Progress Software Corporation (PRGS) Earnings Call Transcript
September 8, 2020
Earnings Call Speaker Segments
Good day, and welcome to the Progress Software Update Conference call. At this time, I would like to turn the conference over to Anthony Folger. Sir, please go ahead.
Thank you, Katie. Good morning, everyone. And thanks for joining us. With me on today's call is Yogesh Gupta, Progress' President and Chief Executive Officer. Earlier today, we announced our proposed acquisition of Chef along with preliminary results for our fiscal third quarter, which ended on August 31, '20, and our preliminary revised business outlook for fiscal year 2020. You can find both of these press releases, a supplemental presentation we will walk through on this call and a link to today's webcast in the Investor Relations section of our website at investors.progress.com. Before we get started, I'd like to point out that the preliminary results for our fiscal third quarter and our preliminary revised business outlook for fiscal year 2020 are subject to revision until we report our full fiscal third quarter results on September 29, 2020. I'd also like to remind you that during this call, we will discuss our outlook for the future financial and operating performance, corporate strategies, product plans, cost initiatives, the impact of the COVID-19 crisis on our business and other information that might be considered forward-looking. We will also discuss our proposed acquisition of Chef. 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 preliminary earnings release as well as in the Investor Relations section of our website at 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, on this call, any financial information we reference are non-GAAP financial measures, unless it is stated that the measure is a GAAP number. This may include revenue and diluted earnings per share. You can find a reconciliation of non-GAAP financial measures to the most directly comparable GAAP numbers in our preliminary earnings release issued today. With that, I'll turn the call over to Yogesh.
Thank you, Anthony, and good morning, everyone. Today is a very exciting day for Progress, and we appreciate you joining us on this call. Earlier this morning, we made 2 announcements. First was the announcement of a definitive agreement to acquire Chef for $220 million. This is truly an exciting acquisition for us, and I'd like to spend most of my time talking about this with you today. Before I do so, I'd also like to highlight our second announcement this morning, which included preliminary results for our fiscal third quarter that exceeded our previously guided ranges and a preliminary updated business outlook for 2020, which takes into account our strong preliminary results for the third quarter and the expected contribution from Chef. We've been saying for quite some time that accretive M&A is the linchpin of our growth strategy, and Chef is exactly the type of acquisition we've been targeting. For those of you who may not be familiar with Chef, they are a leader in the DevOps space and provide complete infrastructure automation, enabling DevOps teams to build, deploy and manage secure applications in modern multi-cloud hybrid and on-prem environments. In fact, Chef is the leader in continuous automation software and innovator in application automation and one of the pioneers of the DevSecOps and DevOps movement. The company was founded in 2008 and boasts more than 700 paying customers across every vertical end market, including many Fortune 500 companies. For any of the more than 250 Chef employees who are listening to today's call, I'd like to let you know that we look forward with excitement to welcoming you to the Progress family when we complete the transaction. As I mentioned, Chef has been a true pioneer in the DevOps movement, and this acquisition will extend Progress' offerings in an ecosystem, which has become increasingly important as teams look to rapidly develop and deploy consistent, reliable, high-performance and secure systems in today's environment, environments which seem to grow larger and more complex with each passing moment. For an IT organization, the right automation products can truly differentiate the agile responses from the slow and reactive. Chef's automation platform allows teams to build, deploy, manage and secure any application running on almost any infrastructure, and it is comprised of Chef Infra and Chef InSpec for visibility into security and compliance; Chef Habitat, which provides automation capabilities for delivering applications to almost any environment; Chef Compliance to help maintain compliance and prevent security incidents. And finally, Chef Desktop, which automates the deployment, management and secure maintenance of any large fleet of IT resources. We intend to build on this impressive platform and combine our and their long-standing record of outstanding customer satisfaction. And we plan to leverage our systems, processes and additional resources to enhance the success of Chef's customers. We will also continue to support Chef's vibrant open source community and overall commitment to open source. There have been more than 40 million downloads of all of the Chef products over the years and hundreds of thousands of organizations have benefited from Chef's offerings. The open source community has been a key ingredient of this success, and we expect that to continue in the future. In addition, we plan to retain a group of Chef's long-tenured leaders and support them with Progress' cross-functional corporate resources in areas such as marketing, finance, IT, human capital, legal and more. We expect to complete integration activities within 12 months of closing. And in doing so, we'll leverage our operating model and infrastructure to help Chef achieve operating margins of more than 35% once fully integrated. We've been very transparent about our M&A strategy and the criteria we use to evaluate opportunities. And Chef checks all the boxes. First, it's clearly complementary to our existing business and plays in the market that we know well. From a financial perspective, Chef has an annual revenue of more than $70 million, at least 95% of which is recurring in nature. And Chef's net retention rates have consistently exceeded 95%. Because of Chef's relatively high mix of recurring revenue, we believe that Chef can increase our already high overall mix of recurring revenue by approximately 200 basis points. By leveraging our operating model and infrastructure, we expect Chef to deliver margins of at least 35% after synergies, and we expect the transaction to be accretive in our first fiscal quarter of 2021. Ultimately, this acquisition will generate returns for our shareholders in excess of our weighted average cost of capital and beyond what we could achieve with other uses of our capital. The transaction is an all-cash deal that will be funded with existing cash on hand and amounts available under our existing credit facility. The definitive agreement is subject to customary closing conditions and U.S. antitrust review, and we expect the transaction to close in early to mid-October. In our updated 2020 guidance, we have reflected approximately 2 months contribution from Chef. As we move into fiscal '21, we will quickly work through our integration plan in order to drive meaningful synergies and expect the integration plan to be complete within 12 months of close. In closing, I'd like to reiterate that we are thrilled with the acquisition and are confident that when completed, our integration efforts will enable us to achieve our acquisition criteria and financial objectives, while also enabling Chefs' business to thrive. Ultimately, this acquisition will make us a stronger company for our customers, partners and employees and create real value for our shareholders. With that, Anthony Folger, our CFO, and myself, we'd like to open the call up for questions. Katie?
[Operator Instructions] Our first question will come from Mark Schappel with Benchmark.
Congratulations on the deal and the nice quarter. Just a couple -- start off with a couple of housekeeping questions on Chef. Yogesh, maybe if you could just give us a sense of how many employees they had with respect to the revenue -- with respect to the -- also with respect to the revenue growth rate? Were they growing at all? And what would you say their operating margins are currently? This would be before any synergies.
Sounds good, Mark. And thank you for joining this early. So they have over 250 employees, Mark. They have been growing. And our expectation is that we see low single-digit growth going forward in the business.
Low single-digit growth.
So the business, they have had a very good business, as you know, and it's a highly recurring revenue business. So -- and we see tremendous stability in the top line because of very high net retention rates. And so we feel really good about the way the top line is.
As far as the cost structure goes, I assume they're profitable. But maybe you could just speak a little bit to the margin structure today?
Well -- and so on a non-GAAP basis, they are -- before the acquisition, they were approaching breakeven, Mark. But we -- as we move forward, very quickly, we'll, through synergies, make the acquisition accretive, starting with the first fiscal quarter of 2021. And we expect to deliver the synergies and the operating margin of over 35% by the fourth quarter of 2021 in 12 months.
That's great. And then just building off your comments on synergies, maybe you just give us, at a high level, where you expect some of those synergies to come from?
Well, Mark, obviously, this is -- we haven't closed the deal yet. So I want to be careful about getting into too much detail. But sort of pretty much similar stuff to Ipswitch. I mean you -- this is very -- as you can see, this is very much both in line with Ipswitch in terms of size and scale and opportunity for us. So we expect very, very similar work to happen on the synergies on this side as well.
Okay. Great. And then just finally, is there any synergies between the Chef business or potential synergies business-wise between the Chef business and maybe the Telerik, UI tools business?
So I think there are synergies with a variety of Progress businesses. But you're absolutely correct. I think the Telerik side is the closest. But I think what I want to basically be very clear here is that in our model and in our projections, we are not taking any revenue synergies into account. If they happen, that will be so much for the better. Our goal is to basically make sure that we keep the business strong, that we serve their customers well, that it continues to grow in the low single digits. And we get to the margin targets that we are targeting, which is 35-plus percent. So that really is the way we're approaching it, Mark. And you are right, there are opportunities for revenue synergies, but we are not at all using them in our projections.
Our next question comes from Anja Soderstrom with Sidoti & Company.
Congratulations on the acquisition and the guidance update. Good questions asked already, but can you just talk a little bit about -- you've been talking about before how Ipswitch has been successful in terms of the culture fit. Can you talk about that for Chef? And how you've been able to conduct the due diligence process in this COVID environment?
Absolutely, Anja. So thank you. And Anja, the culture fit has been one of the key pluses with Chef as well. As you know, for any acquisition to work well, the teams have to work well together. They have to have a very similar approach to doing things. So the very first sort of centerpiece of what makes our 2 cultures very similar is that we're both very much a customer-centric organization. The focus that Chef has had on making sure that the customers are successful and happy and stay with them, which, by the way, is evidenced by the fact that they have more than 95% net retention rate consistently, right? And very similar to Progress, right? We have a history of nearly 40 years of making sure that our customers are served well, a focus on continuing to innovate on both sides, a focus on making sure that the products speak for themselves, and it is the product that basically keeps these customers happy and continues to solve their problems and continues to address their needs. So I think those are the sort of the external type of cultural things. So internally, both companies are very much employee-centric. Both companies have a very strong tradition of equality and inclusion and diversity. And I am really, really excited about the fact that we're able to bring these 2 organizations together. And I think the Chef employees, as they get more and more of them, get to know more and more of us, it is really, really very, very similar. And then they will discover that what -- the home that they have is the right home to be. In terms of how did we do the due diligence during the COVID-19, everything was done virtually. It is a testament to the Chef organization and the Progress organization that we were able to conduct this due diligence during this tough period, lots of video calls and so on. But it has been very, very good. And the Chef team has been very transparent, and our team has worked tremendously hard as well on our side. So I really thank both teams, both the Progress team and the Chef team for their hard work during the due diligence period. Obviously, we still have approximately a month to go before the deal closes. And so we continue to do our integration planning. And then, of course, even harder work after. So it has been an interesting new learning experience to do due diligence during this period, Anja.
Okay. And are there any specific learnings from the Ipswitch acquisition that you can apply to this that you think is going to be helpful?
So I think, Anja, one of the things that we have done, and we continue to do with each acquisition, and we will continue to do with each acquisition is that we built a playbook on how to do things with Ipswitch. And we built a playbook on doing acquisitions with Ipswitch, and we learned lots of things. And then we're applying all of them and we're applying them, and we're learning new ones and there are some nuance differences. And so we continue to refine our playbook as well. Jeremy Siegel, who joined us just a few months ago, he has had tremendous experience doing M&A as well. And he has brought his own perspective and his own best practices to bear as well. So I feel really confident that we will be able to do a very similar outcome for Progress as we did with Ipswitch.
Thank you. I'm showing no further questions at this time. I would now like to turn the call back over to Yogesh Gupta for closing remarks.
Thank you, Katie. Thank you, everyone, for joining on this call. I really appreciate it on short notice and early in the morning, immediately after a long weekend. We look forward to speaking with you again when we officially announce our third quarter results on September 29. And have a wonderful day. Thank you.
Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.
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