Progress Software Corporation (PRGS) Earnings Call Transcript & Summary

Good day, and welcome to the Progress Software acquisition of MarkLogic update call. [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. Michael Micciche, Progress Software's Vice President of Investor Relations. Please go ahead.

Okay. Thank you, Sherri. Good afternoon, everyone. We're glad you've joined us. With us on today's call is Yogesh Gupta, Progress' President and CEO; and Anthony Folger, our CFO. Earlier today, we announced our proposed acquisition of MarkLogic, along with some preliminary results for our fiscal fourth quarter ended November 30, 2022, in a press release issued after the market closed. You can find this press release on the Investor Relations section of our website at investors.progress.com. Before we get started, I'd like to point out that any preliminary results for our fourth fiscal quarter are subject to revision until we report the full fourth fiscal quarter and fiscal 2022 results on January 17. Details and instructions for accessing that call 2 weeks from now were issued in a separate press release today after the close. I'd also like to remind you that during this call, we may discuss items including our outlook for future and prospective financial and operating performance, corporate strategies, product plans, cost initiatives and other information that might be considered forward looking, including the timing and the potential results associated with our proposed acquisition of MarkLogic. This forward-looking information represents Progress Software's outlook and the potential impact of the MarkLogic acquisition 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 release as well as on the Progress Investor Relations section of our website. Again, that's investors.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, we will make reference to several non-GAAP measures on the call, including annual recurring revenue, or ARR, and revenue and diluted earnings per share. We will include a reconciliation of non-GAAP financial measures to the most directly comparable GAAP numbers in our earnings release on January 17. So with that, let me turn the call over to Yogesh. Yogesh, go ahead.

Thank you, Mike, and good evening, everyone, and a happy new year. Thank you for joining us today as we share some really exciting news about our latest acquisition. As you saw in our press release earlier this afternoon, we entered into a definitive agreement to acquire MarkLogic for $355 million in an all-cash deal. MarkLogic was founded in 2001 and is the best-in-class provider of a proprietary multimodal NoSQL database as well as robust semantic metadata management and AI capabilities. These technologies, along with MarkLogic's loyal customers and deep relationships with partners and resellers, will complement Progress' robust infrastructure software offerings and strengthen our commitment to delivering the best products to develop, deploy and manage high impact business applications. When the deal closes, we expect the acquisition to add more than $100 million in total annual revenue, pushing Progress past the $700 million in annual sales, and closer to the goal we laid out in 2019 of doubling our size in 5 years. To pay for this transaction, we expect to utilize cash on hand and draw approximately $200 million from our existing revolving line of credit. Although this is the largest acquisition since we embarked on our total growth strategy 4 years ago, for us, this deal simply marks the latest step in the consistent and disciplined execution of our total growth strategy. And we are thrilled to discuss why we're so excited about welcoming MarkLogic's employees, customers and products into the Progress family. We have always been transparent in our assessment of the M&A landscape and how it's evolving. We have also consistently reaffirmed our commitment to remaining patient and to make acquisitions only if they meet our strict criteria. We remain committed to the -- we are committed to remaining disciplined and to deploying shareholder capital in a way that provides the best possible returns. The base metric for that is achieving a return on invested capital that exceeds our weighted average cost of capital. In addition, there must also be clear potential for the acquired business to reach operating margin targets at or above 40% after synergies. In our search for good acquisition candidates, we look for infrastructure software businesses with great products, a sticky customer base with high retention rates, significant recurring revenue, strong cash flows and the potential to leverage our existing sales support and go-to-market platform. In addition to our target's product, customers and go-to-market fit as well as its financial merits, we look for alignment across people and culture. And that is why we're so excited about MarkLogic. It hits the mark on every one of these measures. MarkLogic is a pioneer in multimodal data platform, data integration and the semantic analysis of structured and unstructured data, all of which helps customers meet modern complex data needs. MarkLogic's technology and expertise will allow Progress to deepen its data offerings and enable customers to connect, create and consume data grounded in analytics, informed search and fact-based intelligence. MarkLogic products complement Progress' DataDirect by extending data capabilities for our enterprise customers beyond structured data integration to natively manipulate, store and manage nonrelational data such as graph data, triples and other unstructured data as well as perform semantic metadata analysis and apply AI capabilities to all data to glean insights. The company has over 300 customers and strong relationships with key partners and resellers and has offices in Redwood City, Chicago, Paris and Tokyo. MarkLogic customers and partners will gain access to our expansive product portfolio, which will enhance their digital experiences and elevate their infrastructure management. They will also deepen their ability to drive value from any data, any application in any architecture, in any workflow. MarkLogic customers and partners will also benefit from Progress' unparalleled track record of customer success. With our financial strength, global presence and a history of being the trusted provider of mission-critical infrastructure software to organizations around the globe, MarkLogic customers can have greater confidence in the long-term investment in its products and services. MarkLogic employees share a culture of product innovation and customer success that is very similar to ours. They have built a great business by offering strategically important and innovative mission-critical products as have we. And like us, they focus on the success of their customers, which has led to impressive loyalty and high retention rates. As I mentioned earlier, we expect that by the time we fully integrate MarkLogic, this deal will add more than $100 million in total annual revenues and over $75 million in ARR. With the addition of strong cash flows, world-class operating margins and solid recurring revenue made stronger by our proven integration processes, we expect to achieve solid returns for our shareholders. The transaction is subject to customary closing conditions and regulatory approvals, and we currently expect the deal to close in the first half of February. As with previous acquisitions, we expect to complete the integration of MarkLogic within 12 months of closing. Before wrapping up, I'd also want to mention that our press release today included a reaffirmation of the guidance provided on our third quarter conference call in September and a preliminary look at our fourth quarter 2022 ARR. Based on our most recent assessment, ARR ended the fourth quarter of FY '22 at approximately $497 million, which is a 3.5% increase over the prior year. We also expect non-GAAP revenue and earnings per share to be within or above the high end of our guidance. We look forward to discussing all the results of the fourth quarter and the full year FY '22 on our earnings call scheduled for January 17. To conclude, we believe that our acquisition of MarkLogic creates significant demonstrable value for shareholders, customers and employees. We can't wait to close the deal and get started on the integration. With that, I'd like to open the lines for questions. Operator?

[Operator Instructions] And today's first question will come from the line of Ittai Kidron with Oppenheimer.

I have a couple of questions, Yogesh, maybe starting on the technology side. Can you give us a little bit more detail how does this technology fit your portfolio? And what I mean by that more specifically, is this just an upsell to existing installed base type of an exercise? Or there is a deeper technology integration process? How does this technology coexist with OpenEdge , for example?

Yes. So Ittai, great question. So OpenEdge, of course, is a relational database, and DataDirect is really our data integration capability that supports this relational or structured data, right? What this does is it really complements, right? So MarkLogic has a NoSQL database that can deal with unstructured data and triples. It also has the capabilities to take both structured and unstructured data, do semantic metadata modeling on it and basically effectively create enriched data set of sources that can then be used for all kinds of analysis and consumed in a variety of ways, whether it is for informed search or whether it is for contextual applications or fact-based intelligence, those kind of things. So let me give you a customer example. Maybe that could be helpful. A very, very large global manufacturer uses this to look at, for example, the entire set of parts that go into what all they manufacture. This manufacturer has hundreds of thousands of parts that they use coming from thousands of suppliers. Often, the parts are -- the same part can be named different things. And tying that all together and making sense of it is extremely, extremely difficult. And so by using MarkLogic's capabilities, they're able to take that information and make sense out of it, apply AI and machine learning to the unstructured data and structured data and basically come up with, aha, this is the same set of parts, even though they are being called differently and they are being supplied by different suppliers, et cetera, and make some sense out of what they have. And then, of course, then they can -- that can then lead to optimizing costs or optimizing the number of suppliers they have or whatever business outcomes they want to target. What's -- the way it complements both OpenEdge and DataDirect is that OpenEdge can be one of the structured data sources into this exercise. And DataDirect, of course, is -- allows for structured data from a whole lot of other structured data sources as well, not just OpenEdge. And so we see this as extremely complementary to what we have. And actually, it really -- those are the 3 products that go together in our portfolio with the 2 products we have and then the MarkLogic and Smartlogic product that MarkLogic has.

Got it. Okay. Helpful. And then on the financial side, I know you're limited in what you can say right now until the deal closes. But if I remember correctly from my previous interactions with MarkLogic, there's a very significant professional services component to this company, which is [ offward ] than what your criteria is usually for operating margin threshold. And so can you help me understand, is the gap between the revenue and the ARR professional services driven? And how do I think about -- if I remember correctly, this company also had a fairly lumpy revenue recognition model. Maybe it's a bit out of date. But help me understand some of the dynamics here. I don't need the numbers. But just conceptually speaking, how did the model fit into your model?

So absolutely, happy to share. So a couple of things that, over time, I think percentage-wise, the professional services revenue -- the contribution of professional services as a percentage has gone down. So that's part A. So it is not as high as maybe when you saw it. Secondly, the difference between ARR and the overall revenue is a combination of both professional services and some perpetual license that they do. So there is that component to it as well. You are correct that there is some lumpiness to the actual reported revenue, which is why I think ARR is a better metric. The lumpiness to reported revenues, very similar to what we have with DataDirect, right? When you have term license to on prem, ASC 606 ends up forcing you to [ write ] multiyear term licenses all upfront as opposed to looking at it from an annualized perspective. So yes, there is some lumpiness, but we will get into more detail when we do the call once the deal closes. But we actually see a clear line of sight to the 40-plus percent operating margin for this business. It is -- we, at this point -- again, we'll talk more when we close the deal, but the business is really a solid business, and we see clear line of sight to our targets.

And maybe just before I open up, can you tell me if this company had any growth over the last 2, 3 years? Or it's just sideways essentially?

Yes. Ittai, the ARR has been growing steadily over the last 2 years.

[Operator Instructions] And that will come from the line of Fatima Boolani with Citi.

Yogesh, a technology question for you. So appreciate the synergy that you've talked about with respect to the capabilities of MarkLogic being added to the portfolio. But in a pretty crowded field of database layer options for both developers and app architects, what is it that makes the MarkLogic technology and the intellectual property there really stand out and what appears to be, to us anyway, just a surplus and surfeit of options in the marketplace for database technologies? And then just a follow-up, Anthony, if I may.

Yes, sure. So I mean I think part of it is the -- with database technology, Fatima, at this point, you're right. There's a whole lot of options out there. The question becomes how well integrated is it, how easy it is to implement, how robust it is, how reliable it is, how scalable it is. I think those are some of the differentiators. They -- actually, even though they say NoSQL, the reality is that what that really stands for in MarkLogic language is not only SQL. So they do SQL and unstructured as well. The other part really is, I mean, Fatima, as you know that in our acquisition modeling and in our approach, right, new customer acquisition is a very small part of what we focus on, right? Our -- in general, our focus is on retention and expansion of existing customers, if possible, maybe a little bit of cross-sell. But really, that's what we build our models on and that's what we do our planning on. So if there is some significant new customers to win, that is great. And as you know, with database products, customers who once they start using the product and they build their business on top of it, whether it is an application of some kind or an analysis system of some kind, they end up with a mission-critical system that the database is extremely, extremely hard to replace. And fundamentally, you -- and anybody that has used databases 30 or 40 years ago, they're still using those databases, even databases like IMS and IDMS and Datacom, which nobody here probably remembers. So I think -- to me, I think that's one of the beauty of database business, is that it's a forever business. And that -- so to us, it is that retention and that expansion that happens with usage and capacity that is really the fundamental principal driver on how we see the modeling of this. But it is a competitively differentiated offering. We think that our DataDirect offering helps it differentiate even more. And so that's how we see it.

I appreciate that. And Anthony, for you, just as a segue, just with respect to the customer overlap of the 300, can you share with us how many of those customers are sort of large enterprises versus some of your customers who tend to be using your product of an embedded, an OEM solution? Just curious to get your views on how much of it is sort of direct to large enterprises versus ISV type relationships when looking at the body of the 300 customers that you're acquiring. And then just as a follow-up, your expectations of driving or actively driving cross portfolio monetization versus independently trying to scale that $100 million base from here. And that's it for me.

Yes, I can just quickly say on the second question, I think the cross-portfolio sales sort of cross-sell is not something that we would put into our model and generally not something that we would sort of build our outlook on. Some of those opportunities may come to pass internally, but it's certainly not a focus for the business. And in terms of the MarkLogic customer set, I think it's probably similar in size. And I mean in terms of dollar values and type and profile of customer to, say, OpenEdge, sort of that SME or maybe a little larger enterprise-type customer. So I think to Yogesh's point, there is a lot of opportunity and a lot of complement within our product set and what MarkLogic brings to the table. But I wouldn't necessarily assume that that's going to lead to a lot of cross-sell in the portfolio. We may see that over time, over time develop but certainly not something we're modeling at this point.

That will come from the line of John DiFucci with Guggenheim Partners.

Yogesh, you said ARR is growing steadily over the last few years. I mean I know MarkLogic's strength has always been to work with large, complex problems. But back to Ittai's -- one of his questions. My memory is kind of like his, that they were about this size many years ago. And frankly, I thought they were bigger. Did they actually decline at one time? And I don't know, can you shed a little bit of light over the last like, I don't know, 5 to 7 years? And then what do you expect? I know it's not your focus to grow organically or grow new logos anyway. You mentioned that. But is this something where you're just going to continue to maintain the product and farm the existing installed base and perhaps grow that capacity, I guess?

Yes. So let me answer both those parts. So John, you're absolutely correct. I think about 7 years ago, this was a bigger business. So I think they went through some tough times. I don't know why, but that was significantly long ago. But over the last 3 years, the business on the product side has been growing. As I said, the ARR has been growing very steadily. I also mentioned that professional services has been coming down as a percentage of the overall contribution. So that has been the trend. And I think part of it was that actually back 6, 7 years ago, professional services was huge. I think they had extremely, extremely large professional services. So I think that some of it was that. But I don't really fully know, to be honest, 6 or 7 years ago. What I do know is that, over the last 3 years, ARR has been growing steadily. Professional Services has been reducing as a percentage contribution. And by the way, the other interesting thing is that, from our perspective going forward, I think retaining existing customers is critical. We actually have demonstrated that we can drive net retention rates to over 100%. I think that is something that we believe that is doable with this portfolio. And then in addition to that, we do expect some new sales. We do expect some sales by both winning new logos as well as by us being able to maybe do some -- a little cross-sell, not modeling that in a very large way within -- not modeling top sell at all and not modeling a significant new customer acquisition either, John. So I just wanted to share that. But from our perspective, if this business continues to grow, their ARR in line with what our ARR is growing and on an annual basis, we'd be very happy.

Okay. So -- and you guys do that very well. So we should expect this business to continue to grow ARR steadily in the future.

We are expecting the ARR to continue to grow in low single digits, yes.

That will come from the line of Pinjalim Bora with JPMorgan.