excellent financial results and the progress we have made with MarkLogic in Q2, we also held our first Investor Day in 7 years in early April. During my session, I provided an overview of the company and described the successes we've had with our total growth strategy. I also discussed our longer-term plan to create shareholder value and talked about our great products, employees, customers, and our culture.
Anthony provided a full financial review and gave metrics and details on a longer-term model. And he was followed by our Head of Corporate Development, Jeremy Siegel, who gave an extensive review of our M&A and integration strategies, which covered everything from how we source deep at the top of the funnel to the details of our integration methodology. If you haven't seen it yet, the website -- the webcast and slide deck are available on the Investor Relations section of the Progress website. The key theme in all our comments was our commitment to our total growth strategy, which is, number one, invest in our product system and processes to keep our products relevant and to be operationally efficient; two, to acquire and integrate great businesses that make us stronger and create sustained shareholder value; and three, an unrelenting focus on customer success to drive great retention rates.
All of this is supported by a prudent capital allocation strategy focused on maximizing shareholder return. Our acquisition model is highly disciplined yet simple. We find solid infrastructure companies with great complementary technology, the right size and scale with an excellent customer base, strong recurring revenues, and high retention rates, and achievable synergies to ensure that our return on invested capital is greater than our WACC. We then pay a reasonable price for it, improve customer retention, and maximize cash flows and margins to deliver sustained shareholder value. We shall repeatedly demonstrate our ability to execute M&A while following these disciplined criteria, and we will continue to do so.
From a broader M&A perspective, we've previously discussed how we believe that the M&A market is moving in our favor. We still believe this is true. As capital continues to get scarcer in the private market and unfavorable cyclical economic conditions prevail over the coming years, many more attractive companies will be looking for exit strategies and alternatives to go in public. Jeremy and his team are busy as ever, and the number of potential targets continues to be healthy while the competitive dynamics for completing a deal have become more constructive for us.
Further, we have continued to institutionalize the learning process that comes with acquiring and integrating companies, and we are compounding our success to help make us better at it each time. While we remain very optimistic and excited about our ability to source and complete future acquisitions and that includes doing more than one deal in a year if the opportunity arises, we intend to remain as patient and disciplined as we have been since we embarked on our total growth strategy in 2019.
Finally, I want to take a moment to address an issue that our team has been very focused on over the last few weeks. As many of you are aware, from the 8-K that Progress filed on June 7, we have identified and patched a 0-day exploit in the move transfer and move cloud product. We've been taking this issue very seriously. We have engaged with industry-leading cybersecurity experts and researchers. And together, our focus throughout this process has been on supporting our customers and securing their environment.
While working through an issue of this nature, it's important not to speculate broadly or prematurely but rather focus on the task at hand, doing what we can to protect our customers against the ongoing threat of side chemos. As you know, an unrelented focus on customer success across our entire product portfolio is a foundational pillar of our strategy and has led to our strong performance over the past few years, including the most recent quarter.
So in summary, we delivered better-than-expected financial results across the board and are confident about the strength of our business to raise guidance for the rest of the year. The integration of MarkLogic is proceeding on plan, and MarkLogic is already making meaningful contributions to revenue, ARR, and profitability. Lastly, we still believe that the market for M&A is improving for us, while we continue to improve our internal capabilities to source, integrate, and complete deals. As always, I'm very proud of our teams for their excellent work and thank them for their dedication and commitment towards our success. With that, I'll turn it over to Anthony to provide the financial details and guidance. Anthony?
Anthony Folger
Thank you, Yogesh. Good afternoon, everyone, and thanks for joining our call. As Yogesh mentioned, we're very pleased with our Q2 results, which again exceeded the high end of our guidance range on revenue and earnings per share. We're also very pleased to see some of this upside coming from MarkLogic, which is performing a bit better than our expectations thus far.
Turning to the numbers. We'll start on the top line with ARR. We closed the second quarter with ARR of $569 million, which represents approximately 19% growth on a year-over-year basis and 3% pro forma growth on a year-over-year basis. To be clear, the pro forma results include MarkLogic in both periods. As Yogesh mentioned, the growth in ARR was again driven by multiple products across our portfolio, including OpenEdge, MarkLogic, Sitefinity, and DataDirect. A trend that continues to fuel our ARR growth is strong net retention, with Q2 rates at just over 101%. In addition to our strong ARR growth, revenue for the quarter of $179 million was well above the high end of the guidance range we provided back in March and represents approximately 19% growth on a year-over-year basis. The better-than-expected revenue performance in the quarter was driven by stronger-than-expected demand for multiple products, including OpenEdge, Loadmaster, Chef, MarkLogic, and Sitefinity.
For those of you who listened to our Q1 earnings call, you'll recall that our Q1 performance was aided slightly by timing. In that, some revenue we expected to recognize in the second quarter actually came in early and was recognized in the first quarter. I mentioned this only to highlight our exceptional top-line performance in Q2, which punctuated a very strong first half of 2023. Turning now to expenses. Our total costs and operating expenses for the quarter were $112 million, up 25% compared to the prior year and in line with our expectations. The year-over-year increase was driven by the acquisition of MarkLogic and to a lesser extent, an expected increase in compensation and benefit costs across the rest of our business, which we've detailed on previous calls.
Operating income was $67 million, up $6 million compared to the prior year quarter, and our operating margin was 38% compared to 41% in the second quarter of 2022. On the bottom line, earnings per share of $1.06 for the quarter is $0.14 above the high end of our guidance range. This overperformance relative to our expectations was driven by outstanding top-line performance, coupled with solid cost management across the business. Our outlook for the MarkLogic integration remains unchanged, and we continue to expect that we'll achieve all our synergy targets by the end of this fiscal year.
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 $126 million and debt of $795 million for a net debt position of $669 million. This represents net leverage of roughly 2.5x using our forecasted fiscal year 2023 adjusted EBITDA. And if we pro forma that EBITDA to consider MarkLogic synergies, our net leverage drops even further. I'd also like to mention that during the second quarter, we paid down $25 million against the revolving line of credit that we drew down to partially fund the acquisition of MarkLogic, bringing the outstanding balance on our revolving line of credit to $170 million at the end of the quarter. DSO for the quarter was 44 days, which is generally consistent with last quarter and in line with our expectations.
Adjusted free cash flow was $48 million for the quarter, an increase of $1 million from Q1 and generally in line with our expectations. During the second quarter, we repurchased $15 million of Progress stock. And at the end of the quarter, we had $198 million remaining under our current share repurchase authorization Okay. Now I'd like to turn to our outlook for Q3 and the full year 2023. When considering our outlook, we continue to see strength in the demand environment for our solutions despite the potential that the macro environment may become more challenging. With that, for the third quarter of 2023, we expect revenue between $172 million and $176 million and earnings per share of between $0.98 and $1.02.
For the full year 2023, we expect revenue between $690 million and $698 million, an increase of $10 million from our prior guidance. We expect an operating margin of between 38% and 39%, generally consistent with our prior guidance. Adjusted free cash flow between $175 million and $185 million, again consistent with our prior guidance, and earnings per share of between $4.16 and $4.24, an increase of $0.07 from our prior guidance. Our annual EPS estimate contemplates a tax rate of 20% to 21%, approximately 44.7 million shares outstanding, the impact of $30 million of share repurchases, and the paydown of $85 million on our revolving line of credit, which we believe we can complete by the end of 2023.
In closing, we're excited to deliver strong financial results across the board in the second quarter, a continuation of the trend that we saw from most of 2022 and the first quarter of 2023. We're thrilled to see the MarkLogic integration gaining momentum, and we believe we're very well-positioned to deliver strong results for the remainder of 2023 and well beyond. With that, I'd like to open the call for Q&A.
Question and Answer Session
Operator
Thank you. (Operator Instructions) Our first question will come from the line of Ittai Kidron with Oppenheimer.
Ittai Kidron
And great execution. Maybe a couple of questions for you, Yogesh. First, on the MOVEit issuing this past quarter. Can you, first of all, quantify how big of a product line that is for you from a revenue standpoint? And what has been the feedback from customers? I know it's not easy to move on something like this quickly, but what is the risk here down the road that customers try to find alternatives to this situation?
Yogesh K. Gupta
Thank you, Ittai, for the nice feedback on the quarter. We had actually in our 8-K that we filed mentioned that the MOVEit file paper, move it transfer product, and MOVEit Cloud, which are the 2 products that were impacted, were less than 4% of our overall annual revenue. So it's a rather limited impact, so to speak. As far as customers are concerned, Ittai, we are continuing to engage with them. Our focus at this point is making sure that they get their environment secure and continue to get work done.
We feel really good about the effort our team is putting in to help our customers. And at this point, it's really too early to speculate about potentially what kind of an impact we might have in terms of customers saying that they want to use something else. So right now, it's either just focused on making sure that our customers are back to running back to feeling that their environment is secured, applying the patches that we provided, et cetera.
Ittai Kidron
Very good. And maybe a follow-up for you. I want to make sure I understand the commentary. Last quarter, clearly, there was some pull-forward element in some components. Help me understand to what degree do you have visibility, whether the product outperformance this quarter is also a pull forward from the third quarter perhaps or just pure expansion activity given the specific needs of customers. How do you get your hands around this?
Yogesh K. Gupta
Yes. So go ahead
Anthony Folger
Yes, I was just going to jump in there and say yes, in Q1 of this year, we did have a couple of deals that came in earlier than we anticipated, and I think they came in earlier, and maybe they were a little bit bigger. In Q2, there really was none of that activity. So I don't think anything in this quarter, at least nothing material is something that should have been recognized in Q3. And that's why I made the comment in my remarks because I think we felt really good about the performance in the quarter. And I think in light of the fact that some of the revenue got booked in Q1, I think it just -- it makes an even stronger case for how good the performance was in Q2 on the top line. So it's continuing to acquire new customers, continuing to renew, continuing to expand with our existing customers. I think in a lot of areas, we are performing.
Operator
Thank you. One moment for our next question. That will come from the line of Ray McDonough with Guggenheim Securities.
Raymond Michael McDonough
Yogesh, maybe for you. You mentioned customer success is obviously core to your strategy, and you opened up with statements regarding customers remaining committed to using Progress products. But I was wondering how conversations went outside of the moving customer base regarding the vulnerability. Have customers outside of that installed base indicated any concern around using any other Progress products? Or just in general, how those conversations went?
Yogesh K. Gupta
So at this point, the way the -- because the issue is limited to MOVEit, we really have not had other customers come to us and these concerns. One of the state of things in the software industry is that there are vulnerabilities that show up all the time. I think somebody was telling me that more than 10,000 vulnerabilities have been highlighted by software vendors in this last 6 months alone. So it is -- in some ways, unfortunately, it is the state of the world that basically you have cybercriminals going out there and doing what they do. So no, we've not had customers of other products raise an issue at this point.
Raymond Michael McDonough
That makes sense. And then maybe a follow-up for you, Anthony. You guys give a non-GAAP operating margin guidance by a significant margin here, and you're maintaining your full-year guidance as it relates to margins. Do you expect to ramp spending in terms of OpEx in the back half of the year? And should we be thinking about incremental spending on cybersecurity, for instance, to move the needle in terms of OpEx spending? Any color there would be helpful.
Anthony Folger
Yes, sure. I don't think that we had, I would say, a pretty significant investment in cyber coming into the year, and we have for a couple of years ongoing now. And so I think with the top line beat, if there's an opportunity to invest more, where necessary, obviously, we would. But there are other costs in the business, wage inflation continues to run, and we talked about that from time to time and inflation generally seems to be pretty persistent. And so I think we are trying to give ourselves a little bit of latitude around the margin -- on the operating margin, as some of those costs may continue to escalate as the year goes on. I think that's really it.
Operator
Thank you. One moment for our next question. And that will come from the line of Pinjalim Bora with JPMorgan.
Pinjalim Bora
Great. Congrats on a great quarter. Yogesh, on the edit point or the issue, I guess, I'm wondering if you can actually take any proactive steps or are you taking any kind of proactive steps to look at the rest of the product portfolio, mainly the new acquisitions to kind of the customers from those -- using those products?
Yogesh K. Gupta
So that is really a really good question, right? So we, of course, have had a very robust purity program at Progress. We take product security extremely seriously. I mean, I'm sure you can imagine being a provider of software to the wide range of customers that we are. We have -- we are basically investigating -- so right now, by the way, in the last 4 weeks, it has been all hands on deck for our customers, so I just -- I don't want to imply that we are going around doing other things, but we are looking to sort of see are there other areas of our products where we need to do better in the area of security.
We also, I think, maybe need to look at whether we are going to improve our M&A process around the security of the products we acquire. I think that was part of the comment that you made. This came to us through it switching 2019. So I think those things are all really important. But I don't want to imply that we've not taken security seriously all along. We actually do. We have -- we use industry-leading core scanning software to scan our code for vulnerabilities. We have hackers come in and test our software to find vulnerabilities if they can. It's a multifaceted approach, and we have a very strong response team in case something does go wrong. So I don't want you to think, Pinjalim, that now we will think about other product security. We've actually taken product security very, very seriously all along, but this also creates an opportunity for us to see if there are other things where we ought to improve.
Pinjalim Bora
Got it. And one question on just the M&A front. I'm wondering if the wave of investments in generative AI companies could be good for you maybe as VCs kind of reprioritize their portfolio, could that actually drag down the exit multiples for some traditional assets?
Yogesh K. Gupta
I think that the -- this has always been one of the fun things about being who we are, right? The VC usually moves to the next shiny object. And so the workhorse businesses that got created over the last decade that the -- over the last 15 years that become really, really strong. they then become not that interesting to the season, right? And when that happens, that basically means that their valuations do change. And you're absolutely correct. I think that it will create an opportunity for us to pick up vendors. I just pick up other companies. I'll give you a very interesting example I'm sure you noticed this, right? When cloud became really, really exciting, on-prem software company valuations came down even though we know that on-prem software companies are -- have greater -- better gross margins and all that good stuff. And so from the kind of business we won, I think we will find other companies that are really good companies in our industry, which are now less interesting to VCs who might say, you know what, the combination of capital being scarce and there's some hot stuff going on with generate AI, let's put our money to work there. So I think that's a really astute observation.
Operator
Thank you. One moment for our next question. And that will come from the line of Brent Thill with Jefferies.
Brent John Thill
I was curious if you could drive into the strength in the customer demand, and you had mentioned strength -- it sounded like it was no waiver in demand. Maybe if you can just unpack where you're seeing the strongest signals from your customers in excitement? And if you could also drill a little into MarkLogic, you mentioned that was a bit better. Can you remind us what revenue you recognized this quarter from MarkLogic and any other color that you could share?
Yogesh K. Gupta
I will let Anthony come in on the MarkLogic part and share numbers around that. But I will -- I think overall, in terms of demand, I mean, Brent, it's actually been really wonderful to see, as I mentioned, across the board as to us are looking to do things with products that they already know how to use, right? So that's one of the reasons why expansions are really sort of a big part of our business. Whether it is a product like OpenEdge, where customers are saying -- I'll give you an interesting example of what an OpenEdge customer, right? And I won't say names because sometimes it's a bit challenging, but I'll give you an example anyway.
The customer has spent the last 5 years thinking that they needed to find a different platform, and they were sold by somebody saying, "Hey, if you use our platform, you will be able to modernize and have an application that replaces the application you're currently using on top of OpenEdge with something so much better micesinier, greater, right?" They spent, let's just say, north of $50 million over the last 5 years. And they just decided that you know what, enough is enough. The project is now -- the product still has a similar timeline going forward. They have as many years to go as they did when they started, right? They haven't made any progress in terms of going to completion at this point. This is bizarre, right? So anyways, so we -- basically, they recommitted to us, they expanded. They decided to modernize using OpenEdge. We shared with them what they could do with it. And they signed a 7-figure expansion deal with us.
So I think to me, that's part of the trend. People are saying, am I wasting money somewhere where I should basically have something, and what can I do with it already? And that cuts once across the board. We're also seeing new customer wins with products like Loadmaster and Sitefinity Cloud because these products are addressing, again, the problems of efficiency, the problems of network performance availability. And we really look at Loadmaster. Loadmaster is front-end things like Dell cloud storage and Dell OEM set and sells it because it makes their environment much more reliable, much more resilient, much better performance and always on. And therefore, they basically do -- it's a growing channel for us for Loadmaster. Sitefinity Cloud, it's just -- it saves marketing dollars. It makes it easier for marketing folks to do their work. It is a great product at a great value. And I think right now, in the market, value sells, right? Are you selling a good product? Are you selling things that do the job? Do you have customers that you can point to?
So we're seeing this across the board, we're seeing this across virtually every geography, brand, I wish I could give you a thing further sort of insight into this. It's just broad. It's our application development products. It is our digital experience products with Sitefinity and others. It is our DevOps and SecOps product, it's our IT management, infrastructure management products. It is truly across the board. Anthony, you want to take the MarkLogic question?
Anthony Folger
Yes. Yes, sure. So we were right around $25 million for the quarter, Brent. And honestly, that was a bit ahead of our expectations, maybe a few million dollars ahead, to be honest. And there is a lot of seasonality in that business. We mentioned it on the last call, but we would probably expect Q2 and Q4 for this year to be the bigger quarters. I would expect Q3 to be seasonally a bit slower, and so it might step down a few million bucks during the third quarter because of just seasonality. But overall, we did come in a bit higher than expected, both top line and bottom line on MarkLogic this quarter. So that was really encouraging.
Operator
Thank you. One moment for our next question, and that will come from the line of Anja Soderstrom with Sidoti.
Anja Marie Theresa Soderstrom
Congratulations on another great quarter in execution. You mentioned in the previous question that you expect expenses to creep up a bit due to inflation and bridge inflation. Is there anything you can do to offset that?
Yogesh K. Gupta
Thank you, Anja. We actually are looking to see, right, what we really can do. I mean, I'll let Anthony talk about this more around expenses. But from our perspective, we continue to look for opportunities where we can control costs and reduce spend. But at the same time, there are some market factors that are really out of our control. Anthony, do you want to expand?
Anthony Folger
Yes. No, I think that's right, Yogesh. And in past years, we have taken steps in other areas of the business where we could get a little bit leader -- selling our corporate headquarters last year was a pretty good example where we took some assets off the balance sheet, put some capital on the balance sheet and took down our operating spend. There are smaller opportunities that we're pursuing now.
And I think it's just part of the progress DNA, where we're constantly doing that. So I think we have the ability to maintain and, over the long run, slightly improve our margins. And we've sort of talked about that a little bit during Investor Day. I think the inflation that we're seeing, wage inflation in particular, is something that's been a bit stubborn for maybe the past 2 years. I think up to this point, we've done a good job offsetting it. And I think we'll continue to do that. But it just takes -- it takes sort of a lot of work, and we need to be scrappy as we work through the back half of the year. So I guess I would probably leave it at that. But yes, there are areas we can look into, and I think that's been our history.
Operator
Thank you. As I'm showing no further questions in the queue at this time. At this time, I would like to turn the call back over to Mr. Yogesh Gupta for any closing remarks.
Yogesh K. Gupta
Well, thank you, everyone, for joining us. Once again, we're excited about where we're going in our second half of the year as well, in addition to what we have delivered in the first half. We look forward to talking to you again soon. Have a good night.
Operator
Thank you all for participating. This concludes today's program. You may now disconnect.
