Welcome to the Progress Software Corporation Q2 2022 earnings call. My name is Daryl, and I'll be your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. During the question-and-answer session, if you have a question, please press zero one on your touch tone phone. I will now turn the call over to Michael Micciche. Michael, you may begin.
Okay. Thanks, Daryl. Nice to have you back with us this quarter. Good afternoon, everybody, and thanks for joining us for Progress Software second quarter fiscal 2022 financial results conference call. With us today is Yogesh Gupta, President and Chief Executive Officer, and Anthony Folger, our Chief Financial Officer. Before we get started, I'd like to remind you that during this call we will discuss our outlook for future financial and operating performance, corporate strategies, product plans, cost initiatives, our acquisition of Kemp, the impact on our business of the COVID-19 pandemic and the sanctions against Russia, and other information that might be considered forward-looking. This forward-looking information represents Progress Software's outlook and guidance only as of today and is subject to risks and uncertainties.
For a description of the risk factors that may affect our results, please refer to our recent SEC filings and in particular the section captioned Risk Factors in our most recent Form 10-K. Progress Software assumes no obligation to update the forward-looking statements included in this call, whether a result of new developments or otherwise. Additionally, on this call, all the financial figures we discuss are non-GAAP measures unless otherwise indicated. You can find a reconciliation of these 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 and is also available on our website. This document contains the full details of our financial results for the fiscal second quarter of 2022, and I recommend you reference it for specific details.
We also have prepared a presentation that contains supplemental data for our second quarter 2022 results, providing highlights and additional financial metrics. Both the earnings release and this presentation are available in the investor relations section of our website at investors.progress.com. Today's conference call is being recorded in its entirety and will be available via replay on the investor relations section of our website. With that out of the way, I'll now turn it over to Yogesh.
Thank you, Michael. Good afternoon, everyone, and thank you for joining our second quarter 2022 earnings conference call. I'm extremely pleased to share with you the details of another great quarter for Progress, where we again exceeded expectations across the board. Our results were driven by our total growth strategy, which layers accretive M&A upon a highly profitable and predictable business with strong recurring revenues and very high retention rates. Our disciplined execution of this strategy over the past several years has resulted in consistent performance that is delivering meaningful returns to our shareholders. Against a challenging macro backdrop, our second quarter performance was strong and our outlook for the remainder of fiscal 2022 and beyond remains healthy. A very important aspect of our business is its predictability and stability during times of economic turbulence.
Demand for our product remains steady and positive as Progress products are mission critical for most of our customers. Even when post-COVID demand helped to deliver upside to our guidance in the recent quarters, the reliable recurring revenues from our large installed base of global customers still form the foundation of our business. This, combined with the mission-critical nature of our products, leads to a high visibility business model and provides a natural hedge against uncertainties that may impact the budgets of other types of projects. The results of our second quarter speak to this strength. Revenues and earnings again finished above expectations and exceeded the top end of our guidance, thanks to the continuation of strong sales performance and the stickiness of our products.
Total revenues during the quarter grew 19% year over year at constant currency, and operating margins came in at 41%, driven by the strong execution of our total growth model and healthy expense management. Annual recurring revenues continue to grow, up 13% on an as-reported basis and 3.5% year over year on a pro forma basis to $486 million. Net retention rate was again over 100%, coming in at 100.9% and continues to be a key driver for the business overall. Free cash flow was also ahead of plan, and our balance sheet continues to strengthen. The develop, deploy, and manage software ecosystem we serve is vital to our customers, especially as they scrutinize their investments in new projects and other technologies.
It is increasingly important for Progress to continue innovating our products and remain relevant to our customers. As an example, we recently launched our new Progress Chef Cloud Security product designed to help organizations around the world ensure that their native cloud, multi-cloud, and hybrid environments are safe and secure. This product builds on our commitment to deliver a unified and scalable platform that enables our clients to accelerate the delivery of secure and compliant application releases in any kind of environment. We also launched MOVEit 2022 with advanced capabilities to further secure and simplify the movement of mission-critical data across cloud and on-prem infrastructures. We delivered Telerik UI for .NET MAUI on the same day that Microsoft made the .NET MAUI framework generally available.
The impact of our ongoing drive to invest in our products and in customer support and success efforts is reflected in our retention rates and increasing recurring revenues. While we remain judicious with our investments in these line item costs, we invest where needed because we know that it is much more expensive to replace a customer than it is to retain one. Let's talk a bit about inflation. First, inflation has created an opportunity to increase effective prices wherever possible. A significant portion of Progress revenue comes from over 1,700 ISVs who embed our products in their offerings and have either revenue sharing or some form of royalty arrangements with us. As many of these companies raise the prices of their products, we indirectly benefit.
We also have a variety of contract agreements with our large numbers of customers and partners, which results in a variety of methods by which we pursue price increases. For example, in some cases, we may increase price at the time of renewal, and in other cases, a price increase may take the form of reduced discounts. We've successfully begun to implement this where we can, and we continue to look for more opportunities. On the expense side, the labor market remains tight. Experienced personnel are harder to find and command a higher premium. We believe that it's significantly better for our business and less expensive to keep good employees instead of recruiting and training new ones. We focus our energies on employee retention. We continue to be rewarded by a turnover rate, which has averaged about 1% per month over the past 12 months.
This is well below the norm of 2% or more among many tech companies, and we are proud of it. We are also proud of our amazing employee engagement, which is a key driver of strong retention and is demonstrated by the positive results of our broad employee surveys. Further, Progress has won 10 third-party awards for employee engagement and corporate social responsibility in the first six months of this year alone. Just last week, Progress was once again honored by the Boston Business Journal as one of the top five companies to work for in the Boston area, making this our second consecutive year of being included on this list. We were also selected by Forbes as one of America's best midsize employers of 2022 for the second year in a row and by Inc. magazine for its 2022 Best Workplaces list.
Further, we took home our second consecutive Stevie for achievements in diversity and inclusion and our third consecutive International CSR Excellence Award. We recently announced the winners of this year's Progress Women in STEM scholarships, which went to four outstanding young ladies in Bulgaria, India, and the U.S. I'm incredibly proud of these awards and the work it took to achieve them. I'm very grateful to the whole Progress team for their ongoing contributions to the success of our company. Before moving on to the impact of changing macro environment on our M&A efforts, let me share that the integration of our latest acquisition, Kemp, which closed last October, is going well. Recall that Kemp acquired Flowmon in late 2020 and kept the two businesses largely separate.
Our Kemp integration has essentially been two simultaneous integrations, and I'm happy to report that we've overcome some unique challenges with no major issues or setbacks. The integration is progressing according to plan, and we remain on track to complete it over the next several months. Our optimism continues to grow regarding M&A, the most significant driver of our total growth strategy. Progress remains well-positioned, both from a financial and strategic perspective. We're well capitalized, with the vast majority of our current financing facilities fixed at very low rates. Our balance sheet continues to strengthen. Our base of recurring revenues is stable and growing, and our outlook for free cash flow is favorable. All this, combined with our prior successes integrating acquired companies, equips us well to remain active in the M&A market as an acquirer of choice.
Further, as we shop for the right kind of infrastructure software businesses, we're seeing early signs of a shift towards a more buyer-friendly environment. The IPO window appears to be closed for now. Funding is getting more scarce, and higher interest rates may negatively impact the ability of many of our competitors to lever up. All of these factors will give us the ability to focus on acquisitions that meet our disciplined framework for financial returns, product compatibility, and overall fit. We're happy to remain patient and be very selective in where and how we choose our capital to work. The strength of our capital allocation policy is that it is multifaceted, and we continually evaluate options to select those we believe will generate the highest return for our shareholders. I'm happy to say that compared to the broader markets, Progress stock has done well.
We've had relatively few occasions to buy back shares opportunistically amid dramatic market turmoil. Even so, we bought back $26.5 million of our shares in the second quarter, and we'll continue to repurchase shares whenever buybacks produce compelling returns. In all, our second quarter was another solid one, and I'm very pleased with the results. I'm also optimistic about our outlook for the rest of 2022. Q3 is off to a good start, and despite a tumultuous market and an economy with increasing macro risks, I am confident that Progress is well-positioned to deliver stable and predictable results. With that, I'll turn it over to Anthony to provide details on the numbers for Q2 and the forward outlook. Anthony?
Thanks, Yogesh. Thanks, Michael. Good afternoon, everyone, and thanks for joining our call. As Yogesh mentioned, Q2 was another great quarter for Progress, and our results reflect strong execution across our product portfolio, coupled with a strong and stable demand environment. Total revenue for the second quarter was $151 million or 17% growth over the year-ago quarter and was approximately $3 million above the high end of the guidance range we provided back in March. In constant currency, our second quarter revenue exceeded $154 million or 19% growth on a year-over-year basis. The addition of Kemp is the biggest contributor to our year-over-year growth. However, many of our other product lines also contributed to growth, most notably our DataDirect and DevTools products.
In addition, we closed the second quarter with approximately $486 million in annualized recurring revenue, representing 13% growth on a constant currency basis and 3.5% growth on a pro forma constant currency basis. Consistent with prior quarters, our growth in ARR was driven by virtually all products in our portfolio, led by OpenEdge, DevTools, Sitefinity, and DataDirect. As we've mentioned many times before, the mission-critical nature of the applications we power and our consistent focus on improving the customer experience have resulted in a very stable and durable top line. At the end of Q2, our trailing 12-month net retention rate was approximately 101%, with improvements and strength evident across our entire product portfolio. Turning now to expenses.
Our total costs and operating expenses were $89.6 million for the quarter, an increase of $10.1 million compared to Q2 of 2021. Virtually all of this year-over-year spend increase is driven by the addition of Kemp to our business. Operating income was $61.3 million for the quarter, up approximately 23% compared to Q2 of 2021, and our operating margin was approximately 41% compared to 38% in the year-ago quarter. On the bottom line, our earnings per share of $1.04 for the quarter was $0.08 above the high end of our guidance range and approximately 27% above our earnings per share of $0.82 in the year-ago quarter. Moving on to a few balance sheet and cash flow metrics.
We ended the quarter with cash and short-term investments of $226 million. Having restructured our credit facilities during Q1, we also have approximately $300 million in untapped capacity under our revolving line of credit for total liquidity of approximately $526 million. Our DSO for the quarter was 39 days, an improvement of five days compared to Q2 of last year. Adjusted free cash flow was $68 million for the quarter, up $13 million or 23% from Q2 of last year. The increase in free cash flow was driven primarily from increased profitability and improved collections in the quarter. In the second quarter, we repurchased $26.5 million of stock and at the end of Q2 had $104 million remaining under our share repurchase authorization.
I would now like to turn to our outlook for the full year in Q3. For the full year, we are maintaining our revenue guidance to be between $609 million and $617 million, and I'd like to highlight a few points about our annual revenue guide. First, it includes the negative impact of exchange rates on a year-over-year basis of approximately $12 million, with approximately $6 million of that negative impact spread across Q3 and Q4. Next, it does not assume any increase to revenue associated with the price increases that Yogesh mentioned earlier. Finally, as mentioned on our last call, our full year revenue guidance excludes $2 million-$3 million in revenue associated with previously forecasted business activity in Russia.
I call out these points because they highlight the considerable strength of our business in light of the challenging macro environment that Yogesh referred to. Moving on, we expect an operating margin of between 39% and 40%, consistent with our prior guidance. We are projecting adjusted free cash flow between $185 million and $190 million, consistent with our prior guidance. We are increasing our guidance for earnings per share to be between $4.05 and $4.11. Our annual EPS estimate contemplates a tax rate of 20%-21% and approximately 44.5 million shares outstanding, and does not assume any additional share repurchases in 2022.
Turning now to our third quarter guidance, I'd like to start by reminding everyone that in the third quarter of 2021, we exceeded the midpoint of our revenue guidance by $22 million, and a significant portion of this overperformance was the result of timing, specifically revenue shifting from Q4 into Q3. There was also increased contract durations in that $22 million overperformance. I would encourage everyone to review our Q3 2021 earnings materials when making year-over-year comparisons. With that, for the third quarter, we expect revenue between $147 million and $150 million and earnings per share of between $0.96 and $0.98. In closing, we are thrilled with our Q2 results and the execution across our business that drove those results.
We are well positioned for the balance of 2022 and feel we're even better positioned to continue executing our total growth strategy. Okay, Daryl, I think we're ready to open it up for Q&A.
If anyone has a question, you can press zero one on your touch tone phone. Once again, if you have a question, it's zero one on your touch tone phone. Our first question comes from Anja Soderstrom. Go ahead, Anja.
Hi. Yes. Thank you for taking my questions, and congratulations on the good quarter. You mentioned.
Thank you.
You had a tough compare in the third quarter versus last year, but it still seems a little bit tough. Was there some pull into the second quarter from the third quarter as well, or can you talk about the dynamics of the revenue base for this quarter?
No.
Yeah.
Yeah, go ahead, Anthony.
No, I was just gonna say, Anja, no, there was no pull-in from Q3 into Q2. You know, I think we had solid performance across multiple products in the quarter. I don't think there was anything specific to timing that we called out. Yogesh, I'll let you add to that.
Yeah, no, I was going to say exactly the same thing, Anja. Really, the timing happened last year quarter, not this year. This year, we have had a very steady business and no timing shift.
Okay. Thank you. In terms of the M&A activity, what do you see there in terms of valuations, and also who do you compete against? You said you're the acquirer of choice with many of your targets, but who do you compete against mostly these days?
Yeah. Anja, two parts to your question, right? The first is around the, you know, what are we seeing with respect to the environment? You know, as we all know, the public markets have really changed in terms of valuation metrics. We are beginning to see some of that change in the private markets. By the way, just, you know, to highlight something, the first six months of this year, we were busier with M&A activity and reviewing deals and pursuing transactions than we have ever been in any prior six-month period. It really, there's a lot of activity going on. We are being very disciplined.
We want to make sure that we find the right assets and that we pay the right amount that delivers the kind of shareholder return that we expect to deliver and that our shareholders expect us to deliver. You know, we actually find that on the second point with respect to competitive landscape, many times, the other buyers are private equity-owned businesses. Some of them are strategic themselves, but it is primarily private equity-owned businesses that actually are participating in these transactions on the other side.
Okay. Thank you. One last one. Given the slow economy, what are you starting to see any change in behavior among your customers in your conversations with them, or?
Interestingly enough, Anja, we are not, right? We continue to be confident. We are, you know, seeing that our customers continue to invest in the businesses and the products that we offer them. What's interesting, Anja, as you know, right, the vast majority of our business is recurring revenue and retaining customers. Really that strong foundation allows us to feel good about the way our whole year is continuing to shape up, right? We are confident. We're not seeing anything from our customers that is different today. I think, you know, the COVID demand was last year. You know, that pent-up demand went away last year. Other than that, no difference in this quarter compared to the last couple of quarters.
Okay, great. Thank you. That was all for me.
Thanks, Anja.
Our next question comes from Tyler Radke. Go ahead, Tyler.
Hi. Thanks for taking the question. You made some comments during your prepared remarks that you're seeing some customers pull back on other spending categories. I was wondering if you could elaborate on what those categories are and, you know, where you see customers kinda making the biggest cutbacks to spending.
Tyler, I wouldn't. I don't know whether we can comment on other people's businesses as much as we can on ours, right? Most of our customers from our perspective are focused on cost control measures at this point. There's a significant focus on businesses to make sure that technologies that can help them reduce costs are where they are willing to continue to spend. Because Progress products are all structured that way, right? We are whether we, you know, are about increasing the productivity of developers or those that are building, you know, great digital experiences or those that are deploying and running great digital experiences and managing them in cloud and on-prem environments, it is about doing things more efficiently. It is doing things more effectively and more securely that we support.
I think we are seeing continued demand, Tyler. I think when it comes to you know some kind of new projects that potentially might have been planned, I think there is some hesitation in the customer base. Those are related to you know potentially you know maybe new projects to do some things that might have helped with the top line. But you know from our perspective, we primarily help drive expense control with our products and you know make the organization more efficient and more successful, which is why we find that our products are actually consistently in you know in good shape.
Great. Just to follow up on the price increase commentary, could you help quantify, you know, what percent of your business is, has seen price increases and just give us a sense on maybe the blended ASP?
Yeah.
Increase that you've seen?
Yeah. Tyler, absolutely. First of all, you know, about 60% of our business is indirect, right? Whether it is through the ISVs or whether it is through the channel, you know, the two-tier channel, right? There isn't a direct increase that we can affect because we basically have relationships with these, which are, you know, either, you know, as I said, with ISVs around royalties or revenue sharing or with even, you know, the two-tier model where there's a price that they, you know, basically get a discount from us, and then they basically charge something different to their customers. You know, and that's really not in our hands. Really what we have is about 40% of our business is really possibly where we can affect change.
The other interesting thing to realize is that those changes only happen when there's a contract that comes up, so when the renewals come up. In many of our products, you know, we have three-year contracts. It isn't something that happens instantly, Tyler. It is something that we will see the benefit of over time, which is why, you know, we have not included that in our guidance for the remainder of 2022. Usually the price increases are rather modest. You know, they might be 3%-5% a year. Again, as I said, because a small percentage of them get touched every year, and it's a small percent of a 40% pool to begin with, it is, you know.
The impact is not that significant.
Thank you.
You're welcome.
Our next question comes from Pinjalim Bora. Go ahead, Benjamin.
Hey, guys. It's Pinjalim Bora. Thanks for taking the questions, and, congrats on the quarter.
Hi, Pinjalim Bora.
Hey, Yogesh.
Thank you.
Yogesh, I wanted to ask you a high-level question. When I was looking back at Progress Software in 2008, 2009, how it did. I know the business had changed a lot. Is there a way to help kind of compare the business today versus during the great financial crisis? How resilient do you expect the core organic business to be going into any potential macro slowdown next year or in the future?
Pinjalim Bora, absolutely, yes, right? I can do it at a high level. Obviously, I wasn't here 15 years ago. When you think about the Progress products then, right? They were primarily products that were the tail end of their life cycle from the perspective, you know, basically relevance, right? You know, while they were continuing to be relevant to the existing customers, the relevance in the market at that time had significantly declined. That is not the case today if you look at sort of what has happened, or especially over the last three years with what we have done, in terms of acquisitions and over the last five years in terms of what we have done with our investments. We have cloud-enabled our products.
We have acquired products like Chef, which are truly relevant in this modern cloud DevOps space, from a, you know, deployment and configuration management and secure infrastructure, scalability. When you look at what we've acquired with Ipswitch and Kemp around observability and high availability and delivering performance and making sure that the infrastructure continues to perform well and sort of resilience to failures and those kind of things, you know, those offerings are much more relevant today. Then again, all those offerings are also applicable not just to on-prem environments, but to cloud. You know, those things are much more relevant today going forward. As you realize, right, that business is now, you know, approaching 40% of our overall business.
You have these sort of the legacy business, which by the way, has become much stronger. Our you know retention rates even there have gone up significantly. We have 101% retention rate, which we never had in 2008 or 2007, as far back as I can recall or as far back as I can talk to people who can recall. Pinjalim, I think we're in a very different spot. I feel really confident about our business. You know, I mean, look at for example, I mean, I remember, you know, two years ago, March 2020, right? We were the first enterprise software company that actually announced results because last week of March right?
Which was basically two weeks after the pandemic. We basically said, "Yeah, maybe we're at 3% impact is what we would expect." We actually ended up having a 1.5% impact, right? You know, but to us, that 3% was very measured. It wasn't just a, you know, random number out of a hat, right? Since then, we've acquired Kemp, and we're a stronger business because of that. I actually am really confident about our business.
Got it. Thanks for the thoughtful answer. One for Anthony. The guidance for Q3 seems to suggest like an air pocket in Q3 and a big ramp in Q4. I understand what you're saying with respect to a year ago, maybe consensus got it wrong, but is that it? Are you baking in some extra level of conservatism as well, given where the environment is at today? Are you baking in some kind of an acquisition in Q4? Help us understand, kind of unpack it a little bit.
Yeah. No, yeah, sure, Pinjalim. It's a great question, and thank you for that. You know, I would say no, we're not really, I mean, there's always a little bit of conservatism in the guide. I really you know, if you look at the different variables, on a year-over-year basis, whether it's, you know, the impact of foreign exchange, if you sort of, you know, take Kemp, if you wanna sort of take it out of both years, and then just look at the business on a pure sort of year-over-year comp basis, you know, I guess I would say Q3 to us, especially relative to the overperformance we saw last year, which was a bit anomalous, you know, feels incredibly steady, and pretty solid, you know, Q3 of 2022 versus Q3 of 2021.
When you sort of consider all the factors like I said, FX and, you know, the addition of Kemp, when you sort of normalize for those things, you know, even our annual guide is really up from Q1 to Q2. I mean, FX is sort of eating the uptick in our guide. You know, I mean, we put out the constant currency numbers. You know, I mentioned the $12 million FX headwind on a year-over-year basis. When you look at that from quarter to quarter and how it's trended, you can kind of see that FX has sort of steadily continued to increase or eat into the increase in our guide.
You know, despite all those macro factors, we've been able to, you know, hold the range for the year, and I think we view that as a good demonstration of durability of the business. You know, I know there's a lot to it and there's a lot to unpack there. You know, fundamentally, I think we feel really good about the outlook.
Okay.
One-
I'll get back to this. Go ahead.
Should we move on to the next question?
Yes, please.
I got our next question. Ittai Kidron, go ahead.
Hey, guys. This is Gershel on for Ittai. Thanks for taking the question. I just wanted to ask around, you know, new customer adds, and is that still primarily being driven by OpenEdge or are you seeing other parts of the portfolio becoming more prominent landing points?
Gershel, definitely, we are seeing much more new customer adds on products like Chef, the Kemp product, the Ipswitch products such as MOVEit and WhatsUp Gold. You know, OpenEdge itself doesn't land new customers directly for us. What it does land is the ISVs that use our products use OpenEdge, and they have built their applications on top of OpenEdge. They go out and land additional customers for their offerings, those business applications. We indirectly benefit from that. But really for us, you know, the way we go out and win new customers ourselves, it's primarily around the DevTools business, the Chef business, the MOVEit and WhatsUp Gold businesses that we acquired from Ipswitch and the Kemp products, LoadMaster and Flowmon.
Got it. Just on Kemp, I know you said that most of the integration so far has still really been on the cost side, but have you begun to see any cross-selling materialize between Kemp and, you know, maybe WhatsUp Gold or any other parts of the portfolio?
Gershel, that's another good question. You know, when we model these acquisitions, we do not include any cross-sell synergies in those. You know, we believe that, you know, those are not always realizable, and we know that we can realize the expense ones, so we focus on the expense synergies. It's been the first six months. I think it's really still early. We are beginning to see a little bit, but not in any meaningful way of cross-sell between products like WAG and Kemp, like Flowmon. Really, Flowmon is the main product that would, you know, go well with Whats Up Gold. But I think as I said, it's rather early.
Got it. Thank you.
We have no more questions at this time. I'll pass it back to the speakers for closing comments.
Thank you, Daryl. Thank you all for joining our call today. I look forward to speaking with you soon. Thanks again and goodbye.
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.
Thank you, Daryl.
Yep.