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Good day and welcome to the Progress Software Corporation Q2 2018 Investor Relations Conference Call. At this time, I’d like to turn the conference over to Mr. Brian Flanagan. Please go ahead, sir.
Thank you, Cody. Good afternoon, everyone, and thanks for joining us for Progress Software’s fiscal second quarter 2018 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 may discuss our outlook for future financial and operating performance, corporate strategies, product plans, cost initiatives or 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 both in today’s 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, the revenue, operating margin, diluted earnings per share and adjusted free cash flow amounts we 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 second quarter 2018 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 will now turn it over to Yogesh.
Thank you, Brian, and good afternoon, everyone. Welcome to our second quarter 2018 conference call. I want to first walk you through the highlights of our financial quarter -- financial results for the quarter and then provide an update on our business, operations and strategy.
Our continuous focus on keeping our business strong and on running our operations efficiency enabled us to achieve another strong result -- another quarter of strong financial results in Q2. We far exceeded our earnings per share expectations while also achieving revenue that was slightly above the high end of our guidance range, despite foreign exchange headwinds during the quarter.
Earnings per share increased by 43% following 59% growth in the first quarter and we also had a very strong free cash flow performance. Operating margins were 39% and we maintained our disciplined approach to capital allocation by returning over $50 million to shareholders during Q2.
The strength of our business combined with our first half performance has given us the confidence to raise our full-year guidance for earnings per share and operating margin for the second quarter in a row and to increase our expectations for free cash flow as well. As we have discussed, our goal is to drive sustainable, long-term value by building an increasingly stronger business. Our solid first half results and consistent execution are evidence that our strategy is sound and working and is generating real value for our shareholders.
Now, let’s take a look at some of the operational highlights for the quarter. OpenEdge, the foundation of our business, continued to perform well in Q2, including strong license growth from direct enterprise customers. As we have discussed in previous calls, the timing of additional license sales to direct enterprises can fluctuate somewhat from quarter-to-quarter, based on their additional capacity requirements. Churn in the direct business continues to be very low with maintenance renewal rates that remain well over 90%. For the full year, we still expect a slight decline in license sales to direct customers, offset by growth from our ISV channel. Our ISV partners had another solid consistent quarter. SaaS-related revenue from our partners who offer their applications in the cloud grew by 9% in Q2 and by 17% in the first half, demonstrating that our partners’ applications remain current and competitive in today’s cloud environment.
I’ve mentioned before that ongoing investment in our OpenEdge technology is necessary to keep our partners competitive within their evolving markets. We continued those efforts in Q2 with the recent release of the Progress Application Server for OpenEdge. This new functionality makes it even easier, faster and more efficient for our partners to modernize their legacy applications and deploy new, cloud and mobile first apps, all while continuing to leverage their existing OpenEdge ABL code and business logic. This continued investment strengthens our relationships with our OpenEdge partners, helping to ensure that our maintenance renewal rates remain well over 90% for our ISV channel as well just as they are for our direct customers.
Our DCI revenue decreased in Q2. This is consistent with our expectations and our view of DCI’s full-year revenue performance has not changed. We remain the premier provider of data connectivity in the market with most major software vendors including 8 of the top 10 BI and analytic companies embedding data direct into their products. DCI is also key to our Cognitive Apps strategy, because fast, scalable and secure access to all modern and legacy data is critical for tomorrow’s business application.
Bookings declined in our App Dev segment in Q2, although we did achieve slight growth from Sitefinity. Despite that, we still expect DevTools and overall App Dev bookings to increase in the second half and for the full year, and remain confident in the health of this business.
Contributing to this optimism is our success in continually delivering the new features and functionality that developers need in a fast-moving marketplace. For example, we recently announced availability of chatbots that developers can deploy within their applications. Conversational UI is a critical capability to engage users of today’s modern apps, but building chatbots that deliver an effective, natural customer interaction is difficult and time-consuming. Our innovative solution makes it extremely easy to rapidly implement cutting-edge conversational UI capabilities using existing development skills and industry standards.
Turning now to our new initiative. As we have previously discussed, while it is still early for the revenue opportunity for DataRPM and Kinvey, we have confidence in the trajectory of these new businesses, having added nearly 20 new customers this year. We are pleased with the pipeline growth we are seeing. And to address the increasing interest in these offerings, we are gradually scaling up our go to market efforts and headcount for these initiatives in the second half of the year.
For Kinvey, compliance, especially HIPAA compliance is proving to be a differentiator in the market. Reflecting this, during this quarter, we added another customer for our Health Cloud solution, who chose Kinvey specifically for its out-of-the-box HIPAA compliance. We also had an existing Kinvey customer expand its usage during the quarter with compliance at the center of its decision-making. This major real estate development company has developed and deployed a mobile app on top of the Kinvey platform that allows seamless single-point access to office building amenities and services for its customers. However, as they scale to add more and more users on their mobile offering, they realize it was critical to protect users’ personal data. Purchasing and deploying Kinvey’s secure data privacy capabilities allowed them to meet this key requirement.
Our OpenEdge ISVs continue to express enthusiasm for our cognitive anomaly detection and prediction or CADP initiative. They know that adding predictive maintenance technology into their applications is a critical future user requirement. And feedback from them on our Cognitive App strategy during our recent customer and partner conference further validates our strategy.
As we have discussed in the past, it is a 12 to 18-month process for them to build and integrate DataRPM’s cognitive capabilities into their applications, and they recognize the imperative of providing this functionality over the longer term.
We also see enthusiasm for DataRPM’s capabilities among new enterprise end users. For instance, Progress recently hosted an event in Silicon Valley on how to apply machine learning to industrial IoT. This event, which I personally attended, attracted a who’s who of manufacturing enterprises including Cisco, Siemens, Mitsubishi, Intel and NTT Data, all exploring ways to more efficiently utilize AI technology.
Also, to enable R&D and innovation groups within manufacturers to rapidly leverage machine learning for industrial IoT, we recently announced a DataRPM offering on the AWS Marketplace. This self-service option enables users to rapidly connect to their organization’s time series sensor data and start identifying anomalies and predicting failures more quickly and easily than previously possible.
As we execute on our product and business strategy, we’re also continuing on the path we’ve established for M&A and capital allocation. On the M&A front, the market remains active and highly competitive, and our internal team continues to see many opportunities that would be complementary to our business and enhance our recurring revenue. However, it is still difficult to predict the timing of any potential transaction. We’re confident that we have the management team and the internal expertise required to successfully integrate and operate the types of companies we are targeting.
We will also continue to execute on a disciplined capital allocation policy with established targets for both dividends and share repurchases. Consistent with this policy, we returned over $50 million to our shareholders during the second quarter and have returned over $100 million so far during 2018. After completion of our currently authorized share repurchases at the end of 2019, we will target 75% to 80% of our annual operating cash flow to be returned to our shareholders in the form of dividends and share repurchases.
I briefly mentioned our customer and partner conference earlier, but I’d like to spend a couple of minutes recapping the event. The conference was a huge success with more than double the number of attendees from last year covering users of all of our products from OpenEdge to DCI to DevTools, Sitefinity, NativeScript, Kinvey, and DataRPM. Attendees included representatives from more than 300 companies who traveled from 30 different countries, plus industry analysts and media representatives. We also had over 3,000 more people watching a live stream of the session. Sessions were packed right up until the end of the conference with many testimonials from customers and partners about the vital contributions that Progress products make in their businesses. Overall, there was a tremendous level of excitement and energy, and our sales team is now working a pipeline of opportunities stemming from this event. Of particular importance, enthusiasm for the opportunities presented by our newer products, Kinvey and DataRPM shows that our strategy is resonating with our partners and customers alike.
In closing, we’re very pleased with our Q2 performance and our strong start for the first half of the year. Our better-than-expected earnings per share, operating margins and free cash flow are indicative of our efforts to run a lean business. And we continually look for opportunities to gain further efficiencies. Our core remains strong and stable. And we continue to invest in innovative products that provide existing and new customers and partners with the modern, cutting edge technology we need to compete and succeed in their market. Of course, there’s plenty of work to do in the second half to maintain our momentum. We must continue to execute on all facets of our product and business strategy, and on our M&A and capital allocation framework, which enable us to deploy our capital consistent with both short and long-term goals. We remain focused on building a stronger company with each passing quarter and look forward to continued engagement with all of our shareholders in the rest of 2018 and into the future.
I will now turn the call over to Paul to review our Q2 performance in more detail and outline our financial expectations for Q3 and 2018. Paul?
Thank you, Yogesh, and good afternoon, everyone. As a reminder, all numbers that I’ll be referring to in my remarks are on a non-GAAP basis.
For the second quarter, total revenue was $96.2 million, which was slightly above the high end of our guidance range of $96 million. Based on exchange rates in effect at the time that we provided our guidance in March, revenue would have been $500,000 higher or approximately $96.7 million if not for the unfavorable FX impact of a stronger U.S. dollar in the second quarter. Our higher-than-expected revenue was primarily due to an OpenEdge direct enterprise deal that closed earlier than expected.
Our earnings per share of $0.60 for the quarter grew 43% year-over-year and significantly beat the high-end of our guidance range of $0.53. The $0.07 overachievement was due to lower expenses as we continued to tightly control, both hiring and discretionary spending. The solid revenue performance coupled with continued prudent expense management enabled us to achieve 39% operating margin for the quarter, an increase of nearly 400 basis points over Q2 of last year.
Looking at our consolidated revenue for the quarter compared to Q2 of last year. Total revenue of $96.2 million was 3% higher at actual exchange rates and approximately flat on a constant currency basis. The year-over-year impact of exchange rates on the second quarter revenue was up favorable $2.4 million. License revenue of $26.5 million increased by 3% at actual exchange rates and 1% on a constant currency basis, driven by an increase in our OpenEdge segment.
Maintenance and services revenues was $69.8 million, an increase of 3% year-over-year at actual exchange rates and approximately flat to last year on a constant currency basis. Maintenance revenue was $62.4 million, an increase of 1% on a constant currency basis, driven by our OpenEdge and AD&D segments. Professional services revenue was $7.4 million, down 6% on a constant currency basis, due to lower service revenue from OpenEdge, which was partially offset by increased Sitefinity services revenue from our AD&D segment. Q2 EPS of $0.60 was $0.18 higher than last year, primarily due to the improved operating performance, a much lower tax rate, and to a lesser extent, a lower share count. The year-over-year impact of exchange rate movements on our second quarter EPS was a favorable $0.02.
Turning now to our revenue by segment, which is all at constant currency, OpenEdge revenue was $67.7 million for the second quarter, up 3% versus Q2 2017, yet another solid quarter from our high ISV partners and a good performance from our OpenEdge direct enterprise customers due to the timing of additional license sales, and one transaction in particular that we did not expect to close until Q3. License revenue from our partner channel continues to be solid, fueled primarily by the growth from partners who deploy their applications in a SaaS model. Our SaaS-related revenue for OpenEdge was $6.1 million for the quarter, up 9% versus Q2 of last year. First half growth was 17%, above our expectations of the low-double-digit growth for this revenue stream going forward.
OpenEdge maintenance revenue increased by 1% on a constant currency basis compared to last year with maintenance renewal rates for the quarter again well over 90% for both ISV partners and direct enterprise customers.
I noted earlier, OpenEdge professional services revenue decreased in the second quarter and for the first half, consistent with our expectations. While revenue was down compared to last year, we also reduced the associated costs, part of our decision late last year to optimize the profitability of OpenEdge professional services. Excluding professional services revenue, OpenEdge license and maintenance revenue was stable with growth of 4% for Q2 and 3% for the first half of 2018.
DCI revenue was $5.7 million for the second quarter, a decrease of 19% compared to Q2 of last year. The decrease for the quarter was slightly higher than expected due to the timing of the two OEM renewal agreements, but our expectations for the full-year have not changed. Our multiyear license backlog at the end of the second quarter was $14.9 million compared to $20.4 million at the end of Q2 of last year and $15.6 million at the end of last quarter. While the annualized value of our OEM contracts has not changed, the timing and structure of the renewal agreements affects the amount of our backlog from quarter to quarter.
Turning to our AD&D segment, revenue was $20.4 million for the quarter flat to Q2 of 2017. Total bookings were $19.4 million for the quarter, down 10% versus Q2 of last year. The bookings decrease was primarily due to lower license and new maintenance sales for our DevTools and Sitefinity products, partially offset by increased renewal maintenance and services revenue for Sitefinity. We still expect DevTools bookings to be flat or increase slightly for the full-year of 2018.
The total revenue by geography within our international -- with our international regions at constant currency. North American revenue was $50.9 million, down 1% versus Q2 2017; EMEA revenue was $32.8 million, up 7%; Latin America revenue was $4.5 million, down 20%; and Asia Pacific revenue was $5.6 million, up 3%.
Total costs and operating expenses were $58.8 million for the quarter, down $2 million from a year ago. The year-over-year decrease in costs and operating expenses was primarily due to lower compensation and benefit costs, the professional services, and sales and marketing, partially offset by increased costs related to our annual customer and partner conference.
Q2 2018 operating income grew 50% over Q2 of last year. Operating margin improved nearly 400 basis points from 35% in Q2 of last year to 39% this year. The improvement in both operating income and margin is primarily the result of the cost reductions from our restructuring actions from last year, as well as additional savings from ongoing expense management.
Moving on to a few balance sheet and cash flow metrics. The Company ended the quarter with a strong balance sheet with cash, cash equivalents and short-term investments of $144 million. Our debt principal balance at the end of Q2 was $121 million. DSO for Q2 2018 was 40 days, down 11 days sequentially and down two days to Q2 of last year.
Deferred revenue was a $148 million at the end of the second quarter, up $6 million versus Q2 2017. The increase was primarily due to solid year-over-year increases in deferred revenue for OpenEdge and Sitefinity. Adjusted free cash flow was $43 million for the quarter compared to $28 million in Q2 of last year. The increase versus last year is due to higher collections, lower tax payments partially offset by increased CapEx. Here today, adjusted free cash flow was $76 million, an increase of $5 million versus 2017.
In the quarter, we repurchased 1.1 million shares at a cost of $45 million. At the end of the quarter we have a $130 million remaining under our current authorization. We are targeting an additional $30 million of repurchases during the remainder of fiscal ‘18 and intend to spend the remaining $100 million of our authorization during fiscal ‘19.
I’d now like to turn to our business outlook and guidance for fiscal 2018 and Q3. For the year, our revenue guidance remains unchanged at $399 million to $404 million, flat to an increase of 1% versus 2017. After weakening during Q1, the U.S. dollar strengthened significantly in Q2. Based on current exchange rates, the total expected positive impact on our 2018 results is now $4.5 million, a slight increase from the $4 million estimate from when we provided revenue guidance for 2018, but down nearly $4 million from when we provided guidance in March.
Turning to our earnings per share and operating margin. Our continued strong performance in Q2 has enabled us to again increase our full-year guidance for both metrics. Our guidance includes a modest expense increase in the second half of the year, as we began to gradually scale up sales headcount for our Cognitive App strategy, as Yogesh mentioned.
We will also incur a higher compensation cost in Q4, even when compared to our normal seasonality due to the changes in our variable compensation plans this year that create a steeper payout ramp as we near our full-year financial target. This change shifts compensation expense later into the year, and our guidance reflects these additional expenses in Q4.
We are now expecting operating margin to be approximately 38%, an increase of a 100 to 200 basis points versus our March guidance. For EPS, we now expect full-year earnings per share of $2.45 to $2.50, $0.09 above our prior guidance. This represents 28% to 31% increase over fiscal 2017 EPS. Our EPS outlook reflects our anticipated increase in operating margins and $30 million of share repurchases we are targeting to complete by the end of the year.
Current exchange rates, the weaker dollar is expected to have a positive year-over-year currency translation impact of approximately $0.02 on our full year EPS. Our prior estimate was $0.04. We are also raising our guidance for adjusted free cash flow to be in the range of 120 to $125 million for 2018, an increase of $5 million from our previous estimate. And our expected tax rate is 22%, unchanged from our prior estimate.
Now, turning to our guidance for Q3 2018. We expect revenue to be between $95 million and $97 million, a year-over-year decline of 1$ to 3%, partially due to the OpenEdge deal that closed earlier than expected in Q2. The year-over-year expected currency translation impact on our Q3 revenue is not meaningful. On a constant currency basis, although we expect lower OpenEdge professional services revenue, our guidance assumes slight overall growth from our OpenEdge segment, revenue from our AD&D segment is expected to decline and we expect DCI revenue to be lower than last year.
We expect earnings per share of $0.56 to $0.58 for the third quarter compared to $0.48 in Q3 of last year, an increase of 17 to 21%. Based on current exchange rate, the expected currency translation impact on our Q3 EPS is not meaningful.
In closing, yet another strong financial performance for the quarter, and I’m pleased with our improved profitability and cash flow outlook for the year. We will continue to run lean by carefully monitoring our discretionary spending and will be thoughtful in our hiring plans. We remain focused on generating strong cash flows, which will enable us to make investments we need to strengthen our business and also return meaningful amounts of capital to our shareholders.
With that, I’d like to hand it back to Brian for Q&A.
Thank you, Paul. That concludes our formal remarks for today. 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 Instructions] We’ll take our first question from Mark Schappel with Benchmark. Please go ahead.
Yogesh, starting with you, I was wondering if you could just speak to the brand campaigns and the upcoming marketing awareness campaigns, initiatives that you have planned around the new predictive maintenance solutions that you spoke to -- that you touched on in your prepared remarks.
So, Mark, we are increasing a little bit of our spend around both, go-to-market efforts as well as modest hiring for the sales organization. Primarily, the marketing efforts are not around branding but around demand generation. So, that’s where the effort is going. It isn’t a branding exercise, Mark; it’s more of a targeted demand generation effort.
Great. That’s helpful. And then, on the predictive maintenance solutions, if I recall correctly, you had 10, your customers last quarter, I think you mentioned 20 this quarter, or you’re making [ph] another 10 this quarter. Could you just maybe speak a little bit about some of the trends you’re seeing as far as the type of customers and industries that are gravitating to the new product.
So, across our portfolio of new products, the customers range from -- I think I’ve mentioned a couple of those when it comes to healthcare cloud customers, of course manufacturers for the predictive maintenance side of things. And also really from the Kinvey perspective, it really is a horizontal solution. So, we are not -- other than the Progress Health Cloud, which is -- where we’re seeing healthcare related companies coming, we actually are seeing a very broad segment of industries.
We’re not seeing a specific, like one or two industries at this point, Mark. So, numbers are small to sort of make a trend out of it. As the numbers get larger, we may be able to see a trend. And if so, we will share it.
And then, finally, one last question. Yogesh, you mentioned in your prepared remarks, you mentioned in your chatbot tools, and I was wondering if you could just expand a little bit on those as to what you’re thinking there. I know it’s early days, but maybe just give an example to how customers have asked you to move into this area?
Yes. So, as you’re aware, Mark, right, the frontend UI experience continues to evolve rapidly. Conversational interfaces have become something that people want to provide in their apps now. One of the big challenges with conversational interfaces and creating them that our customers are facing is that they -- the hand coding of these and the tools that are out there, require people to sort of identify every use case of what the person might say and how to respond to it and so on and so forth, becomes an extremely complex set of programming. And if -- I’m sure you’ve used chatbots where you basically decide, oh wait a second, I gave three pieces of information, now I want to go back and change the first piece, after having given the second and third, and you basically end up starting over. Right? We have leveraged machine learning and AI for our chatbot capability as well. And it manages the conversation and it allows for developers to create a chatbot and embed it in their application extremely easily. And it learns from the interactions that it continues to have with various folks that use that application, and as it gets used, it actually gets better. It’s a cloud offering on the backend from the run time perspective and is a frontend tool that the developer uses to make it easy. We’re seeing interest from folks across industries. Again interesting enough, financial industries and healthcare are two of the ones that are what I call the early users and early -- they were the early testers and they are the early users from -- for that product today. It’s a very new product. We just announced it recently.
Thank you. We’ll now take our next question from Joseph Winn with Wedbush Securities.
Hey guys, Joe Winn on for Steve Koenig. Yogesh, you’ve talked about a consolidation strategy to pull in a mature business. Can you give us any additional color around the type of business you’re pursuing, and any additional thoughts on the current market conditions and deal landscape? I also have a follow-up. Thanks.
So, in terms of M&A, our -- we’ve always said this, and Joe, our goal is to identify businesses that are complementary to us in terms of product, audience, and growth profile, so that we can leverage our existing field organization, we can leverage our existing, of course G&A organization and so on. And so things that actually help with application development and the application development markets and markets related to what we already do whether it is data or application development is where we are focused. From a financial perspective, we have a very high bar. And these would bolster our recurring revenue and be highly synergistic, so that they end up with operating margins after synergies that are equal to or better than our current margin that generated return on invested capital within one year of completion that is above our rack. And given our return criteria, we anticipate that any such acquisition would be immediately accretive to our non-GAAP earnings. And so, that’s -- we set up fairly high bar. There is a lot of activity going on. Prices are something that we are -- given our criteria, we’re being very selective and we are going to be selective and find the right assets and make sure that it meets those financial criteria and business criteria that we’ve laid out.
All right, thanks. And then, my next question is on the HIPAA-compliant Health Cloud. And I was just wondering if you could give any additional color on how incremental that can become to revenue in the long term and do you have any market sizing ideas there? Thanks.
So, Joe, the market is for HIPAA-compliant cloud platforms is projected to be almost $2 billion in five years and is growing very, very rapidly. We’re of course early in the game, and the game has just started actually. We of course are not disclosing any revenue; we have said before that we will as we get closer. In fact, we expect to share our bookings before we get to share revenue because all of these are ratable cloud offerings. So, the bookings will come ahead of and will be a leading indicator of our revenues. Competitively, we feel really good about our offering. We’re seeing wins that are tremendously strong against all kinds of competitors.
Thank you. I will take our final question from Glenn Mattson with Ladenburg Thalmann.
First, a quick one. How big was the pull-in from the enterprise OpenEdge deal that you mentioned?
Yes. Glenn, it’s Paul. So, it’s just a little under $1 million. So, when you look at it, that really resulted in the over-performance, if you look at the actual exchange rates at the time that we provided the guidance. So, it is really something that we had planned for in the back half of the year and it closed earlier. So, it got reflected in Q2.
And then, can you give me a better sense, perhaps your guess about the degree of confidence in the bookings acceleration in the App Dev segment? It seems like the bookings have kind of been less than perhaps you would like in the last couple of quarters. So, just little more color around why this is going to turn around?
So, Glenn, good question. We actually have focused some additional efforts around driving that, including demand-gen efforts. We feel good about what we’re seeing. And we see this as a fairly stable market where we continue to win our fair share of deals. And so, from our perspective, based on what we are seeing, based on what the trend has been -- even though we report quarterly, as you can imagine, there are -- that business by the way has a 30 to 60-day sales cycle. So, we are able to tweak and see things at even shorter timeframes. We feel confident where the direction is going.
And that does conclude today’s question-and-answer session. I’d like to turn the conference back over to Mr. Flanagan for any additional or closing remarks.
Thank you, Cody. Thank you all for joining the call today. As a reminder, we plan on releasing financial results for our fiscal third quarter of 2018 on Thursday, September 27, 2018, after the financial markets close and holding a conference call the same day at 5 p.m. Eastern time.
I’ll now turn the call over to Yogesh for his closing remarks.
Thanks, Brian. We are committed to executing on a strategy that would benefit all our shareholders and we will work hard to sustain the momentum we’ve achieved during our strong first half. I want to thank everyone again for joining us on today’s call and look forward as always to getting your feedback on our progress to-date and our goals for the future. Thank you.
Thank you. This does conclude today’s conference. Thank you all for your participation.