10-Q 1 q3201610-q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2016
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-19417
 
PROGRESS SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
 
 
DELAWARE
(State or other jurisdiction of
incorporation or organization)
 
04-2746201
(I.R.S. Employer
Identification No.)
14 Oak Park
Bedford, Massachusetts 01730
(Address of principal executive offices)(Zip code)
Telephone Number: (781) 280-4000
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
ý
Accelerated filer
 
¨
Non-accelerated filer
 
¨
Smaller reporting company
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  ¨ No  ý
As of September 29, 2016, there were 48,592,417 shares of the registrant’s common stock, $.01 par value per share, outstanding.



PROGRESS SOFTWARE CORPORATION
FORM 10-Q
FOR THE NINE MONTHS ENDED AUGUST 31, 2016
INDEX

 
 
 
PART I
 
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 5.
Other Matters
Item 6.
 
 
 
 
 
Exhibit Index

2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets

(In thousands, except share data)
August 31,
2016
 
November 30, 2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
188,084

 
$
212,379

Short-term investments
44,600

 
28,900

Total cash, cash equivalents and short-term investments
232,684

 
241,279

Accounts receivable (less allowances of $1,565 and $2,193, respectively)
55,758

 
66,459

Other current assets
20,521

 
15,671

Total current assets
308,963

 
323,409

Property and equipment, net
50,778

 
54,226

Intangible assets, net
87,684

 
114,113

Goodwill
370,097

 
369,985

Deferred tax assets
11,626

 
10,971

Other assets
3,631

 
4,419

Total assets
$
832,779

 
$
877,123

Liabilities and shareholders’ equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
13,125

 
$
9,375

Accounts payable
9,647

 
11,188

Accrued compensation and related taxes
20,967

 
29,720

Income taxes payable
5,098

 
2,941

Other accrued liabilities
17,796

 
21,465

Short-term deferred revenue
129,354

 
125,227

Total current liabilities
195,987

 
199,916

Long-term debt
123,750

 
135,000

Long-term deferred revenue
8,529

 
8,844

Deferred tax liabilities
6,149

 
7,112

Other noncurrent liabilities
3,785

 
3,787

Commitments and contingencies

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; authorized, 1,000,000 shares; issued, none

 

Common stock, $0.01 par value, and additional paid-in capital; authorized, 200,000,000 shares; issued and outstanding, 48,575,307 shares in 2016 and 50,579,539 shares in 2015
237,136

 
227,930

Retained earnings
281,303

 
319,162

Accumulated other comprehensive loss
(23,860
)
 
(24,628
)
Total shareholders’ equity
494,579

 
522,464

Total liabilities and shareholders’ equity
$
832,779

 
$
877,123

See notes to unaudited condensed consolidated financial statements.

3


Condensed Consolidated Statements of Operations
 
 
Three Months Ended
 
Nine Months Ended
(In thousands, except per share data)
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
Revenue:
 
 
 
 
 
 
 
Software licenses
$
33,624

 
$
31,840

 
$
86,366

 
$
85,794

Maintenance and services
68,394

 
62,797

 
201,251

 
179,042

Total revenue
102,018

 
94,637

 
287,617

 
264,836

Costs of revenue:
 
 
 
 
 
 
 
Cost of software licenses
1,424

 
1,441

 
4,139

 
4,526

Cost of maintenance and services
11,825

 
9,612

 
33,217

 
31,174

Amortization of acquired intangibles
3,940

 
4,079

 
11,818

 
12,805

Total costs of revenue
17,189

 
15,132

 
49,174

 
48,505

Gross profit
84,829

 
79,505

 
238,443

 
216,331

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
29,852

 
30,004

 
88,648

 
92,607

Product development
21,706

 
20,422

 
65,800

 
65,533

General and administrative
11,411

 
14,076

 
36,055

 
42,065

Amortization of acquired intangibles
3,186

 
3,186

 
9,556

 
9,559

Impairment of intangible assets
5,051

 

 
5,051

 

Restructuring expenses
(36
)
 
2,561

 
229

 
8,715

Acquisition-related expenses
53

 
662

 
449

 
3,180

Total operating expenses
71,223

 
70,911

 
205,788

 
221,659

Income (loss) from operations
13,606

 
8,594

 
32,655

 
(5,328
)
Other (expense) income:
 
 
 
 
 
 
 
Interest expense
(1,174
)
 
(987
)
 
(3,244
)
 
(2,808
)
Interest income and other, net
260

 
450

 
686

 
1,153

Foreign currency (loss) gain, net
(374
)
 
(628
)
 
(1,916
)
 
397

Total other (expense) income, net
(1,288
)
 
(1,165
)
 
(4,474
)
 
(1,258
)
Income (loss) before income taxes
12,318

 
7,429

 
28,181

 
(6,586
)
Provision (benefit) for income taxes
4,742

 
11,555

 
10,114

 
(7,256
)
Net income (loss)
$
7,576

 
$
(4,126
)
 
$
18,067

 
$
670

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
(0.08
)
 
$
0.36

 
$
0.01

Diluted
$
0.15

 
$
(0.08
)
 
$
0.36

 
$
0.01

Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
48,611

 
50,120

 
49,765

 
50,377

Diluted
49,135

 
50,120

 
50,310

 
51,117

See notes to unaudited condensed consolidated financial statements.

4


Condensed Consolidated Statements of Comprehensive Income (Loss)

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
August 31, 2016
 
August 31, 2015
Net income (loss)
$
7,576

 
$
(4,126
)
 
$
18,067

 
$
670

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(1,332
)
 
(257
)
 
485

 
(8,411
)
Reclassification adjustment for losses included in net income, net of tax of $0 for the third quarter and first nine months of 2016

 

 
256

 

Unrealized gains (losses) on investments, net of tax of $16 for the third quarter and first nine months of 2016 and $0 for the third quarter and first nine months of 2015
30

 
(17
)
 
27

 
(52
)
Total other comprehensive income (loss), net of tax
(1,302
)
 
(274
)
 
768

 
(8,463
)
Comprehensive income (loss)
$
6,274

 
$
(4,400
)
 
$
18,835

 
$
(7,793
)

See notes to unaudited condensed consolidated financial statements.


5


Condensed Consolidated Statements of Cash Flows
 
 
Nine Months Ended
(In thousands)
August 31,
2016
 
August 31,
2015
Cash flows from operating activities:
 
 
 
Net income
$
18,067

 
$
670

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
6,480

 
7,209

Amortization of intangibles and other
23,316

 
24,420

Stock-based compensation
19,009

 
18,812

Loss on disposal of property
364

 

Asset impairment
5,051

 
3,999

Deferred income taxes
(996
)
 
(23,067
)
Excess tax benefit from stock plans
(305
)
 
(1,107
)
Allowances for accounts receivable
(334
)
 
356

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
11,209

 
11,160

Other assets
(3,866
)
 
(508
)
Accounts payable and accrued liabilities
(14,920
)
 
(3,378
)
Income taxes payable
2,025

 
7,367

Deferred revenue
3,810

 
31,255

Net cash flows from operating activities
68,910

 
77,188

Cash flows used in investing activities:
 
 
 
Purchases of investments
(33,861
)
 
(20,068
)
Sales and maturities of investments
17,275

 
10,436

Purchases of property and equipment
(3,747
)
 
(6,079
)
Capitalized software development costs

 
(1,661
)
Payments for acquisitions, net of cash acquired

 
(246,275
)
Proceeds from divestitures, net

 
4,500

Net cash flows used in investing activities
(20,333
)
 
(259,147
)
Cash flows (used in) from financing activities:
 
 
 
Proceeds from stock-based compensation plans
8,166

 
10,459

Purchases of stock related to withholding taxes from the issuance of restricted stock units
(2,751
)
 
(2,850
)
Repurchases of common stock
(71,507
)
 
(32,868
)
Excess tax benefit from stock plans
305

 
1,107

Payment of contingent consideration

 
(209
)
Proceeds from the issuance of debt

 
150,000

Payment of long-term debt
(7,500
)
 
(5,625
)
Payment of issuance costs for long-term debt

 
(1,787
)
Net cash flows (used in) from financing activities
(73,287
)
 
118,227

Effect of exchange rate changes on cash
415

 
(10,237
)
Net decrease in cash and cash equivalents
(24,295
)
 
(73,969
)
Cash and cash equivalents, beginning of period
212,379

 
263,082

Cash and cash equivalents, end of period
$
188,084

 
$
189,113


6


Condensed Consolidated Statements of Cash Flows, continued
 
Nine Months Ended
 
August 31,
2016
 
August 31,
2015
Supplemental disclosure:
 
 
 
Cash paid for income taxes, net of refunds of $781 in 2016 and $1,887 in 2015
$
11,918

 
$
7,329

Cash paid for interest
$
2,348

 
$
2,150

Non-cash financing activities:
 
 
 
Total fair value of restricted stock awards, restricted stock units and deferred stock units on date vested
$
12,137

 
$
9,963

See notes to unaudited condensed consolidated financial statements.

7


Notes to Condensed Consolidated Financial Statements

Note 1: Basis of Presentation

Company Overview - We are a global leader in application development, empowering the digital transformation organizations need to create and sustain engaging user experiences in today's evolving marketplace. With offerings spanning web, mobile and data for on-premise and cloud environments, we power startups and industry titans worldwide. Our solutions are used across a variety of industries.

Our products are generally sold as perpetual licenses, but certain products also use term licensing models and our cloud-based offerings use a subscription based model. More than half of our worldwide license revenue is realized through relationships with indirect channel partners, principally application partners and original equipment manufacturers (OEMs). Application partners are independent software vendors (ISVs) that develop and market applications using our technology and resell our products in conjunction with sales of their own products that incorporate our technology. OEMs are companies that embed our products into their own software products or devices.

We operate in North America and Latin America (the Americas); Europe, the Middle East and Africa (EMEA); and the Asia Pacific region, through local subsidiaries as well as independent distributors.

Basis of Presentation and Significant Accounting Policies - We prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements and these unaudited financial statements should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended November 30, 2015.

We made no significant changes in the application of our significant accounting policies that were disclosed in our Annual Report on Form 10-K for the fiscal year ended November 30, 2015. We have prepared the accompanying unaudited condensed consolidated financial statements on the same basis as the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended November 30, 2015, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full fiscal year.

Recent Accounting Pronouncements - In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15). ASU 2016-15 is intended to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows and to eliminate the diversity in practice related to such classifications. The guidance in ASU 2016-15 is required for annual reporting periods beginning after December 15, 2017, with early adoption permitted. We are currently evaluating the effect that implementation of this update will have upon adoption on our consolidated statement of cash flows.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016-09 is intended to simplify various aspects of the accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance in ASU 2016-09 is required for annual reporting periods beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the effect that implementation of this update will have upon adoption on our consolidated financial position and results of operations.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (ASU 2016-02), which requires lessees to record most leases on their balance sheets, recognizing a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The guidance in ASU 2016-02 is required for annual reporting periods beginning after December 15, 2018, with early adoption permitted. We currently expect that most of our operating lease commitments will be subject to the update and recognized as operating lease liabilities and right-of-use assets upon adoption. However, we are currently evaluating the effect that implementation of this update will have upon adoption on our consolidated financial position and results of operations.


8


In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03). ASU 2015-03 requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, consistent with the presentation of a debt discount. The guidance in ASU 2015-03 is required for annual reporting periods beginning after December 15, 2015, including interim periods within the reporting period. Early adoption is permitted for financial statements that have not been previously issued. We estimate that the impact on our consolidated balance sheets will be a reclassification of up to $1.1 million from other assets to long-term debt as of December 1, 2016.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09). ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new guidance is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early adoption is not permitted. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance. In July 2015, the FASB voted to defer the effective date of this ASU by one year for reporting periods beginning after December 15, 2017, with early adoption permitted as of the original effective date. As a result, the new effective date for the Company will be December 1, 2018. This update will impact the timing and amounts of revenue recognized. Management is currently assessing the impact the adoption of this ASU will have on the Company’s consolidated financial statements.

Note 2: Cash, Cash Equivalents and Investments

A summary of our cash, cash equivalents and available-for-sale investments at August 31, 2016 is as follows (in thousands):
 
 
Amortized Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash
$
179,548

 
$

 


 
$
179,548

Money market funds
8,536

 

 


 
8,536

State and municipal bond obligations
34,489

 
43

 


 
34,532

U.S. treasury bonds
6,534

 

 


 
6,534

U.S. government agency bonds
525

 
1

 
(4
)
 
522

Corporate bonds
3,006

 
6

 


 
3,012

Total
$
232,638

 
$
50

 
$
(4
)
 
$
232,684


A summary of our cash, cash equivalents and available-for-sale investments at November 30, 2015 is as follows (in thousands):
 
 
Amortized Cost Basis
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
Cash
$
186,241

 
$

 
$

 
$
186,241

Money market funds
26,138

 

 

 
26,138

State and municipal bond obligations
20,387

 
30

 

 
20,417

U.S. treasury bonds
3,109

 

 
(15
)
 
3,094

U.S. government agency bonds
1,645

 

 
(4
)
 
1,641

Corporate bonds
3,756

 

 
(8
)
 
3,748

Total
$
241,276

 
$
30

 
$
(27
)
 
$
241,279



9


Such amounts are classified on our condensed consolidated balance sheets as follows (in thousands):
 
 
August 31, 2016
 
November 30, 2015
 
Cash and
Equivalents
 
Short-Term
Investments
 
Cash and
Equivalents
 
Short-Term
Investments
Cash
$
179,548

 
$

 
$
186,241

 
$

Money market funds
8,536

 

 
26,138

 

State and municipal bond obligations

 
34,532

 

 
20,417

U.S. treasury bonds

 
6,534

 

 
3,094

U.S. government agency bonds

 
522

 

 
1,641

Corporate bonds

 
3,012

 

 
3,748

Total
$
188,084

 
$
44,600

 
$
212,379

 
$
28,900


The fair value of debt securities by contractual maturity is as follows (in thousands):
 
 
August 31,
2016
 
November 30,
2015
Due in one year or less
$
23,474

 
$
15,945

Due after one year (1)
21,126

 
12,955

Total
$
44,600

 
$
28,900

 
(1)
Includes state and municipal bond obligations and corporate bonds, which are securities representing investments available for current operations and are classified as current in the consolidated balance sheets.

We did not hold any investments with continuous unrealized losses as of August 31, 2016 and as of November 30, 2015.

Note 3: Derivative Instruments

We generally use forward contracts that are not designated as hedging instruments to hedge economically the impact of the variability in exchange rates on intercompany accounts receivable and loans receivable denominated in certain foreign currencies. We generally do not hedge the net assets of our international subsidiaries. All forward contracts are recorded at fair value in other current assets or other accrued liabilities on the consolidated balance sheets at the end of each reporting period and expire from 30 days to one year. In the three and nine months ended August 31, 2016, realized and unrealized gains of $2.2 million and $1.4 million, respectively, from our forward contracts were recognized in foreign currency (loss) gain, net, in the condensed consolidated statements of operations. In the three and nine months ended August 31, 2015, realized and unrealized gains of $0.6 million and realized and unrealized losses of $1.9 million, respectively, from our forward contracts were recognized in foreign currency gain (loss), net, in the condensed consolidated statements of operations. The gains and losses were substantially offset by realized and unrealized losses and gains on the offsetting positions.

The table below details outstanding foreign currency forward contracts where the notional amount is determined using contract exchange rates (in thousands):
 
 
August 31, 2016
 
November 30, 2015
 
Notional Value
 
Fair Value
 
Notional Value
 
Fair Value
Forward contracts to sell U.S. dollars
$
83,992

 
$
(5,170
)
 
$
76,748

 
$
(4,026
)
Forward contracts to purchase U.S. dollars
2,209

 
4

 
2,077

 
5

Total
$
86,201

 
$
(5,166
)
 
$
78,825

 
$
(4,021
)


10


Note 4: Fair Value Measurements

Recurring Fair Value Measurements

The following table details the fair value measurements within the fair value hierarchy of our financial assets and liabilities at August 31, 2016 (in thousands):
 
 
 
 
Fair Value Measurements Using
 
Total Fair
Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Money market funds
$
8,536

 
$
8,536

 
$

 
$

State and municipal bond obligations
34,532

 

 
34,532

 

U.S. treasury bonds
6,534

 

 
6,534

 

U.S. government agency bonds
522

 

 
522

 

Corporate bonds
3,012

 

 
3,012

 

Liabilities
 
 
 
 
 
 
 
Foreign exchange derivatives
$
(5,166
)
 
$

 
$
(5,166
)
 
$


The following table details the fair value measurements within the fair value hierarchy of our financial assets and liabilities at November 30, 2015 (in thousands):
 
 
 
 
Fair Value Measurements Using
 
Total Fair
Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Money market funds
$
26,138

 
$
26,138

 
$

 
$

State and municipal bond obligations
20,417

 

 
20,417

 

U.S. treasury bonds
3,094

 

 
3,094

 

U.S. government agency bonds
1,641

 

 
1,641

 

Corporate bonds
3,748

 

 
3,748

 

Liabilities
 
 
 
 
 
 
 
Foreign exchange derivatives
$
(4,021
)
 
$

 
$
(4,021
)
 
$


When developing fair value estimates, we maximize the use of observable inputs and minimize the use of unobservable inputs. When available, we use quoted market prices to measure fair value. The valuation technique used to measure fair value for our Level 1 and Level 2 assets is a market approach, using prices and other relevant information generated by market transactions involving identical or comparable assets. If market prices are not available, the fair value measurement is based on models that use primarily market based parameters including yield curves, volatilities, credit ratings and currency rates. In certain cases where market rate assumptions are not available, we are required to make judgments about assumptions market participants would use to estimate the fair value of a financial instrument.

The following table reflects the activity for our liabilities measured at fair value using Level 3 inputs, which relate to a contingent consideration obligation in connection with a prior acquisition, for each period presented (in thousands):

 
Three Months Ended
 
Nine Months Ended
 
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
Balance, beginning of period
$

 
$
295

 
$

 
$
1,717

Changes in fair value of contingent consideration obligation

 
(295
)
 

 
(1,508
)
Transfer to Level 2 fair value measurement

 

 

 
(209
)
Balance, end of period
$

 
$

 
$

 
$


11



We recorded credits of approximately $0.3 million and $1.5 million during the three and nine months ended August 31, 2015, respectively, due to the change in fair value of a contingent consideration obligation in connection with a prior acquisition, which is included in acquisition-related expenses in our condensed consolidated statement of operations. The contingent consideration obligation was reduced to $0 during the fiscal year ended November 30, 2015.

Nonrecurring Fair Value Measurements

During the third quarter of fiscal year 2016, certain assets have been measured at fair value on a nonrecurring basis using significant unobservable inputs (Level 3). Based on the fair value measurement, we recorded a $5.1 million asset impairment charge as of August 31, 2016, which was applicable to the intangible assets obtained in connection with our acquisition of Modulus during the second quarter of fiscal year 2014 (Note 5).

The following table presents nonrecurring fair value measurements as of August 31, 2016 (in thousands):

 
Total Fair Value
 
Total Losses
Intangible assets
$

 
$
5,051


The fair value measurement was determined using an income-based valuation methodology, which incorporates unobservable inputs, including expected cash flows over the remaining estimated useful life of the technology, thereby classifying the fair value as a Level 3 measurement within the fair value hierarchy. The expected cash flows include subscription fees to be collected from existing customers using the platform, offset by hosting fees and compensation related costs to be incurred over the remaining estimated useful life.

Note 5: Intangible Assets and Goodwill

Intangible Assets

Intangible assets are comprised of the following significant classes (in thousands):
 
 
August 31, 2016
 
November 30, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Purchased technology
$
109,880

 
$
(64,438
)
 
$
45,442

 
$
117,151

 
$
(54,963
)
 
$
62,188

Customer-related
67,602

 
(33,257
)
 
34,345

 
67,602

 
(25,493
)
 
42,109

Trademarks and trade names
15,140

 
(7,243
)
 
7,897

 
15,330

 
(5,514
)
 
9,816

Total
$
192,622

 
$
(104,938
)
 
$
87,684

 
$
200,083

 
$
(85,970
)
 
$
114,113


During the third quarter of fiscal year 2016, we evaluated the ongoing value of the intangible assets associated with the technology obtained in connection with the acquisition of Modulus. As a result of our decision to abandon the related assets due to a change in our expected ability to use the technology internally, we determined that the intangible assets were fully impaired. As a result, we incurred an impairment charge of $5.1 million in the third quarter of fiscal year 2016.

In the three and nine months ended August 31, 2016, amortization expense related to intangible assets was $7.1 million and $21.4 million, respectively. In the three and nine months ended August 31, 2015, amortization expense related to intangible assets was $7.3 million and $22.4 million, respectively.


12


Future amortization expense for intangible assets as of August 31, 2016, is as follows (in thousands):
 
Remainder of 2016
$
6,852

2017
27,426

2018
26,613

2019
25,489

2020
714

Thereafter
590

Total
$
87,684


Goodwill

Changes in the carrying amount of goodwill in the nine months ended August 31, 2016 are as follows (in thousands):

Balance, November 30, 2015
$
369,985

Translation adjustments
112

Balance, August 31, 2016
$
370,097


Changes in the goodwill balances by reportable segment in the nine months ended August 31, 2016 are as follows (in thousands):
 
November 30, 2015
 
Translation Adjustments
 
August 31, 2016
OpenEdge
$
211,980

 
$
112

 
$
212,092

Data Connectivity and Integration
19,040

 

 
19,040

Application Development and Deployment
138,965

 

 
138,965

Total goodwill
$
369,985

 
$
112

 
$
370,097


During the fourth quarter of fiscal year 2015, we completed our annual testing for impairment of goodwill and, based on those tests, concluded that no impairment of goodwill existed as of October 31, 2015. During the quarter ending August 31, 2016, no triggering events have occurred that would indicate that it is more likely than not that the carrying values of any of our reporting units exceeded their fair values.

Note 6: Business Combinations

Telerik Acquisition

On December 2, 2014, we completed the acquisition of all of the outstanding securities of Telerik AD (Telerik), a leading provider of application development tools based in Sofia, Bulgaria, for total consideration of $262.5 million. Approximately $10.5 million of the total consideration was paid to Telerik’s founders and certain other key employees in restricted stock units, subject to a vesting schedule and continued employment. Under the Securities Purchase Agreement, 10% of the total consideration was deposited into an escrow account to secure certain indemnification and other obligations of the sellers to Progress. In accordance with the agreement, the full amount of the escrow was released to the former equity holders in June 2016.

Through this acquisition, we now provide comprehensive cloud and on-premise platform offerings that enable developers to rapidly create applications, driven by data for any web, desktop or mobile platform. We funded the acquisition through a combination of existing cash resources and a $150 million term loan (Note 7).

Acquisition-related transaction costs (e.g., legal, due diligence, valuation, and other professional fees) and certain acquisition restructuring and related charges are not included as a component of consideration transferred, but are required to be expensed as incurred. We incurred $0 and $0.3 million of acquisition-related costs during the three and nine months ended August 31, 2016, respectively, and $0.8 million and $2.7 million during the three and nine months ended August 31, 2015, respectively, which are included in acquisition-related expenses in our condensed consolidated statement of operations.

13



In connection with the acquisition of Telerik, we agreed to provide retention bonuses to certain Telerik employees as an incentive for those employees to remain with Telerik for at least one year following the acquisition. We concluded that the retention bonuses for these individuals, which totaled approximately $2.2 million, are compensation arrangements and recognized these costs over the one-year service period. During the three and nine months ended August 31, 2015, we incurred $0.6 million and $1.8 million of expense related to the retention bonuses, respectively, which is included in the acquisition-related expenses in our consolidated statement of operations. There were no additional expenses related to the retention bonuses incurred during the three and nine months ended August 31, 2016 and the entire amount accrued during fiscal year 2015 was paid in December 2015.

The operations of Telerik are included in our operating results as part of the Application Development and Deployment segment from the date of acquisition. The amount of revenue of Telerik included in our condensed consolidated statement of operations during the three and nine months ended August 31, 2016 was $19.4 million and $56.0 million, respectively. The amount of revenue of Telerik included in our condensed consolidated statement of operations during the three and nine months ended August 31, 2015 was $12.5 million and $26.2 million, respectively. The revenue from sales of Telerik products and maintenance is primarily recognized ratably over the maintenance period, which is generally one year, as vendor specific objective evidence of fair value cannot be established for such maintenance. The amount of pretax losses of Telerik included in our condensed consolidated statement of operations during the three and nine months ended August 31, 2016 was $7.0 million and $20.2 million, respectively. The amount of pretax losses of Telerik included in our condensed consolidated statement of operations during the three and nine months ended August 31, 2015 was $10.2 million and $41.2 million, respectively. The pretax losses in each three and nine month period includes the amortization expense of approximately $6.2 million and $18.5 million, respectively, related to the acquired intangible assets discussed above. In addition, the pretax losses in the three and nine months ended August 31, 2016 includes stock-based compensation expense of approximately $2.2 million and $6.5 million, respectively.

Note 7: Term Loan and Line of Credit

Our credit agreement provides for a $150 million secured term loan and a $150 million secured revolving credit facility, which may be made available in U.S. Dollars and certain other currencies. The revolving credit facility may be increased by up to an additional $75 million if the existing or additional lenders are willing to make such increased commitments. We borrowed the $150 million term loan included in our credit agreement to partially fund our acquisition of Telerik, as described in Note 6. The revolving credit facility has sublimits for swing line loans up to $25.0 million and for the issuance of standby letters of credit in a face amount up to $25.0 million. We expect to use the revolving credit facility for general corporate purposes, including acquisitions of other businesses, and may also use it for working capital.

The credit facility matures on December 2, 2019, when all amounts outstanding will be due and payable in full. The revolving credit facility does not require amortization of principal. The outstanding balance of the $150 million term loan as of August 31, 2016 was $136.9 million, with $13.1 million due in the next 12 months. The term loan requires repayment of principal at the end of each fiscal quarter, beginning with the fiscal quarter ended February 28, 2015. The first eight payments are in the principal amount of $1.9 million each, the following eight payments are in the principal amount of $3.8 million each, the following three payments are in the principal amount of $5.6 million each, and the last payment is of the remaining principal amount. The term loan may be prepaid before maturity in whole or in part at our option without penalty or premium. As of August 31, 2016, the carrying value of the term loan approximates the fair value, based on Level 2 inputs (observable market prices in less than active markets), as the interest rate is variable over the selected interest period and is similar to current rates at which we can borrow funds. The interest rate of the credit facility as of August 31, 2016 was 2.25%.

Costs incurred to obtain our long-term debt of $1.8 million were recorded as debt issuance costs within other assets in our consolidated balance sheet as of August 31, 2016 and are being amortized over the term of the debt agreement using the effective interest rate method. Amortization expense related to debt issuance costs of $0.1 million and $0.3 million for the three and nine months ended August 31, 2016, respectively, and $0.1 million and $0.3 million for the three and nine months ended August 31, 2015, respectively, is recorded within interest expense in our condensed consolidated statements of operations.

Revolving loans may be borrowed, repaid and reborrowed until December 2, 2019, at which time all amounts outstanding must be repaid. As of August 31, 2016, there were no amounts outstanding under the revolving line and $0.5 million of letters of credit.


14


As of August 31, 2016, aggregate principal payments of long-term debt for the next five years and thereafter are (in thousands):

Remainder of 2016
$
1,875

2017
15,000

2018
15,000

2019
105,000

Total
$
136,875


Note 8: Common Stock Repurchases

We repurchased and retired 0.4 million shares of our common stock for $11.5 million in the three months ended August 31, 2016 and 2.8 million shares for $71.5 million in the nine months ended August 31, 2016. We did not repurchase shares of our common stock during the three months ended August 31, 2015 and in the nine months ended August 31, 2015, we repurchased and retired 1.3 million shares for $32.9 million. The shares were repurchased in both periods as part of our Board of Directors authorized share repurchase program.

In March 2016, our Board of Directors authorized a new $100.0 million share repurchase program, which increased the total authorization to $202.8 million. As of August 31, 2016, there is $143.0 million remaining under this current authorization.

Note 9: Stock-Based Compensation

Stock-based compensation expense reflects the fair value of stock-based awards measured at the grant date and recognized over the relevant service period. We estimate the fair value of each stock-based award on the measurement date using the current market price of the stock or the Black-Scholes option valuation model. In addition, during the first quarter of fiscal year 2014, each of the first three quarters of fiscal year 2015, and the first and third quarters of fiscal year 2016, we granted performance-based restricted stock units to members of executive management that include a three-year market condition. In order to estimate the fair value of such awards, we used a Monte Carlo Simulation valuation model. The Black-Scholes and Monte Carlo Simulation valuation models incorporate assumptions as to stock price volatility, the expected life of options or awards, a risk-free interest rate and dividend yield. We recognize stock-based compensation expense related to options and restricted stock units on a straight-line basis over the service period of the award, which is generally 4 or 5 years for options and 3 years for restricted stock units. We recognize stock-based compensation expense related to performance stock units and our employee stock purchase plan using an accelerated attribution method.

The following table provides the classification of stock-based compensation as reflected in our condensed consolidated statements of operations (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
Cost of maintenance and services
$
223

 
$
144

 
$
599

 
$
462

Sales and marketing
751

 
1,604

 
2,792

 
4,328

Product development
2,524

 
912

 
7,600

 
3,476

General and administrative
2,281

 
3,878

 
8,018

 
10,546

Total stock-based compensation
$
5,779

 
$
6,538

 
$
19,009

 
$
18,812



15


Note 10: Accumulated Other Comprehensive Loss

The following table summarizes the changes in accumulated balances of other comprehensive loss during the nine months ended August 31, 2016 (in thousands):

 
Foreign Currency Translation Adjustment
 
Unrealized Gains (Losses) on Investments
 
Accumulated Other Comprehensive Loss
Balance, December 1, 2015
$
(24,582
)
 
$
(46
)
 
$
(24,628
)
Other comprehensive loss before reclassifications, net of tax
485

 
27

 
512

Amounts reclassified from accumulated other comprehensive loss to realized losses included in earnings
256

 

 
256

Balance, August 31, 2016
$
(23,841
)
 
$
(19
)
 
$
(23,860
)

The tax effect on accumulated unrealized gains (losses) on investments was minimal as of August 31, 2016 and November 30, 2015.

Note 11: Restructuring Charges

The following table provides a summary of activity for all of the restructuring actions, which are detailed further below (in thousands):

 
Excess
Facilities and
Other Costs
 
Employee Severance and Related Benefits
 
Total
Balance, December 1, 2015
$
412

 
$
2,949

 
$
3,361

Costs incurred
338

 
(109
)
 
229

Cash disbursements
(514
)
 
(2,487
)
 
(3,001
)
Translation adjustments and other
4

 
20

 
24

Balance, August 31, 2016
$
240

 
$
373

 
$
613


2015 Restructurings

During the first quarter of fiscal year 2015, we restructured our operations in connection with the acquisition of Telerik. This restructuring resulted in a reduction of redundant positions primarily within the administrative functions. This restructuring also resulted in the closing of two facilities as well as asset impairment charges for assets no longer deployed as a result of the acquisition. During the second and third quarters of fiscal year 2015, we incurred additional costs with respect to this restructuring, including reduction of redundant positions primarily within the product development function, as well as an impairment charge discussed further below.

Restructuring expenses are related to employee costs, including severance, health benefits and outplacement services (but excluding stock-based compensation), facilities costs, which include fees to terminate lease agreements and costs for unused space, net of sublease assumptions, and other costs, which include asset impairment charges.

During the second quarter of fiscal year 2015, we decided to replace our existing cloud-based mobile application development technology with technology acquired in connection with the acquisition of Telerik. Accordingly, we evaluated the ongoing value of the assets associated with this prior mobile technology and, based on this evaluation, we determined that the long-lived assets with a carrying amount of $4.0 million were no longer recoverable and were impaired and wrote them down to their estimated fair value of $0.1 million. Fair value was based on expected future cash flows using Level 3 inputs under ASC 820.

As part of this first quarter of fiscal year 2015 restructuring, for the three months ended August 31, 2016 we incurred minimal expenses and for the nine months ended August 31, 2016 we incurred expenses of $0.3 million. For the three and nine months ended August 31, 2015, we incurred expenses of $2.5 million and $7.4 million, respectively. The expenses are recorded as restructuring expenses in the condensed consolidated statements of operations. We do not expect to incur additional material costs with respect to this restructuring.

16



A summary of the first nine months of fiscal year 2016 activity for this restructuring action is as follows (in thousands):

 
Excess
Facilities and
Other Costs
 
Employee Severance and Related Benefits
 
Total
Balance, December 1, 2015
$
209

 
$
309

 
$
518

Costs incurred
323

 
(43
)
 
280

Cash disbursements
(358
)
 
(267
)
 
(625
)
Translation adjustments and other
4

 
3

 
7

Balance, August 31, 2016
$
178

 
$
2

 
$
180


Cash disbursements for expenses incurred to date under this restructuring are expected to be made through the fourth quarter of fiscal year 2016. As a result, the total amount of the restructuring reserve of $0.2 million is included in other accrued liabilities on the condensed consolidated balance sheet at August 31, 2016.

During the fourth quarter of fiscal year 2015, our management approved, committed to and initiated plans to make strategic changes to our organization to further build on the focus gained from operating under our business segment structure and to enable stronger cross-collaboration among product management, marketing and sales teams and a tighter integration of the product management and product development teams. In connection with the new organizational structure, we no longer have presidents of our three segments, as well as certain other positions within the administrative organization. Our Chief Operating Officer, appointed during fiscal year 2015, assumed responsibility for driving the operations of our three segments. The organizational changes did not result in the closing of any of our facilities.

Restructuring expenses are related to employee costs, including severance, health benefits and outplacement services (but excluding stock-based compensation), and other costs, which include charges for the abandonment of certain assets.

As part of this fourth quarter of fiscal year 2015 restructuring, for the three and nine months ended August 31, 2016, we recorded a minimal credit to restructuring expenses in the consolidated statements of operations due to changes in estimates of severance to be paid. We do not expect to incur additional material costs with respect to this restructuring.

A summary of the first nine months of fiscal year 2016 activity for this restructuring action is as follows (in thousands):

 
Excess
Facilities and
Other Costs
 
Employee Severance and Related Benefits
 
Total
Balance, December 1, 2015
$

 
$
2,617

 
$
2,617

Costs incurred

 
(42
)
 
(42
)
Cash disbursements

 
(2,220
)
 
(2,220
)
Translation adjustments and other

 
16

 
16

Balance, August 31, 2016
$

 
$
371

 
$
371


Cash disbursements for expenses incurred to date under this restructuring are expected to be made through the fourth quarter of fiscal year 2016. As a result, the total amount of the restructuring reserve of $0.4 million is included in other accrued liabilities on the condensed consolidated balance sheet at August 31, 2016.

2012 - 2014 Restructurings

During fiscal years 2012, 2013, and 2014, our management approved, committed to and initiated plans to make strategic changes to our organization to provide greater focus and agility in the delivery of next generation application development, deployment and integration solutions. During each of these fiscal years, we took restructuring actions that involved the elimination of personnel and/or the closure of facilities.

As part of these restructuring actions, for the three and nine months ended August 31, 2016, we incurred minimal expenses, and for the three and nine months ended August 31, 2015, we incurred expenses of $0 and $1.3 million, respectively, which are related to employee costs, including severance, health benefits, and outplacement services (but excluding stock-based

17


compensation), and facilities costs, which include fees to terminate lease agreements and costs for unused space, net of sublease assumptions. The expenses are recorded as restructuring expenses in the condensed consolidated statements of operations. We do not expect to incur additional material costs with respect to the 2012, 2013, and 2014 restructuring actions. The restructuring reserve of $0.1 million is included in other accrued liabilities on the condensed consolidated balance sheet as of August 31, 2016.

Note 12: Income Taxes

Our income tax provision for the third quarter of fiscal years 2016 and 2015 reflects our estimates of the effective tax rates expected to be applicable for the full fiscal years, adjusted for any discrete events which are recorded in the period they occur. The estimates are reevaluated each quarter based on our estimated tax expense for the full fiscal year.

The decrease in our effective tax rate in the nine months ended August 31, 2016 compared to the same period in the prior year is primarily due to the jurisdictional mix of profits as a result of the acquisition of Telerik, where substantial losses were incurred in Bulgaria in fiscal year 2015 and tax effected at a 10% statutory rate and other jurisdictions’ earnings, primarily in the United States, were taxed at higher rates.

In addition, during the preparation of our condensed consolidated financial statements for the three months ended May 31, 2016, we identified an error in our prior year income tax provision whereby income tax expense was overstated for the year ended November 30, 2015 by $2.7 million related to our tax treatment of an intercompany gain. We determined that the error is not material to the prior year financial statements. We also concluded that recording an out-of-period correction would not be material and have therefore corrected this error by recording an out-of-period $2.7 million tax benefit in our interim financial statements for the periods ended May 31, 2016.

The Internal Revenue Service is currently examining our U.S. Federal income tax returns for fiscal years 2013 and 2014. Our Federal income tax returns have been examined or are closed by statute for all years prior to fiscal year 2012, and we are no longer subject to audit for those periods. Our state income tax returns have been examined or are closed by statute for all years prior to fiscal year 2011, and we are no longer subject to audit for those periods.

Tax authorities for certain non-U.S. jurisdictions are also examining returns, none of which are material to our consolidated balance sheets, cash flows or statements of income. With some exceptions, we are generally no longer subject to tax examinations in non-U.S. jurisdictions for years prior to fiscal year 2010.

Note 13: Earnings Per Share

We compute basic earnings per share using the weighted average number of common shares outstanding. We compute diluted earnings per share using the weighted average number of common shares outstanding plus the effect of outstanding dilutive stock options, restricted stock units and deferred stock units, using the treasury stock method. The following table sets forth the calculation of basic and diluted earnings per share on an interim basis (in thousands, except per share data):

 
Three Months Ended
 
Nine Months Ended
 
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
Net income (loss)
$
7,576

 
$
(4,126
)
 
$
18,067

 
$
670

Weighted average shares outstanding
48,611

 
50,120

 
49,765

 
50,377

Dilutive impact from common stock equivalents
524

 

 
545

 
740

Diluted weighted average shares outstanding
49,135

 
50,120

 
50,310

 
51,117

Basic earnings per share
$
0.16

 
$
(0.08
)
 
$
0.36

 
$
0.01

Diluted earnings per share
$
0.15

 
$
(0.08
)
 
$
0.36

 
$
0.01


We excluded stock awards representing approximately 287,000 shares and 423,000 shares of common stock from the calculation of diluted earnings per share in the three and nine months ended August 31, 2016, respectively, because these awards were anti-dilutive. In the three and nine months ended August 31, 2015, we excluded stock awards representing 1,173,000 shares and 296,000 shares of common stock, respectively, from the calculation of diluted earnings per share as they were anti-dilutive.


18


Note 14: Business Segments and International Operations

Operating segments are components of an enterprise that engage in business activities for which discrete financial information is available and regularly reviewed by the chief operating decision maker in deciding how to allocate resources and assess performance. Our chief operating decision maker is the combination of our Chief Executive Officer and Chief Operating Officer.

We do not manage our assets or capital expenditures by segment or assign other income (expense) and income taxes to segments. We manage and report such items on a consolidated company basis.

The following table provides revenue and contribution from our reportable segments and reconciles to the consolidated income (loss) before income taxes:

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
August 31, 2016
 
August 31, 2015
Segment revenue:
 
 
 
 
 
 
 
OpenEdge
$
67,534

 
$
73,398

 
$
198,595

 
$
214,775

Data Connectivity and Integration
14,251

 
8,281

 
30,852

 
22,669

Application Development and Deployment
20,233

 
12,958

 
58,170

 
27,392

Total revenue
102,018

 
94,637

 
287,617

 
264,836

Segment costs of revenue and operating expenses:
 
 
 
 
 
 
 
OpenEdge
18,180

 
18,550

 
53,539

 
56,529

Data Connectivity and Integration
2,828

 
3,180

 
8,863

 
9,563

Application Development and Deployment
11,021

 
9,933

 
29,555

 
30,169

Total costs of revenue and operating expenses
32,029

 
31,663

 
91,957

 
96,261

Segment contribution:
 
 
 
 
 
 
 
OpenEdge
49,354

 
54,848

 
145,056

 
158,246

Data Connectivity and Integration
11,423

 
5,101

 
21,989

 
13,106

Application Development and Deployment
9,212

 
3,025

 
28,615

 
(2,777
)
Total contribution
69,989

 
62,974

 
195,660

 
168,575

Other unallocated expenses (1)
56,383

 
54,380

 
163,005

 
173,903

Income (loss) from operations
13,606

 
8,594

 
32,655

 
(5,328
)
Other (expense) income, net
(1,288
)
 
(1,165
)
 
(4,474
)
 
(1,258
)
Income (loss) before income taxes
$
12,318

 
$
7,429

 
$
28,181

 
$
(6,586
)
 
 
 
 
 
 
 
 
(1) The following expenses are not allocated to our segments as we manage and report our business in these functional areas on a consolidated basis only: product development, corporate marketing, administration, amortization and impairment of acquired intangibles, stock-based compensation, restructuring, and acquisition related expenses.
                                
Our revenues are derived from licensing our products, and from related services, which consist of maintenance and consulting and education. Information relating to revenue from customers by revenue type is as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
Software licenses
$
33,624

 
$
31,840

 
$
86,366

 
$
85,794

Maintenance
60,368

 
55,365

 
178,189

 
157,259

Professional services
8,026

 
7,432

 
23,062

 
21,783

Total
$
102,018

 
$
94,637

 
$
287,617

 
$
264,836



19


In the following table, revenue attributed to North America includes sales to customers in the U.S. and sales to certain multinational organizations. Revenue from Europe, the Middle East and Africa (EMEA), Latin America and the Asia Pacific region includes sales to customers in each region plus sales from the U.S. to distributors in these regions. Information relating to revenue from external customers from different geographical areas is as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31,
2016
 
August 31,
2015
 
August 31,
2016
 
August 31,
2015
North America
$
58,275

 
$
49,810

 
$
160,732

 
$
139,454

EMEA
32,719

 
30,656

 
95,517

 
89,667

Latin America
4,667

 
4,621

 
12,749

 
13,977

Asia Pacific
6,357

 
9,550

 
18,619

 
21,738

Total
$
102,018

 
$
94,637

 
$
287,617

 
$
264,836


Note 15: Subsequent Events

On September 27, 2016, our Board of Directors approved the initiation of a quarterly cash dividend to Progress shareholders. The first quarterly dividend of $0.125 per share of common stock will be paid on December 15, 2016 to shareholders of record as of the close of business on December 1, 2016.

On September 28, 2016, we announced the appointment of Kurt J. Abkemeier as our new chief financial officer. As CFO, Mr. Abkemeier will oversee the company's global finance and accounting operations and be a member of the company's executive leadership team, reporting to Phil Pead, president and chief executive officer. Mr. Abkemeier succeeds Chris E. Perkins, who informed the company in March 2016 that he would retire as CFO upon the appointment of his successor. Mr. Abkemeier began as CFO at Progress on September 28, 2016.


20


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Form 10-Q, and other information provided by us or statements made by our directors, officers or employees from time to time, may contain “forward-looking” statements and information, which involve risks and uncertainties. Actual future results may differ materially. Statements indicating that we “expect,” “estimate,” “believe,” “are planning” or “plan to” are forward-looking, as are other statements concerning future financial results, product offerings or other events that have not yet occurred. There are various factors that could cause actual results or events to differ materially from those anticipated by the forward-looking statements, including but not limited to the following: (1) Economic, geopolitical and market conditions, including the continued difficult economic environment in Brazil, and the continued slow economic recovery in Europe, parts of the U.S. and other parts of the world, can adversely affect our business, results of operations and financial condition, including our revenue growth and profitability, which in turn could adversely affect our stock price. (2) We may fail to achieve our financial forecasts due to such factors as delays or size reductions in transactions, fewer large transactions in a particular quarter, fluctuations in currency exchange rates, or a decline in our renewal rates for contracts. (3) Our ability to successfully manage transitions to new business models and markets, including an increased emphasis on a cloud and subscription strategy, may not be successful. (4) If we are unable to develop new or sufficiently differentiated products and services, or to enhance and improve our existing products and services in a timely manner to meet market demand, partners and customers may not purchase new software licenses or subscriptions or purchase or renew support contracts. (5) We depend upon our extensive partner channel and we may not be successful in retaining or expanding our relationships with channel partners. (6) Our international sales and operations subject us to additional risks that can adversely affect our operating results, including risks relating to foreign currency gains and losses. (7) If the security measures for our software, services or other offerings are compromised or subject to a successful cyber-attack, or if such offerings contain significant coding or configuration errors, we may experience reputational harm, legal claims and financial exposure. (8) We may make acquisitions in the future and those acquisitions may not be successful, may involve unanticipated costs or other integration issues or may disrupt our existing operations and those factors discussed in Part II, Item 1A (Risk Factors) in this Quarterly Report on Form 10-Q, and in Part I, Item 1A (Risk Factors) in our Annual Report on Form 10-K for the fiscal year ended November 30, 2015. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized. We also cannot assure you that we have identified all possible issues which we might face. We undertake no obligation to update any forward-looking statements that we make.

Use of Constant Currency

Revenue from our international operations has historically represented a substantial portion of our total revenue. As a result, our revenue results have been impacted, and we expect will continue to be impacted, by fluctuations in foreign currency exchange rates. For example, if the local currencies of our foreign subsidiaries weaken, our consolidated results stated in U.S. dollars are negatively impacted.

As exchange rates are an important factor in understanding period to period comparisons, we believe the presentation of revenue growth rates on a constant currency basis enhances the understanding of our revenue results and evaluation of our performance in comparison to prior periods. The constant currency information presented is calculated by translating current period results using prior period weighted average foreign currency exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with accounting principles generally accepted in the United States of America (GAAP).

Overview

We are a global leader in application development, empowering the digital transformation organizations need to create and sustain engaging user experiences in today's evolving marketplace. With offerings spanning web, mobile and data for on-premise and cloud environments, we power startups and industry titans worldwide. Our solutions are used across a variety of industries. We operate as three distinct segments: OpenEdge, Data Connectivity and Integration, and Application Development and Deployment, each with dedicated product management and product marketing functions.

At the beginning of fiscal year 2015, we acquired Telerik AD, a leading provider of application development tools. Telerik enables its 1.9 million strong developer community to create compelling user experiences across cloud, web, mobile and desktop applications. Through this acquisition, we provide comprehensive cloud and on-premise platform offerings that enable developers to rapidly create applications, driven by data for any web, desktop or mobile platform.


21


The revenue of Telerik is being recognized ratably over the maintenance period, which is generally one year, as vendor specific objective evidence (or VSOE) of fair value cannot be established for such maintenance. As a result of acquisition accounting, the acquired deferred revenue balance was significantly reduced to reflect its fair value as of the acquisition date. However, we are still incurring the associated costs to fulfill the acquired deferred revenue, which are reflected in our consolidated statement of operations. As a result, during fiscal year 2015, our expenses as a percentage of total revenue were higher than we expect they will be in future periods once this acquired deferred revenue balance is recognized. The impact of this on fiscal year 2016 has been, and is expected to continue to be, minimal.

In the first nine months of fiscal year 2016, our results were adversely impacted by decreases in sales to OpenEdge direct enterprise customers. During the past three fiscal years, our results have benefited from several large license sales to OpenEdge direct enterprise customers. These large transactions are difficult to predict as they are subject to longer sales cycles and the timing of completion is often uncertain. If we fail to complete these large transactions or if completion is delayed, our results will be adversely impacted.

In March 2016, our Board of Directors authorized a new $100.0 million share repurchase program, which increased the total authorization to $202.8 million. During the three months ended August 31, 2016, we repurchased and retired 0.4 million shares of our common stock for $11.5 million. As of August 31, 2016, there is $143.0 million remaining under the current authorization.

In September 2016, our Board of Directors approved the initiation of a quarterly cash dividend to Progress shareholders. The first quarterly dividend of $0.125 per share of common stock will be paid on December 15, 2016 to shareholders of record as of the close of business on December 1, 2016.

We derive a significant portion of our revenue from international operations, which are primarily conducted in foreign currencies. As a result, changes in the value of these foreign currencies relative to the U.S. dollar have significantly impacted our results of operations and may impact our future results of operations. Beginning in the fourth quarter of 2014, the value of the U.S. dollar strengthened in comparison to certain foreign currencies, including in Europe, Brazil and Australia, and continued to strengthen during the first half of 2015. The U.S. dollar has remained strong in comparison to foreign currencies in 2016. Since approximately one-third of our revenue is denominated in foreign currency, our revenue results have been negatively impacted, and we expect will continue to be impacted, by fluctuations in foreign currency exchange rates.

In addition, the announcement of the Referendum of the United Kingdom’s (or the U.K.) Membership of the European Union (E.U.) (referred to as Brexit), advising for the exit of the United Kingdom from the European Union, has resulted in significant volatility in global stock markets and currency exchange rate fluctuations that resulted in the further strengthening of the U.S. dollar against foreign currencies. The announcement of Brexit may create further global economic uncertainty, which may cause our customers to closely monitor their costs and reduce their spending budget on our products and services. If the Referendum is passed into law, there could be further uncertainty as the U.K. determines the future terms of its relationship with the E.U. Any of these effects of Brexit, among others, could materially adversely affect our business, results of operations and financial condition.

We have evaluated, and expect to continue to evaluate, possible acquisitions and other strategic transactions designed to expand our business and/or add complementary products and technologies to our existing product sets. As a result, our expected uses of cash could change, our cash position could be reduced and we may incur additional debt obligations to the extent we complete additional acquisitions.

We believe that existing cash balances, together with funds generated from operations and amounts available under our credit facility, will be sufficient to finance our operations and meet our foreseeable cash requirements, including our newly announced quarterly cash dividend to Progress shareholders, through at least the next twelve months.


22


Results of Operations

Revenue

 
Three Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
Revenue
$
102,018

 
$
94,637

 
8
%
 
9
%
 
Nine Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
Revenue
$
287,617

 
$
264,836

 
9
%
 
11
%

Total revenue increased $7.4 million, or 8%, in the third quarter of fiscal year 2016 as compared to the same quarter last year. Revenue would have increased by 9% if exchange rates had been constant during the period as compared to exchange rates in the same quarter last year. In addition, total revenue increased $22.8 million, or 11% on a constant currency basis and 9% using actual exchange rates, in the first nine months of fiscal year 2016 as compared to the same period last year. The increase in all periods was primarily a result of an increase in maintenance and services revenue as further described below. Changes in prices from fiscal year 2015 to 2016 did not have a significant impact on our revenue.

License Revenue

 
Three Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
License
$
33,624

 
$
31,840

 
6
%
 
6
%
As a percentage of total revenue
33
%
 
34
%
 
 
 
 
 
Nine Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
License
$
86,366

 
$
85,794

 
1
%
 
2
%
As a percentage of total revenue
30
%
 
32
%
 
 
 
 

License revenue increased $1.8 million, or 6%, in the third quarter of fiscal year 2016 as compared to the same quarter last year and increased $0.6 million, or 1%, in the first nine months of fiscal year 2016 as compared to the same period last year. The increase in license revenue was primarily due to an increase in Data Connectivity and Integration license sales, partially offset by decreases in sales to OpenEdge customers and in Corticon license sales.

Maintenance and Services Revenue
 
 
Three Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
Maintenance
$
60,368

 
$
55,365

 
9
%
 
11
%
As a percentage of total revenue
59
%
 
59
%
 
 
 
 
Services
8,026

 
7,432

 
8
%
 
8
%
As a percentage of total revenue
8
%
 
8
%
 
 
 
 
Total maintenance and services revenue
$
68,394

 
$
62,797

 
9
%
 
10
%
As a percentage of total revenue
67
%
 
66
%
 
 
 
 

23


 
Nine Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
Maintenance
$
178,189

 
$
157,259

 
13
%
 
16
%
As a percentage of total revenue
62
%
 
59
%
 
 
 
 
Services
23,062

 
21,783

 
6
%
 
6
%
As a percentage of total revenue
8
%
 
8
%
 
 
 
 
Total maintenance and services revenue
$
201,251

 
$
179,042

 
12
%
 
14
%
As a percentage of total revenue
70
%
 
68
%
 
 
 
 

Maintenance and services revenue increased $5.6 million in the third quarter of fiscal year 2016 as compared to the same quarter last year. Maintenance revenue increased 9% and professional services revenue increased 8% in the third quarter of fiscal year 2016 as compared to the third quarter of fiscal year 2015. Maintenance and services revenue increased $22.2 million in the first nine months of fiscal year 2016 as compared to the same period last year. Maintenance revenue increased 13% and professional services revenue increased 6% in the first nine months of fiscal year 2016 as compared to the same period of fiscal year 2015.

The increase in maintenance revenue is primarily due to the impact of the Telerik acquisition during the first quarter of fiscal year 2015. As a result of acquisition accounting, the acquired deferred revenue balance was significantly reduced to reflect its fair value as of the acquisition date. Therefore, the reduction of the acquisition date deferred revenue had a negative impact on revenue in the first nine months of fiscal year 2015. However, in the first nine months of fiscal year 2016 we recognized revenue related to the full value of Telerik deferred revenue that was generated during fiscal years 2015 and 2016. The increase in services revenue in the third quarter and first nine months of fiscal year 2016 was primarily due to higher software-as-a-service (SaaS) revenue generated by our Application Development and Deployment segment compared to the same period last year.

Revenue by Region

 
Three Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
North America
$
58,275

 
$
49,810

 
17
 %
 
17
 %
As a percentage of total revenue
57
%
 
53
%
 
 
 
 
EMEA
$
32,719

 
$
30,656

 
7
 %
 
10
 %
As a percentage of total revenue
32
%
 
32
%
 
 
 
 
Latin America
$
4,667

 
$
4,621

 
1
 %
 
2
 %
As a percentage of total revenue
5
%
 
5
%
 
 
 
 
Asia Pacific
$
6,357

 
$
9,550

 
(33
)%
 
(34
)%
As a percentage of total revenue
6
%
 
10
%
 
 
 
 
 
Nine Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant
Currency
North America
$
160,732

 
$
139,454

 
15
 %
 
15
 %
As a percentage of total revenue
56
%
 
53
%
 
 
 
 
EMEA
$
95,517

 
$
89,667

 
7
 %
 
10
 %
As a percentage of total revenue
33
%
 
34
%
 
 
 
 
Latin America
$
12,749

 
$
13,977

 
(9
)%
 
4
 %
As a percentage of total revenue
5
%
 
5
%
 
 
 
 
Asia Pacific
$
18,619

 
$
21,738

 
(14
)%
 
(13
)%
As a percentage of total revenue
6
%
 
8
%
 
 
 
 

North America increased $21.3 million, and total revenue generated outside North America increased $1.5 million, in the first nine months of fiscal year 2016 as compared to the same period last year. The increases in North America and EMEA were

24


primarily due to the impact of the Telerik acquisition, which was completed during the first quarter of fiscal year 2015. As a result of acquisition accounting, the acquired deferred revenue balance was significantly reduced to reflect its fair value as of the acquisition date. Therefore, the reduction of the acquisition date deferred revenue had a negative impact on revenue in the first nine months of fiscal year 2015. However, in the first nine months of fiscal year 2016 we recognized revenue related to the full value of Telerik deferred revenue that was generated during fiscal years 2015 and 2016. The decrease in Latin America in the first nine months of 2016 compared to the same period of 2015 was due to the continuing difficult economic situation in Brazil. The decrease in Asia Pacific in the three and nine months ended August 31, 2016 is due to several large OpenEdge license deals that occurred in the third fiscal quarter of last year.

Total revenue generated in markets outside North America represented 44% of total revenue in the first nine months of fiscal year 2016 and 47% of total revenue in the same period last year. If exchange rates had remained constant in the first nine months of fiscal year 2016 as compared to the exchange rates in effect in the same period of fiscal year 2015, total revenue generated in markets outside North America would have been 45% of total revenue.

Revenue by Segment

 
Three Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant Currency
OpenEdge segment
$
67,534

 
$
73,398

 
(8
)%
 
(7
)%
Data Connectivity and Integration segment
14,251

 
8,281

 
72
 %
 
72
 %
Application Development and Deployment segment
20,233

 
12,958

 
56
 %
 
56
 %
Total revenue
$
102,018

 
$
94,637

 
8
 %
 
9
 %
 
Nine Months Ended
 
Percentage Change
(In thousands)
August 31, 2016
 
August 31, 2015
 
As Reported
 
Constant Currency
OpenEdge segment
$
198,595

 
$
214,775

 
(8
)%
 
(5
)%
Data Connectivity and Integration segment
30,852

 
22,669

 
36
 %
 
36
 %
Application Development and Deployment segment
58,170

 
27,392

 
112
 %
 
112
 %
Total revenue
$
287,617

 
$
264,836

 
9
 %
 
11
 %

Revenue in the OpenEdge segment decreased $5.9 million, or 8%, during the third quarter of fiscal year 2016 as compared to the same quarter last year, primarily due to decreases in sales to OpenEdge customers and in Corticon license sales. Revenue in the OpenEdge segment would have decreased by 7% if exchange rates had been constant in fiscal year 2016 as compared to exchange rates in fiscal year 2015. Data Connectivity and Integration revenue increased $6.0 million, or 72%, quarter over quarter, primarily in North America, due to higher license revenue resulting from renewals and expansions of distribution agreements with large OEM customers. Application Development and Deployment revenue increased $7.3 million, or 56%, quarter over quarter as a result of the impact of the Telerik acquisition during the first quarter of fiscal year 2015 as described above.

Revenue in the OpenEdge segment decreased $16.2 million, or 8%, in the first nine months of fiscal year 2016 as compared to the same period last year. The decrease is primarily due to decreases in sales to OpenEdge customers and in Corticon license sales. Revenue in the OpenEdge segment would have decreased by 5% if exchange rates had been constant in fiscal year 2016 as compared to exchange rates in fiscal year 2015. Data Connectivity and Integration revenue increased $8.2 million, or 36%, period over period, primarily in North America, due to higher license revenue resulting from renewals and expansions of distribution agreements with large OEM customers. Application Development and Deployment revenue increased $30.8 million, or 112%, period over period as a result of the impact of the Telerik acquisition during the first quarter of fiscal year 2015 as described above.

25



Cost of Software Licenses

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Cost of software licenses
$
1,424

 
$
1,441

 
(1
)%
 
$
4,139

 
$
4,526

 
(9
)%
As a percentage of software license revenue
4
%
 
5
%
 
 
 
5
%
 
5
%
 
 
As a percentage of total revenue
1
%
 
2
%
 
 
 
1
%
 
2
%
 
 

Cost of software licenses consists primarily of costs of royalties, electronic software distribution, duplication and packaging. Cost of software licenses remained relatively flat in the third quarter of fiscal year 2016 as compared to the same quarter last year, and decreased as a percentage of software license revenue from 5% to 4%. Cost of software licenses decreased $0.4 million, or 9%, in the first nine months of fiscal year 2016 as compared to the same period last year, and remained flat as a percentage of software license revenue at 5%. Cost of software licenses as a percentage of software license revenue varies from period to period depending upon the relative product mix.

Cost of Maintenance and Services

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Cost of maintenance and services
$
11,825

 
$
9,612

 
23
%
 
$
33,217

 
$
31,174

 
7
%
As a percentage of maintenance and services revenue
17
%
 
15
%
 
 
 
17
%
 
17
%
 
 
As a percentage of total revenue
12
%
 
10
%
 
 
 
12
%
 
12
%
 
 

Cost of maintenance and services consists primarily of costs of providing customer support, consulting and education. Cost of maintenance and services increased $2.2 million, or 23%, in the third quarter of fiscal year 2016 as compared to the same quarter last year, and increased as a percentage of maintenance and services revenue from 15% to 17%. Cost of maintenance and services increased $2.0 million, or 7%, in the first nine months of fiscal year 2016 as compared to the same period last year, and remained flat as a percentage of maintenance and services revenue at 17%. The increase in cost of maintenance and services is primarily due to higher compensation-related costs as a result of an increase in headcount as compared to the same period in the prior fiscal year.

Amortization of Acquired Intangibles
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Amortization of acquired intangibles
$
3,940

 
$
4,079

 
(3
)%
 
$
11,818

 
$
12,805

 
(8
)%
As a percentage of total revenue
4
%
 
4
%
 
 
 
4
%
 
5
%
 
 

Amortization of acquired intangibles included in costs of revenue primarily represents the amortization of the value assigned to technology-related intangible assets obtained in business combinations. Amortization of acquired intangibles decreased $0.1 million, or 3%, in the third quarter of fiscal year 2016 as compared to the same quarter last year and decreased $1.0 million, or 8%, in the first nine months of fiscal year 2016 as compared to the same period last year. The decrease was due to the completion of amortization of certain intangible assets acquired in prior years.


26


Gross Profit
 
 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Gross profit
$
84,829

 
$
79,505

 
7
%
 
$238,443
 
$216,331
 
10
%
As a percentage of total revenue
83
%
 
84
%
 
 
 
83
%
 
81
%
 
 

Our gross profit increased $5.3 million, or 7%, in the third quarter of fiscal year 2016 as compared to the same quarter last year and increased $22.1 million, or 10%, in the first nine months of fiscal year 2016 as compared to the same period last year. Our gross profit as a percentage of total revenue decreased from 84% to 83% and increased from 81% to 83% in the third quarter and first nine months of fiscal year 2016, respectively, compared to the same periods of fiscal year 2015. The dollar increase is primarily related to the increase of maintenance revenue. As a result of acquisition accounting, the deferred revenue balance acquired from Telerik in the first quarter of fiscal year 2015 was significantly reduced to reflect its fair value as of the acquisition date, which impacted the amount of revenue recognized in the quarter and first nine months of 2015. However, we were still incurring the associated costs to fulfill the acquired deferred revenue, which were reflected in our consolidated statement of operations in the third quarter and first nine months of fiscal year 2015. As a result, our expenses as a percentage of total revenue were higher in the third quarter and first nine months of fiscal year 2015.

Sales and Marketing

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Sales and marketing
$
29,852

 
$
30,004

 
(1
)%
 
$
88,648

 
$
92,607

 
(4
)%
As a percentage of total revenue
29
%
 
32
%
 
 
 
31
%
 
35
%
 
 

Sales and marketing expenses decreased $0.2 million, or 1%, in the third quarter of fiscal year 2016 as compared to the same quarter last year, and decreased as a percentage of total revenue from 32% to 29%. Sales and marketing expenses decreased $4.0 million, or 4%, in the first nine months of fiscal year 2016 as compared to the same period last year, and decreased as a percentage of total revenue from 35% to 31%. The decrease in the first nine months of fiscal year 2016 was primarily due to lower outside services costs, largely attributed to our decision to no longer outsource our renewal maintenance business, and lower marketing program costs as compared to the prior year.

Product Development

 
Three Months Ended
 
Nine Months Ended
(In thousands)
August 31, 2016
 
August 31, 2015
 
Percentage
Change
 
August 31, 2016
 
August 31, 2015
 
Percentage
Change
Product development costs
$