e10vq
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
     
þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended August 31, 2007
OR
     
o   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)
     
MASSACHUSETTS   04-2746201
(State or other jurisdiction of
incorporation or organization)
  (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 þ            No o      
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ            Accelerated filer o            Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o            No þ      
As of September 28, 2007, there were 42,076,000 shares of the registrant’s common stock, $.01 par value per share, outstanding.
 
 

 


 

PROGRESS SOFTWARE CORPORATION
FORM 10-Q
FOR THE THREE MONTHS ENDED AUGUST 31, 2007
INDEX
             
PART I          
   
 
       
Item 1.       3  
        3  
        4  
        5  
        6  
Item 2.       11  
Item 3.       21  
Item 4.       21  
   
 
       
PART II          
   
 
       
Item 1.       22  
Item 1A.       23  
Item 2.       23  
Item 6.       24  
   
 
       
        25  
 EX-31.1 Section 302 Certification of CEO
 EX-31.2 Section 302 Certification of CFO
 EX-32.1 Section 906 Certification of CEO & CFO

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PART 1. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
(In thousands)
 
                 
    August 31,     November 30,  
    2007     2006  
 
Assets
               
Current assets:
               
Cash and equivalents
  $ 50,486     $ 46,449  
Short-term investments
    256,485       194,866  
 
Total cash and short-term investments
    306,971       241,315  
Accounts receivable, net
    76,127       82,762  
Other current assets
    17,583       17,943  
Deferred income taxes
    16,437       18,119  
 
Total current assets
    417,118       360,139  
 
Property and equipment, net
    62,869       57,585  
Acquired intangible assets, net
    63,821       75,069  
Goodwill
    157,824       157,858  
Deferred income taxes
    13,462       14,153  
Other assets
    5,481       5,435  
 
Total
  $ 720,575     $ 670,239  
 
 
               
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Current portion, long-term debt
  $ 299     $ 281  
Accounts payable
    9,396       15,034  
Accrued compensation and related taxes
    40,350       48,398  
Income taxes payable
    6,175       6,316  
Other accrued liabilities
    23,603       23,166  
Short-term deferred revenue
    129,659       120,974  
 
Total current liabilities
    209,482       214,169  
 
Long-term debt, less current portion
    1,431       1,657  
 
Long-term deferred revenue
    9,048       6,355  
 
Other non-current liabilities
    3,780       3,494  
 
Commitments and contingencies
               
Shareholders’ equity:
               
Common stock and additional paid-in capital; authorized, 100,000 shares; issued and outstanding, 41,829 shares in 2007 and 41,177 shares in 2006
    225,878       197,748  
Retained earnings, including accumulated other comprehensive gains of $2,706 in 2007 and $1,106 in 2006
    270,956       246,816  
 
Total shareholders’ equity
    496,834       444,564  
 
Total
  $ 720,575     $ 670,239  
 
See notes to unaudited condensed consolidated financial statements.

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Condensed Consolidated Statements of Operations (unaudited)
(In thousands, except per share data)
 
                                 
    Three Months Ended Nine Months Ended  
    Aug. 31, 2007     Aug. 31, 2006     Aug. 31, 2007     Aug. 31, 2006  
 
Revenue:
                               
Software licenses
  $ 44,011     $ 42,296     $ 133,295     $ 126,433  
Maintenance and services
    77,793       69,066       223,380       198,436  
 
Total revenue
    121,804       111,362       356,675       324,869  
 
Costs of revenue:
                               
Cost of software licenses
    2,109       2,034       5,661       6,061  
Cost of maintenance and services
    16,915       15,044       50,048       44,400  
Amortization of acquired intangibles for purchased technology
    2,496       2,255       7,480       5,772  
 
Total costs of revenue
    21,520       19,333       63,189       56,233  
 
Gross profit
    100,284       92,029       293,486       268,636  
 
 
                               
Operating expenses:
                               
Sales and marketing
    47,644       44,609       138,034       132,236  
Product development
    19,829       19,288       61,013       57,561  
General and administrative
    13,188       13,981       47,248       40,213  
Amortization of other acquired intangibles
    1,820       1,961       5,746       5,328  
Acquisition-related expenses
          3             1,834  
 
Total operating expenses
    82,481       79,842       252,041       237,172  
 
Income from operations
    17,803       12,187       41,445       31,464  
 
Other income (expense):
                               
Interest income and other
    2,602       1,931       6,851       5,437  
Foreign currency loss
    (332 )     (263 )     (1,870 )     (2,554 )
 
Total other income, net
    2,270       1,668       4,981       2,883  
 
Income before provision for income taxes
    20,073       13,855       46,426       34,347  
Provision for income taxes
    7,026       4,985       16,250       11,850  
 
Net income
  $ 13,047     $ 8,870     $ 30,176     $ 22,497  
 
 
                               
Earnings per share:
                               
Basic
  $ 0.31     $ 0.22     $ 0.73     $ 0.55  
Diluted
  $ 0.30     $ 0.21     $ 0.69     $ 0.52  
 
 
                               
Weighted average shares outstanding:
                               
Basic
    41,712       41,137       41,319       40,899  
Diluted
    44,153       42,901       43,742       43,144  
 
See notes to unaudited condensed consolidated financial statements.

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Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)
 
                 
    Nine Months Ended August 31,
    2007     2006  
 
Cash flows from operating activities:
               
Net income
  $ 30,176     $ 22,497  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization of property and equipment
    7,276       6,593  
Write-down for asset impairment
    2,388        
Amortization of capitalized software costs
    131       131  
Amortization of acquired intangible assets
    13,226       11,100  
Stock-based compensation
    16,586       16,874  
Deferred income taxes
    1,843       (3,811 )
Tax benefit from stock options
    556       1,137  
In-process research and development
          900  
Changes in operating assets and liabilities, net of effects from acquisitions:
               
Accounts receivable, net
    8,005       7,840  
Other current assets
    1,188       (3,374 )
Accounts payable and accrued expenses
    (18,555 )     (24,868 )
Income taxes payable
    (149 )     8,771  
Deferred revenue
    9,165       4,517  
 
Net cash provided by operating activities
    71,836       48,307  
 
Cash flows from investing activities:
               
Purchases of investments available for sale
    (196,115 )     (258,040 )
Sales and maturities of investments available for sale
    134,496       296,501  
Purchases of property and equipment
    (14,625 )     (12,305 )
Acquisitions, net of cash acquired
          (72,066 )
Decrease (increase) in other non-current assets
    (953 )     125  
 
Net cash used for investing activities
    (77,197 )     (45,785 )
 
Cash flows from financing activities:
               
Issuance of common stock
    24,669       12,961  
Excess tax benefit from stock options
    1,473       875  
Payment of long-term debt
    (209 )     (193 )
Repurchase of common stock
    (19,529 )     (12,679 )
 
Net cash provided by financing activities
    6,404       964  
 
Effect of exchange rate changes on cash
    2,994       5,672  
 
Net increase in cash and equivalents
    4,037       9,158  
Cash and equivalents, beginning of period
    46,449       40,398  
 
Cash and equivalents, end of period
  $ 50,486     $ 49,556  
 
See notes to unaudited condensed consolidated financial statements.

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Notes to Unaudited Condensed Consolidated Financial Statements
Note 1: Basis of Presentation
We have 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 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, 2006.
In the opinion of management, we have prepared the accompanying unaudited condensed consolidated financial statements on the same basis as the audited financial statements, 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.
Note 2: Revenue Recognition
We recognize revenue when earned. We recognize software license revenue upon shipment of the product or, if delivered electronically, when the customer has the right to access the software, provided that the license fee is fixed or determinable, persuasive evidence of an arrangement exists and collection is probable. We do not consider software license arrangements with payment terms greater than ninety days beyond our standard payment terms to be fixed and determinable and therefore such software license fees are recognized upon due date. We do not license our software with a right of return and generally do not license our software with conditions of acceptance. If an arrangement does contain conditions of acceptance, we defer recognition of the revenue until the acceptance criteria are met or the period of acceptance has passed. We generally recognize revenue for products distributed through application partners and distributors when sold through to the end-user.
We generally sell our software licenses with maintenance services and, in some cases, also with consulting services. For the undelivered elements, we determine vendor-specific objective evidence (VSOE) of fair value to be the price charged when the undelivered element is sold separately. We determine VSOE for maintenance sold in connection with a software license based on the amount that will be separately charged for the maintenance renewal period. We determine VSOE for consulting services by reference to the amount charged for similar engagements when a software license sale is not involved.
We generally recognize revenue from software licenses sold together with maintenance and/or consulting services upon shipment using the residual method, provided that the above criteria have been met. If VSOE of fair value for the undelivered elements cannot be established, we defer all revenue from the arrangement until the earlier of the point at which such sufficient VSOE does exist or all elements of the arrangement have been delivered, or if the only undelivered element is maintenance, then we recognize the entire fee ratably. If payment of the software license fees is dependent upon the performance of consulting services or the consulting services are essential to the functionality of the licensed software, then we recognize both the software license and consulting fees using the percentage of completion method.
We recognize maintenance revenue ratably over the term of the applicable agreement. We generally recognize revenue from services, primarily consulting and customer education, as the related services are performed.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with Statement 109 and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and

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transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with early adoption permitted. We will adopt FIN 48 on December 1, 2007. We are currently evaluating the impact that the adoption of FIN 48 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands fair value measurement disclosures. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating whether adoption of SFAS 157 will have an impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007. SFAS 159 also allows an entity to early adopt the statement as of the beginning of an entity’s fiscal year that begins after the issuance of SFAS 159, provided that the entity also adopts the requirement of SFAS No. 157. We are currently evaluating whether adoption of SFAS 159 will have an impact on our consolidated financial statements.
Note 3: Earnings Per Share
We calculate basic earnings per share using the weighted average number of common shares outstanding. We compute diluted earnings per share on the basis of the weighted average number of common shares outstanding plus the effects of outstanding stock options using the treasury stock method. The following table provides the calculation of basic and diluted earnings per share on an interim basis:
(In thousands, except per share data)
 
                                 
    Three Months Ended Aug. 31,         Nine Months Ended Aug. 31,  
    2007     2006     2007     2006  
 
Net income
  $ 13,047     $ 8,870     $ 30,176     $ 22,497  
 
Weighted average shares outstanding
    41,712       41,137       41,319       40,899  
Dilutive impact from outstanding stock options
    2,441       1,764       2,423       2,245  
 
Diluted weighted average shares outstanding
    44,153       42,901       43,742       43,144  
 
Earnings per share:
                               
Basic
  $ 0.31     $ 0.22     $ 0.73     $ 0.55  
Diluted
  $ 0.30     $ 0.21     $ 0.69     $ 0.52  
 
Stock options to purchase approximately 2,098,000 shares and 3,274,000 shares of common stock were excluded from the calculation of diluted earnings per share in the third quarter of fiscal years 2007 and 2006, respectively, because these options were anti-dilutive. Stock options to purchase approximately 2,406,000 shares and 2,313,000 shares of common stock were excluded from the calculation of diluted earnings per share in the first nine months of fiscal years 2007 and 2006, respectively, because these options were anti-dilutive.
Note 4: Stock-based Compensation
We account for stock-based compensation expense in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment” (SFAS 123R). Under SFAS 123R, stock-based compensation expense reflects the fair value of stock-based awards measured at the grant date, is recognized over the relevant service period, and is adjusted each period for anticipated forfeitures. We estimate the fair value of each stock-based award on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model incorporates assumptions as to stock price volatility, the expected life of options, a risk-free interest rate and dividend yield.

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SFAS 123R requires the cash flows resulting from excess tax benefits related to stock compensation to be classified as cash flows from financing activities when realized. In the first nine months of fiscal 2007, the excess tax benefit from the exercise of stock options was $1.5 million, which was classified as a cash flow from financing activities, compared to $0.9 million in the first nine months of fiscal 2006.
The following table provides the classification of stock-based compensation as reflected in our consolidated statements of operations:
(In thousands)
 
                                 
    Three Months Ended Aug. 31,     Nine Months Ended Aug. 31,  
    2007     2006     2007     2006  
 
Cost of software licenses
  $ 24     $ 33     $ 97     $ 110  
Cost of maintenance and services
    286       374       1,148       1,251  
Sales and marketing
    1,499       1,894       5,997       6,278  
Product development
    960       1,171       3,810       3,860  
General and administrative
    1,409       1,636       5,534       5,375  
 
Total stock-based compensation expense
  $ 4,178     $ 5,108     $ 16,586     $ 16,874  
 
On April 12, 2007, we completed a tender offer to amend stock options issued in previous years for which it was determined that the exercise price was less than the fair value on the revised date of grant, in order to mitigate the unfavorable personal tax consequences under Section 409A of the Internal Revenue Code. The amendment of such options resulted in a stock option modification under SFAS 123R. The terms of the offer require us to make cash payments to option holders in an amount equal to the difference between the exercise price of the original option and the amended price of the new option. We recorded a liability of approximately $2.5 million in the second quarter of fiscal 2007 for the present value of the fully vested cash payments to be paid in January 2008, of which $0.5 million was charged to stock-based compensation expense and $2.0 million was recorded charged to additional paid-in capital. The stock-based compensation expense amount represents the incremental fair value of the new options, and was recognized in the second quarter due to the fact that the future cash payments were fully vested as of the conclusion of the tender offer. Also, as a result of the modification and subsequent remeasurement of the options included in the tender offer, we accelerated the recognition of $0.4 million of unamortized stock-based compensation associated with the partial settlement of the unvested portion of the original award.
In December 2006, we also entered into option amendment agreements with a limited number of individuals for whom the deadline for such an amendment was December 31, 2006. These agreements contained similar terms to the tender offer except that the cash payment associated with unvested shares as of the date of the agreements require the individuals to be employed by us on the payment dates. In the first quarter of fiscal 2007, we accounted for the impact of these option amendment agreements as a stock option modification under SFAS 123R. We recorded a liability of approximately $0.7 million in the first quarter for the present value of the expected cash payments, which will be paid in up to five installments, depending on the vest schedules of each individual, through October 2009. Approximately $0.2 million of this liability represents the incremental fair value of the new options, and will be recorded as stock-based compensation expense over the remaining vest period and $0.5 million was recorded as a reduction in additional paid in capital.
Note 5: Income Taxes
We provide for income taxes during interim periods based on the estimated effective tax rate for the full fiscal year. We record cumulative adjustments to the tax provision in an interim period in which a change in the estimated annual effective rate is determined. We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. We have not provided for U.S. income taxes on the undistributed earnings of non-U.S. subsidiaries, as these earnings have been permanently reinvested or would be principally offset by foreign tax credits.

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Note 6: Comprehensive Income
The components of comprehensive income include net income, foreign currency translation adjustments and unrealized gains and losses on investments. The following table provides the composition of comprehensive income on an interim basis:
(In thousands)
 
                                 
    Three Months Ended Aug. 31,     Nine Months Ended Aug. 31,  
    2007     2006     2007     2006  
 
Net income, as reported
  $ 13,047     $ 8,870     $ 30,176     $ 22,497  
Foreign currency translation adjustments, net of tax
    364       436       1,582       2,139  
Unrealized gains on investments, net of tax
    51       66       17       115  
 
Total comprehensive income
  $ 13,462     $ 9,372     $ 31,775     $ 24,751  
 
Note 7: Shareholders’ Equity
Common Stock Repurchases
In September 2006, the Board of Directors authorized, for the period from October 1, 2006 through September 30, 2007, the purchase of up to 10,000,000 shares of our common stock, at such times that management deems such purchases to be an effective use of cash. Approximately 9.3 million shares were available for repurchase under this repurchase authorization as of August 31, 2007. We purchased and retired approximately 705,000 shares of our common stock for $19.5 million in the first nine months of fiscal 2007 as compared to approximately 470,000 shares of our common stock for $12.7 million in the first nine months of fiscal 2006. In September 2007, the Board of Directors authorized, for the period from October 1, 2007 through September 30, 2008, the purchase of up to 10,000,000 shares of our common stock, at such times that management deems such purchases to be an effective use of cash.
Note 8: Goodwill
Goodwill is the amount by which the cost of acquired net assets in a business acquisition exceeded the fair value of net identifiable assets on the date of purchase. For purposes of the annual impairment test, we assigned goodwill of $11.8 million to the operating divisions comprising the OpenEdge operating segment, $57.0 million to the operating divisions comprising the Enterprise Infrastructure reporting segment and $89.0 million to the reporting unit comprising the DataDirect reporting segment.
During the first quarter of fiscal 2007, we completed our annual testing for impairment of goodwill and, based on those tests, concluded that no impairment of goodwill existed as of December 15, 2006, the goodwill impairment measurement date for fiscal 2007.
Note 9: Segment Information
At the end of fiscal 2006, we reorganized our business into five operating units. Our principal operating unit conducts business as the OpenEdge Division. The OpenEdge Division (OED) provides the Progress® OpenEdge platform, a set of development and deployment technologies, including the OpenEdge RDBMS, one of the leading embedded databases, for building business applications. Another significant operating unit, the Enterprise Infrastructure Division (EID), is responsible for the development, marketing and sales of our Sonic, Actional, DataXtend and ObjectStore product lines. The third significant operating unit, DataDirect Technologies, provides standards-based data connectivity software. Our other two operating units are the Apama Division and the EasyAsk Division.
Segment information is presented in accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” This standard is based on a management approach, which requires segmentation based upon our internal organization and disclosure of revenue and operating income based upon internal accounting methods. Our chief decision maker is our Chief Executive Officer.

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Based upon the aggregation criteria for segment reporting, we have three reportable segments: the OpenEdge segment, which includes the OED and EasyAsk Division, the Enterprise Infrastructure segment, which includes the EID and Apama Division, and the DataDirect segment. We do not manage our assets, capital expenditures, interest income or provision for income taxes by segment. We manage such items on a company basis.
At the end of fiscal 2006, we changed the composition of our reporting segments from previous disclosures. We have restated our fiscal 2006 segment disclosure to conform to the current presentation.
The following table provides revenue and income from operations from our reportable segments on an interim basis:
(In thousands)
 
                                 
    Three Months Ended Aug. 31,     Nine Months Ended Aug. 31,  
    2007     2006     2007     2006  
 
Revenue:
                               
OpenEdge segment
  $ 90,971     $ 82,216     $ 268,076     $ 244,858  
Enterprise Infrastructure segment
    16,916       16,210       45,346       44,370  
DataDirect segment
    16,996       15,948       50,191       42,133  
Reconciling items
    (3,079 )     (3,012 )     (6,938 )     (6,492 )
 
Total
  $ 121,804     $ 111,362     $ 356,675     $ 324,869  
 
Income (loss) from operations:
                               
OpenEdge segment
  $ 31,600     $ 26,379     $ 95,570     $ 84,589  
Enterprise Infrastructure segment
    (6,664 )     (5,004 )     (19,318 )     (20,135 )
DataDirect segment
    1,768       1,650       5,307       1,534  
Reconciling items
    (8,901 )     (10,838 )     (40,114 )     (34,524 )
 
Total
  $ 17,803     $ 12,187     $ 41,445     $ 31,464  
 
The reconciling items within revenue primarily represent intersegment sales, which are accounted for as if sold under an equivalent arms-length basis arrangement. Amounts included under reconciling items within income from operations represent expenses which are not charged to segments for internal reporting and include amortization of acquired intangibles, stock-based compensation, acquisition-related expenses and certain unallocated administrative expenses.
Total revenue by significant product line, regardless of which segment generated the revenue, is as follows:
(In thousands)
 
                                 
    Three Months Ended Aug. 31,     Nine Months Ended Aug. 31,  
    2007     2006     2007     2006  
 
DataDirect
  $ 16,996     $ 15,949     $ 50,191     $ 42,134  
Enterprise Infrastructure
    22,511       18,098       60,527       50,300  
Progress OpenEdge and other
    82,297       77,315       245,957       232,435  
 
Total revenue
  $ 121,804     $ 111,362     $ 356,675     $ 324,869  
 
Note 10: Contingencies
On June 23, 2006, we received written notice that the Enforcement Staff in the Boston, Massachusetts office of the SEC had begun an informal inquiry into our option-granting practices during the period December 1, 1995 through November 30, 2002.  On December 19, 2006, the SEC informed us that it had issued a formal order of investigation into our option-granting practices during the period December 1, 1995 through the present.  We are unable to predict with certainty what consequences may arise from the SEC investigation.   We have already incurred, and expect to continue to incur, significant legal expenses arising from the investigation. If the SEC institutes legal action, we could face significant fines and penalties and be required to take remedial actions determined by the SEC or a court. Although we have filed certain restated financial statements that we believe correct the accounting errors arising from our past option-granting practices, the filing of those financial statements did not resolve the pending SEC

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inquiry. The SEC has not indicated to us whether it has reviewed our restated financial statements, and any SEC review could lead to further restatements or other modifications of our financial statements.
On August 17, 2006, a derivative complaint styled Arkansas Teacher Retirement System, Derivatively on Behalf of Progress Software Corporation, v. Joseph Alsop et al, Civ. Act. No. 06-CA-11459 RCL was filed in the United States District Court for the District of Massachusetts by a party identifying itself as one of our shareholders purporting to act on our behalf against our directors and certain of our present and former officers. We were also named as a nominal defendant. The complaint alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly improper backdating of certain stock option grants. The complaint sought monetary damages, restitution, disgorgement, rescission of stock options, punitive damages and other relief.  A Special Litigation Committee was formed by our Board of Directors to investigate and determine the Company’s response to the complaint. On September 25, 2007, the Court, in response to our motion, dismissed the Arkansas Teacher Retirement System complaint on the grounds that the Plaintiff failed to make a proper pre-filing demand upon our Board of Directors, and entered judgment for Defendants.  Also on September 25, 2007, the Board received a demand from the Plaintiff regarding the allegedly improper backdating, which stated that absent Board action the Plaintiff may again seek relief. The Special Litigation Committee has taken the demand under advisement.
On January 16, 2007, another party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled Acuna, Derivatively on Behalf of Progress Software Corporation v. Joseph Alsop et al., Civ. Act. No. 07-0157 against our directors and certain of our present and former officers in Massachusetts Superior Court.  We are named as a nominal defendant in this action as well.  The complaint alleges breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly improper backdating of certain stock option grants.   The complaint seeks monetary damages and disgorgement, among other forms of relief. 
Further, on March 28, 2007, an additional party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled White, Derivatively on Behalf Of Nominal Defendant Progress v. Progress Software Corporation et al., Civ 07-01172, in Massachusetts Superior Court.  This complaint involves substantially the same defendants, allegations and demands for relief as the Acuna complaint described above.  On June 26, 2007, the White and Acuna cases were consolidated.  The consolidated case has been stayed while the Special Litigation Committee’s investigation is ongoing.
The ultimate outcome of any of these matters could have a material adverse effect on our results of operations.  These matters could divert the attention of our management and harm our business.  In addition, we have incurred, and expect to incur legal expenses arising from these matters, which may be significant, including the advancement of legal expenses to our directors and officers. We have certain indemnification obligations to our directors and officers, and the outcome of derivative or any other litigation may require that we indemnify some or all of our directors and officers for expenses they may incur in defending the litigation and other losses.
We are subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these other claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on our consolidated financial position or results of operations.
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

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financial results, product offerings or other events that have not yet occurred. There are several important factors that could cause actual results or events to differ materially from those anticipated by the forward-looking statements. Such factors include those described in Part II, Item 1A of this Form 10-Q under the heading “Risk Factors.” 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.
Overview
We develop, market and distribute software to simplify and accelerate the development, deployment, integration and management of business applications. Our mission is to deliver software products and services that empower partners and customers to improve their development, deployment, integration and management of quality applications worldwide. Our products include development tools, databases, application servers, messaging servers, application management tools, data connectivity products and integration products that enable the highly distributed deployment of responsive applications across internal networks, the Internet and occasionally-connected users. Through our various operating units, we market our products globally to a broad range of organizations in manufacturing, distribution, finance, retail, healthcare, telecommunications, government and many other fields.
We derive a significant portion of our revenue from international operations. In the first half of fiscal 2006, the strengthening of the U.S. dollar against most major currencies, primarily the euro and the British pound, negatively affected the translation of our results into U.S. dollars. In the second half of fiscal 2006 and the first nine months of fiscal 2007, the weakening of the U.S. dollar against most major currencies, primarily the euro and the British pound, positively affected the translation of our results into U.S. dollars.
Critical Accounting Policies
Our management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. However, actual results may differ from these estimates.
We have identified the following critical accounting policies that require the use of significant judgments and estimates in the preparation of our consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 in the Notes to Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K for the year ended November 30, 2006, as well as the notes to our Consolidated Financial Statements included in Item 1 of this Form 10-Q.
Revenue Recognition – Our revenue recognition policy is significant because revenue is a key component affecting results of operations. In determining when to recognize revenue from a customer arrangement, we are often required to exercise judgment regarding the application of our accounting policies to a particular arrangement. For example, judgment is required in determining whether a customer arrangement has multiple elements. When such a situation exists, judgment is also involved in determining whether vendor-specific objective evidence (VSOE) of fair value for the undelivered elements exists. While we follow specific and detailed rules and guidelines related to revenue recognition, we make and use significant management judgments and estimates in connection with the revenue recognized in any reporting period, particularly in the areas described above, as well as collectibility. If management made different estimates or judgments, material differences in the timing of the recognition of revenue could occur.
Allowance for Doubtful Accounts – We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. We establish this allowance using estimates that we make based on factors such as the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, changes to customer creditworthiness and current economic trends. If we used different estimates,

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or if the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, we would require additional provisions for doubtful accounts that would increase bad debt expense.
Goodwill and Intangible Assets – We had goodwill and net intangible assets of approximately $222 million at August 31, 2007. We assess the impairment of goodwill and identifiable intangible assets on an annual basis and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. We would record an impairment charge if such an assessment were to indicate that the fair value of such assets was less than the carrying value. Judgment is required in determining whether an event has occurred that may impair the value of goodwill or identifiable intangible assets. Factors that could indicate that an impairment may exist include significant underperformance relative to plan or long-term projections, changes in business strategy, significant negative industry or economic trends or a significant decline in our stock price or in the value of one of our reporting units for a sustained period of time. We utilize cash flow models to determine the fair value of our reporting units. We must make assumptions about future cash flows, future operating plans, discount rates and other factors in our models. Different assumptions and judgment determinations could yield different conclusions that would result in an impairment charge to income in the period that such change or determination was made.
Income Tax Accounting – We had a net deferred tax asset of approximately $26 million at August 31, 2007. We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. We consider scheduled reversals of temporary differences, projected future taxable income, ongoing tax planning strategies and other matters in assessing the need for and the amount of a valuation allowance. If we were to change our assumptions or otherwise determine that we were unable to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period that such change or determination was made. On a quarterly basis we provide for income taxes based on the estimated effective tax rate for the full fiscal year.
Stock-Based Compensation – We account for stock-based compensation expense in accordance with SFAS 123R. Under SFAS 123R, stock-based compensation expense reflects the fair value of stock-based awards measured at the grant date, is recognized over the relevant service period, and is adjusted each period for anticipated forfeitures. We estimate the fair value of each stock-based award on the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model incorporates assumptions as to stock price volatility, the expected life of options, a risk-free interest rate and dividend yield. Many of these assumptions are highly subjective and require the exercise of management judgment. Our management must also apply judgment in developing an estimate of awards that may be forfeited. If our actual experience differs significantly from our estimates and we choose to employ different assumptions in the future, the stock-based compensation expense that we record in future periods may differ materially from that recorded in the current period.

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Results of Operations
The following table provides certain income and expense items as a percentage of total revenue, and the percentage change in dollar amounts of such items compared with the corresponding period in the previous fiscal year:
                                                 
    Percentage of Total Revenue     Period-to-Period Change  
    Three Months Ended Nine Months Ended   Three     Nine  
    Aug. 31,     Aug. 31,     Aug. 31,     Aug. 31,     Month     Month  
    2007     2006     2007     2006     Period     Period  
 
Revenue:
                                               
Software licenses
    36 %     38 %     37 %     39 %     4 %     5 %
Maintenance and services
    64       62       63       61       13       13  
 
Total revenue
    100       100       100       100       9       10  
 
Costs of revenue:
                                               
Cost of software licenses
    2       1       2       2       4       (7 )
Cost of maintenance and services
    14       14       14       14       12       13  
Amortization of acquired intangibles for purchased technology
    2       2       2       1       11       30  
 
Total costs of revenue
    18       17       18       17       11       12  
 
Gross profit
    82       83       82       83       9       9  
 
Operating expenses:
                                               
Sales and marketing
    39       40       39       41       7       4  
Product development
    16       17       17       18       3       6  
General and administrative
    11       13       13       13       (6 )     17  
Amortization of other acquired intangibles
    2       2       1       1       (7 )     8  
Acquisition-related expenses, net
    0       0       0       0       (100 )     (100 )
 
Total operating expenses
    68       72       70       73       3       6  
 
Income from operations
    14       11       12       10       46       32  
Other income
    2       2       1       1       36       73  
 
Income before provision for taxes
    16       13       13       11       45       35  
Provision for income taxes
    6       5       5       4       41       37  
 
Net income
    10 %     8 %     8 %     7 %     47 %     34 %
 
Revenue. Our total revenue increased 9% from $111.4 million in the third quarter of fiscal 2006 to $121.8 million in the third quarter of fiscal 2007. Total revenue would have increased by 5% if exchange rates had been constant in the third quarter of fiscal 2007 as compared to exchange rates in effect in the third quarter of fiscal 2006. Total revenue increased 10% from $324.9 million in the first nine months of fiscal 2006 to $356.7 million in the first nine months of fiscal 2007. Total revenue would have increased by 5% if exchange rates had been constant in the first nine months of fiscal 2007 as compared to exchange rates in effect in the first nine months of fiscal 2006. In addition to the positive effect of changes in exchange rates, each of our major product lines experienced growth in the first nine months of fiscal 2007.
Revenue from our Progress OpenEdge product line increased from $77.3 million in the third quarter of fiscal 2006 to $82.3 million in the third quarter of fiscal 2007 and increased from $232.4 million in the first nine months of fiscal 2006 to $246.0 million in the first nine months of fiscal 2007. Revenue derived from our Enterprise Infrastructure product lines increased 24% from $18.1 million in the third quarter of fiscal 2006 to $22.5 million in the third quarter of fiscal 2007 and increased 20% from $50.3 million in the first nine months of fiscal 2006 to $60.5 million in the first nine months of fiscal 2007. Revenue from our DataDirect product line increased 7% from $15.9 million in the third quarter of fiscal 2006 to $17.0 million in the third quarter of fiscal 2007 and increased 19% from $42.1 million in the first nine months of fiscal 2006 to $50.2 million in the first nine months of fiscal 2007.

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Software license revenue increased 4% from $42.3 million in the third quarter of fiscal 2006 to $44.0 million in the third quarter of fiscal 2007. Software license revenue would have remained flat if exchange rates had been constant in the third quarter of fiscal 2007 as compared to exchange rates in effect in the third quarter of fiscal 2006. Software license revenue increased 5% from $126.4 million in the first nine months of fiscal 2006 to $133.3 million in the first nine months of fiscal 2007. Software license revenue would have increased by 2% if exchange rates had been constant in the first nine months of fiscal 2007 as compared to exchange rates in effect in the first nine months of fiscal 2006. The increase in software license revenue in the nine month period was primarily due to growth from the DataDirect and the Enterprise Infrastructure product lines. These product lines accounted for 44% of software license revenue in the first nine months of fiscal 2007 compared to 42% in the first nine months of fiscal 2006. Software license revenue from the Progress OpenEdge product set increased year over year, primarily within the development products.
Maintenance and services revenue increased 13% from $69.1 million in the third quarter of fiscal 2006 to $77.8 million in the third quarter of fiscal 2007. Maintenance and services revenue would have increased by 8% if exchange rates had been constant in the third quarter of fiscal 2007 as compared to exchange rates in effect in the third quarter of fiscal 2006. Maintenance and services revenue increased 13% from $198.4 million in the first nine months of fiscal 2006 to $223.4 million in the first nine months of fiscal 2007. Maintenance and services revenue would have increased by 8% if exchange rates had been constant in the first nine months of fiscal 2007 as compared to exchange rates in effect in the first nine months of fiscal 2006. Excluding the impact of changes in exchange rates, the increase in maintenance and services revenue was primarily the result of an increase in professional services revenue, growth in our installed customer base and renewal of maintenance agreements.
Total revenue generated in markets outside North America increased 15% from $59.9 million in the third quarter of fiscal 2006 to $69.0 million in the third quarter of fiscal 2007 and represented 54% of total revenue in the third quarter of fiscal 2006 and 57% of total revenue in the third quarter of fiscal 2007. Revenue from the three major regions outside North America, consisting of EMEA, Latin America and Asia Pacific, each increased in the third quarter of fiscal 2007 as compared to the third quarter of fiscal 2006. Total revenue generated in markets outside North America would have represented 55% of total revenue if exchange rates had been constant in the third quarter of fiscal 2007 as compared to the exchange rates in effect in the third quarter of fiscal 2006.
Total revenue generated in markets outside North America increased 14% from $177.0 million in the first nine months of fiscal 2006 to $202.1 million in the first nine months of fiscal 2007 and represented 54% of total revenue in the first nine months of fiscal 2006 and 57% of total revenue in the first nine months of fiscal 2007. Revenue from the three major regions outside North America, consisting of EMEA, Latin America and Asia Pacific, each increased in fiscal 2007 as compared to fiscal 2006. Total revenue generated in markets outside North America would have represented 55% of total revenue if exchange rates had been constant in the first nine months of fiscal 2007 as compared to the exchange rates in effect in the first nine months of fiscal 2006.
Cost of Software Licenses. Cost of software licenses consists primarily of costs of product media, documentation, duplication, packaging, electronic software distribution, royalties and amortization of capitalized software costs. Cost of software licenses increased 4% from $2.0 million in the third quarter of fiscal 2006 to $2.1 million in the third quarter of fiscal 2007, and remained the same as a percentage of software license revenue at 5%. The dollar increase for the third quarter was primarily due to a slight increase in royalty expense for products and technologies licensed or resold from third parties. Cost of software licenses decreased 7% from $6.1 million in the first nine months of fiscal 2006 to $5.7 million in the first nine months of fiscal 2007, and decreased as a percentage of software license revenue from 5% in the first nine months of fiscal 2006 to 4% in the first nine months of fiscal 2007. The dollar decrease in the first nine months of fiscal 2007 compared to the first nine months of fiscal 2006 was primarily due to a decrease in royalty expense for products and technologies licensed or resold from third parties. Cost of software licenses as a percentage of software license revenue may vary from period to period depending upon the relative product mix.
Cost of Maintenance and Services. Cost of maintenance and services consists primarily of costs of providing customer technical support, education and consulting. Cost of maintenance and services increased 12% from $15.0 million in the third quarter of fiscal 2006 to $16.9 million in the third quarter of fiscal 2007, and remained the same as a percentage of maintenance and services revenue at 22%. Cost of maintenance and services increased 13% from $44.4 million in the first nine months of fiscal 2006 to $50.0 million in the first nine months of fiscal 2007, and

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remained the same as a percentage of maintenance and services revenue at 22%. The total dollar amount in the third quarter of fiscal 2007 and in the first nine months of fiscal 2007 increased primarily due to higher usage of third-party contractors for service engagements. Our technical support, education and consulting headcount decreased by 2% from the end of the third quarter of fiscal 2006 to the end of the third quarter of fiscal 2007.
Amortization of Acquired Intangibles for Purchased Technology. Amortization of acquired intangibles for purchased technology primarily represents the amortization of the value assigned to technology-related intangible assets obtained in business combinations. Amortization of acquired intangibles for purchased technology increased from $2.3 million in the third quarter of fiscal 2006 to $2.5 million in the third quarter of fiscal 2007. Amortization of acquired intangibles for purchased technology increased from $5.8 million in the first nine months of fiscal 2006 to $7.5 million in the first nine months of fiscal 2007. The increase was due to a full nine months of amortization expense in fiscal 2007 associated with the acquisitions of NEON, Actional, Pantero and OpenAccess, which occurred in fiscal 2006.
Gross Profit. Our gross profit increased 9% from $92.0 million in the third quarter of fiscal 2006 to $100.3 million in the third quarter of fiscal 2007. Our gross profit percentage of total revenue decreased from 83% in the third quarter of fiscal 2006 to 82% in the third quarter of fiscal 2007. Our gross profit increased 9% from $268.6 million in the first nine months of fiscal 2006 to $293.5 million in the first nine months of fiscal 2007. Our gross profit percentage of total revenue decreased from 83% in the first nine months of fiscal 2006 to 82% in the first nine months of fiscal 2007. The slight decrease in our gross profit percentage was due to professional services, the lowest margin revenue component, growing at the highest rate of our revenue components.
Sales and Marketing. Sales and marketing expenses increased 7% from $44.6 million in the third quarter of fiscal 2006 to $47.6 million in the third quarter of fiscal 2007, and decreased as a percentage of total revenue from 40% to 39%. Sales and marketing expenses increased 4% from $132.2 million in the first nine months of fiscal 2006 to $138.0 million in the first nine months of fiscal 2007, and decreased as a percentage of total revenue from 41% to 39%. The increase in sales and marketing expenses was due to higher average selling costs, including higher commission expense, partially offset by a decrease in marketing program expenses. Our sales support and marketing headcount decreased 1% from the end of the third quarter of fiscal 2006 to the end of the third quarter of fiscal 2007.
Product Development. Product development expenses increased 3% from $19.3 million in the third quarter of fiscal 2006 to $19.8 million in the third quarter of fiscal 2007, and decreased as a percentage of revenue from 17% to 16%. Product development expenses increased 6% from $57.6 million in the first nine months of fiscal 2006 to $61.0 million in the first nine months of fiscal 2007, and decreased as a percentage of revenue from 18% to 17%. The dollar increase in the first nine months of fiscal 2007 as compared to the first nine months of fiscal 2006 was primarily due to a full nine months of expenses related to the development teams associated with the acquisitions of NEON and Actional, which occurred at the end of the first quarter of fiscal 2006. Our product development headcount increased 3% from the end of the third quarter of fiscal 2006 to the end of the third quarter of fiscal 2007.
General and Administrative. General and administrative expenses include the costs of our finance, human resources, legal, information systems and administrative departments. General and administrative expenses decreased 6% from $14.0 million in the third quarter of fiscal 2006 to $13.2 million in the third quarter of fiscal 2007, and decreased as a percentage of revenue from 13% to 11%. General and administrative expenses increased 17% from $40.2 million in the first nine months of fiscal 2006 to $47.2 million in the first nine months of fiscal 2007, and remained the same as a percentage of revenue at 13%. The dollar increase in the first nine months of fiscal 2007 was primarily due to professional services fees associated with the investigation and shareholder derivative lawsuits related to our historical stock option grant practices of $3.3 million, a write-down associated with a portion of the implementation of a new ERP system of $2.4 million and payments made to compensation committee members for cancelled options of $1.3 million. The write-down was necessitated by the conclusion that it was not advisable to proceed further with the implementation of the third-party application. Our administrative headcount decreased 6% from the end of the third quarter of fiscal 2006 to the end of the third quarter of fiscal 2007.
Amortization of Other Acquired Intangibles. Amortization of other acquired intangibles primarily represents the amortization of value assigned to non-technology-related intangible assets obtained in business combinations.

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Amortization of other acquired intangibles decreased 7% from $2.0 million in the third quarter of fiscal 2006 to $1.8 million in the third quarter of fiscal 2007. Amortization of other acquired intangibles increased from $5.3 million in the first nine months of fiscal 2006 to $5.7 million in the first nine months of fiscal 2007. The increase was due to a full nine months of amortization expense in fiscal 2007 associated with the acquisitions of NEON, Actional, Pantero and OpenAccess, which occurred in fiscal 2006.
Acquisition-Related Expenses. Acquisition-related expenses for the first nine months of fiscal 2006 totaled $1.8 million and included $0.9 million of expenses for retention bonuses to Apama and EasyAsk employees who joined us in fiscal 2005 and $0.9 million of in-process research and development from the acquisition of NEON, which was expensed when the acquisition was consummated because the technological feasibility of several products under development at the time of the acquisition had not been achieved and no alternate future uses had been established. Research and development costs to bring the acquired products to technological feasibility are not expected to have a material impact on our future results of operations or cash flows. The value of in-process research and development was determined in part from an appraisal from an independent third party.
Income From Operations. Income from operations increased 46% from $12.2 million in the third quarter of fiscal 2006 to $17.8 million in the third quarter of fiscal 2007 and increased as a percentage of total revenue from 11% in the third quarter of fiscal 2006 to 14% in the third quarter of fiscal 2007. Income from operations increased 32% from $31.5 million in the first nine months of fiscal 2006 to $41.4 million in the first nine months of fiscal 2007 and increased as a percentage of total revenue from 10% in the first nine months of fiscal 2006 to 12% in the first nine months of fiscal 2007.
Income from operations increased from $26.4 million in the third quarter of fiscal 2006 to $31.6 million in the third quarter of fiscal 2007 in our OpenEdge segment, which primarily includes OED and the EasyAsk Division. Income from operations in the same segment increased from $84.6 million in the first nine months of fiscal 2006 to $95.6 million in the first nine months of fiscal 2007. Losses from operations increased from $5.0 million in the third quarter of fiscal 2006 to $6.7 million in the third quarter of fiscal 2007 in our Enterprise Infrastructure segment. Losses from operations in the same segment decreased from $20.1 million in the first nine months of fiscal 2006 to $19.3 million in the first nine months of fiscal 2007. Income from operations increased from $1.7 million in the third quarter of fiscal 2006 to $1.8 million in the third quarter of fiscal 2007 in our DataDirect segment. Income from operations in the same segment increased from $1.5 million in the first nine months of fiscal 2006 to $5.3 million in the first nine months of fiscal 2007. See Note 9 to the accompanying condensed consolidated financial statements for a reconciliation of income from operations for each segment to consolidated income from operations.
Other Income. Other income increased 36% from $1.7 million in the third quarter of fiscal 2006 to $2.3 million in the third quarter of fiscal 2007. Other income increased 73% from $2.9 million in the first nine months of fiscal 2006 to $5.0 million in the first nine months of fiscal 2007. The increase in each period was primarily due to an increase in interest income, resulting from slightly higher interest rates and higher average cash and short-term investment balances, and lower foreign exchange losses.
Provision for Income Taxes. Our effective tax rate was 35% in the first nine months of both fiscal years 2006 and 2007. A cumulative adjustment was made to the tax provision in the third quarter of fiscal 2006 to reflect a change in the estimated annual effective rate for 2006. We estimate that our effective tax rate will be approximately 35% for all of fiscal 2007.
Liquidity and Capital Resources
At the end of the third quarter of fiscal 2007, our cash and short-term investments totaled $307.0 million. The increase of $65.6 million since the end of fiscal 2006 resulted primarily from cash generated from operations, partially offset by capital expenditures.
We generated $71.8 million in cash from operations in the first nine months of fiscal 2007 as compared to $48.3 million in the first nine months of fiscal 2006. The increase in cash generated from operations in the third quarter of fiscal 2007 over the third quarter of fiscal 2006 was primarily due to increased profitability and a positive increase in working capital.

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A summary of our cash flows from operations for the first nine months of fiscal years 2007 and 2006 is as follows:
                 
(In thousands)   Nine Months Ended Aug. 31,  
    2007     2006  
 
Net income
  $ 30,176     $ 22,497  
Depreciation, amortization and other noncash charges
    39,607       35,598  
Tax benefit from stock plans
    556       1,137  
Changes in operating assets and liabilities
    1,497       (10,925 )
 
Total
  $ 71,836     $ 48,307  
 
Accounts receivable decreased by $6.6 million from the end of fiscal 2006. Accounts receivable days sales outstanding, or DSO, decreased by 5 days to 56 days at the end of the third quarter of fiscal 2007 as compared to 61 days at the end of fiscal 2006 and increased by 2 days from 54 days at the end of the third quarter of fiscal 2006. We target a DSO range of 60 to 80 days.
We purchased property and equipment totaling $14.6 million in the first nine months of fiscal 2007 as compared to $12.3 million in the first nine months of fiscal 2006. The purchases consisted primarily of computer equipment and software and building and leasehold improvements. The increase primarily related to costs associated with our ongoing ERP implementation.
In September 2006, our Board of Directors authorized, for the period from October 1, 2006 through September 30, 2007, the purchase of up to 10,000,000 shares of our common stock, at such times that we deem such purchases to be an effective use of cash. We purchased and retired approximately 705,000 shares of our common stock for $19.5 million in the first nine months of fiscal 2007 as compared to approximately 470,000 shares of our common stock for $12.7 million in the first nine months of fiscal 2006. In September 2007, the Board of Directors authorized, for the period from October 1, 2007 through September 30, 2008, the purchase of up to 10,000,000 shares of our common stock, at such times that management deems such purchases to be an effective use of cash.
We received $24.7 million in the first nine months of fiscal 2007 from the exercise of stock options and the issuance of shares under our Employee Stock Purchase Plan as compared to $13.0 million in the first nine months of fiscal 2006.
We believe that existing cash balances together with funds generated from operations will be sufficient to finance our operations and meet our foreseeable cash requirements (including planned capital expenditures, lease commitments, debt payments, potential cash acquisitions and other long-term obligations) through at least the next twelve months.
Revenue Backlog – Our aggregate revenue backlog at August 31, 2007 was approximately $163 million, of which $139 million was included on our balance sheet as deferred revenue, primarily related to unexpired maintenance and support contracts. At August 31, 2007, the remaining amount of backlog of approximately $24 million was composed of multi-year licensing arrangements of approximately $20 million and open software license orders received but not shipped of approximately $4 million. Our backlog of orders not included on the balance sheet is not subject to our normal accounting controls for information that is either reported in or derived from our basic financial statements.
Our aggregate revenue backlog at August 31, 2006 was approximately $147 million, of which $123 million was included on our balance sheet as deferred revenue, primarily related to unexpired maintenance and support contracts. At August 31, 2006, the remaining amount of backlog of approximately $24 million was composed of multi-year licensing arrangements of approximately $19 million and open software license orders received but not shipped of approximately $5 million.
We typically fulfill most of our software license orders within 30 days of acceptance of a purchase order. Assuming all other revenue recognition criteria have been met, we recognize software license revenue upon shipment of the product, or if delivered electronically, when the customer has the right to access the software. Because there are many elements governing when revenue is recognized, including when orders are shipped, credit approval,

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completion of internal control processes over revenue recognition and other factors, management has some control in determining the period in which certain revenue is recognized. We frequently have open software license orders at the end of the quarter which have not shipped or have otherwise not met all the required criteria for revenue recognition. Although the amount of open software license orders may vary at any time, we generally do not believe that the amount, if any, of such software license orders at the end of a particular quarter is a reliable indicator of future performance. In addition, there is no industry standard for the definition of backlog and there may be an element of estimation in determining the amount. As such, direct comparisons with other companies may be difficult or potentially misleading.
Guarantees and Indemnification Obligations
We include standard intellectual property indemnification provisions in our licensing agreements in the ordinary course of business. Pursuant to our product license agreements, we will indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally business partners or customers, in connection with certain patent, copyright or other intellectual property infringement claims by third parties with respect to our products. Other agreements with our customers provide indemnification for claims relating to property damage or personal injury resulting from the performance of services by us or our subcontractors. Historically, our costs to defend lawsuits or settle claims relating to such indemnity agreements have been insignificant. Accordingly, the estimated fair value of these indemnification provisions is immaterial.
Legal and Other Regulatory Matters
On June 23, 2006, we received written notice that the Enforcement Staff in the Boston, Massachusetts office of the SEC had begun an informal inquiry into our option-granting practices during the period December 1, 1995 through November 30, 2002.  On December 19, 2006, the SEC informed us that it had issued a formal order of investigation into our option-granting practices during the period December 1, 1995 through the present.  We are unable to predict with certainty what consequences may arise from the SEC investigation.   We have already incurred, and expect to continue to incur, significant legal expenses arising from the investigation. If the SEC institutes legal action, we could face significant fines and penalties and be required to take remedial actions determined by the SEC or a court. Although we have filed certain restated financial statements that we believe correct the accounting errors arising from our past option-granting practices, the filing of those financial statements did not resolve the pending SEC inquiry. The SEC has not indicated to us whether it has reviewed our restated financial statements, and any SEC review could lead to further restatements or other modifications of our financial statements.
On August 17, 2006, a derivative complaint styled Arkansas Teacher Retirement System, Derivatively on Behalf of Progress Software Corporation, v. Joseph Alsop et al, Civ. Act. No. 06-CA-11459 RCL was filed in the United States District Court for the District of Massachusetts by a party identifying itself as one of our shareholders purporting to act on our behalf against our directors and certain of our present and former officers. We were also named as a nominal defendant. The complaint alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly improper backdating of certain stock option grants. The complaint sought monetary damages, restitution, disgorgement, rescission of stock options, punitive damages and other relief.  A Special Litigation Committee was formed by our Board of Directors to investigate and determine the Company’s response to the complaint. On September 25, 2007, the Court, in response to our motion, dismissed the Arkansas Teacher Retirement System complaint on the grounds that the Plaintiff failed to make a proper pre-filing demand upon our Board of Directors, and entered judgment for Defendants.  Also on September 25, 2007, the Board received a demand from the Plaintiff regarding the allegedly improper backdating, which stated that absent Board action the Plaintiff may again seek relief. The Special Litigation Committee has taken the demand under advisement.
On January 16, 2007, another party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled Acuna, Derivatively on Behalf of Progress Software Corporation v. Joseph Alsop et al., Civ. Act. No. 07-0157 against our directors and certain of our present and former officers in Massachusetts Superior Court.  We are named as a nominal defendant in this action as well.  The complaint alleges breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly

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improper backdating of certain stock option grants.   The complaint seeks monetary damages and disgorgement, among other forms of relief. 
Further, on March 28, 2007, an additional party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled White, Derivatively on Behalf Of Nominal Defendant Progress v. Progress Software Corporation et al., Civ 07-01172, in Massachusetts Superior Court.  This complaint involves substantially the same defendants, allegations and demands for relief as the Acuna complaint described above.  On June 26, 2007, the White and Acuna cases were consolidated.  The consolidated case has been stayed while the Special Litigation Committee’s investigation is ongoing.
The ultimate outcome of any of these matters could have a material adverse effect on our results of operations.  These matters could divert the attention of our management and harm our business.  In addition, we have incurred, and expect to incur legal expenses arising from these matters, which may be significant, including the advancement of legal expenses to our directors and officers. We have certain indemnification obligations to our directors and officers, and the outcome of derivative or any other litigation may require that we indemnify some or all of our directors and officers for expenses they may incur in defending the litigation and other losses.
We are subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these other claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on our consolidated financial position or results of operations.
Off-Balance Sheet Arrangements
Our only significant off-balance sheet commitments relate to operating lease obligations. We have no “off-balance sheet arrangements” within the meaning of Item 303(a)(4) of Regulation S-K. Future annual minimum rental lease payments are detailed in Note 10 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended November 30, 2006.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with Statement 109 and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with early adoption permitted. We will adopt FIN 48 on December 1, 2007. We are currently evaluating the impact that the adoption of FIN 48 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands fair value measurement disclosures. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating whether adoption of SFAS 157 will have an impact on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur. The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007. SFAS 159 also allows an entity to early adopt the statement as of the beginning of an entity’s fiscal year that begins after the issuance of SFAS 159, provided that the entity also adopts the requirement of SFAS No. 157. We are currently evaluating whether adoption of SFAS 159 will have an impact on our consolidated financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to a variety of market risks, including changes in interest rates affecting the return on our investments and foreign currency fluctuations. We have established policies and procedures to manage our exposure to fluctuations in interest rates and foreign currency exchange rates.
Exposure to market risk for changes in interest rates relates to our investment portfolio. We have not used derivative financial instruments in our investment portfolio. We seek to place our investments with high-quality issuers and have policies limiting, among other things, the amount of credit exposure to any one issuer. We seek to limit default risk by purchasing only investment-grade securities. Our investments have an average remaining maturity of less than two years and are primarily fixed-rate instruments. In addition, we have classified all of our debt securities as available for sale. This classification reduces the income statement exposure to interest rate risk if such investments are held until their maturity date. Based on a hypothetical 10% adverse movement in interest rates, the potential losses in future earnings, fair value of risk-sensitive instruments and cash flows are immaterial.
We enter into foreign exchange option and forward contracts to hedge certain transactions of selected foreign currencies (mainly in Europe and Asia Pacific) against fluctuations in exchange rates. We have not entered into foreign exchange option and forward contracts for speculative or trading purposes. We recognize market value increases and decreases on the foreign exchange option and forward contracts in income each period. We operate in certain countries where there are limited forward currency exchange markets and thus we have unhedged transaction exposures in these currencies. There were approximately $111.1 million of outstanding foreign exchange option contracts at August 31, 2007. Major U.S. multinational banks are counterparties to the option contracts. We also hedge net intercompany balances. We generally do not hedge the net assets of our international subsidiaries. The foreign exchange exposure from a 10% movement of currency exchange rates would have a material impact on our revenue and net income. Based on a hypothetical 10% adverse movement in all foreign currency exchange rates, our revenue would be adversely affected by approximately 6% and our net income would be adversely affected by approximately 20% (excluding any offsetting positive impact from our ongoing hedging programs), although the actual effects may differ materially from the hypothetical analysis.
The table below details outstanding forward contracts, which mature in ninety days or less, at August 31, 2007 where the notional amount is determined using contract exchange rates:
(In thousands)
 
                         
    Exchange     Exchange     Notional  
    Foreign Currency     U.S. Dollars     Weighted  
    For U.S. Dollars     For Foreign Currency     Average  
Functional Currency:   (Notional Amount)     (Notional Amount)     Exchange Rate*  
 
Australian dollar
        $ 8,978       1.23  
Brazilian real
  $ 853             1.99  
Euro
          40,216       0.73  
Japanese yen
    3,991             115.27  
South African rand
    153             7.20  
U.K. pound
          31,816       0.50  
 
 
  $ 4,997     $ 81,010          
 
*   expressed as local currency unit per U.S. dollar
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our management, including the chief executive officer and the chief financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide a reasonable level of assurance that the information required to be disclosed in the reports filed or submitted by us under the Securities Exchange Act of 1934 was recorded, processed, summarized and reported within the requisite time periods.

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(b) Changes in internal control over financial reporting. No changes in our internal control over financial reporting occurred during the quarter ended August 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On June 23, 2006, we received written notice that the Enforcement Staff in the Boston, Massachusetts office of the SEC had begun an informal inquiry into our option-granting practices during the period December 1, 1995 through November 30, 2002.  On December 19, 2006, the SEC informed us that it had issued a formal order of investigation into our option-granting practices during the period December 1, 1995 through the present.  We are unable to predict with certainty what consequences may arise from the SEC investigation.   We have already incurred, and expect to continue to incur, significant legal expenses arising from the investigation. If the SEC institutes legal action, we could face significant fines and penalties and be required to take remedial actions determined by the SEC or a court. Although we have filed certain restated financial statements that we believe correct the accounting errors arising from our past option-granting practices, the filing of those financial statements did not resolve the pending SEC inquiry. The SEC has not indicated to us whether it has reviewed our restated financial statements, and any SEC review could lead to further restatements or other modifications of our financial statements.
On August 17, 2006, a derivative complaint styled Arkansas Teacher Retirement System, Derivatively on Behalf of Progress Software Corporation, v. Joseph Alsop et al, Civ. Act. No. 06-CA-11459 RCL was filed in the United States District Court for the District of Massachusetts by a party identifying itself as one of our shareholders purporting to act on our behalf against our directors and certain of our present and former officers. We were also named as a nominal defendant. The complaint alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly improper backdating of certain stock option grants. The complaint sought monetary damages, restitution, disgorgement, rescission of stock options, punitive damages and other relief.  A Special Litigation Committee was formed by our Board of Directors to investigate and determine the Company’s response to the complaint. On September 25, 2007, the Court, in response to our motion, dismissed the Arkansas Teacher Retirement System complaint on the grounds that the Plaintiff failed to make a proper pre-filing demand upon our Board of Directors, and entered judgment for Defendants.  Also on September 25, 2007, the Board received a demand from the Plaintiff regarding the allegedly improper backdating, which stated that absent Board action the Plaintiff may again seek relief. The Special Litigation Committee has taken the demand under advisement.
On January 16, 2007, another party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled Acuna, Derivatively on Behalf of Progress Software Corporation v. Joseph Alsop et al., Civ. Act. No. 07-0157 against our directors and certain of our present and former officers in Massachusetts Superior Court.  We are named as a nominal defendant in this action as well.  The complaint alleges breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty and unjust enrichment arising from the allegedly improper backdating of certain stock option grants.   The complaint seeks monetary damages and disgorgement, among other forms of relief. 
Further, on March 28, 2007, an additional party identifying itself as one of our shareholders purporting to act on our behalf filed a derivative complaint styled White, Derivatively on Behalf Of Nominal Defendant Progress v. Progress Software Corporation et al., Civ 07-01172, in Massachusetts Superior Court.  This complaint involves substantially the same defendants, allegations and demands for relief as the Acuna complaint described above.  On June 26, 2007, the White and Acuna cases were consolidated.  The consolidated case has been stayed while the Special Litigation Committee’s investigation is ongoing.
The ultimate outcome of any of these matters could have a material adverse effect on our results of operations.  These matters could divert the attention of our management and harm our business.  In addition, we have incurred, and expect to incur legal expenses arising from these matters, which may be significant, including the advancement of legal expenses to our directors and officers. We have certain indemnification obligations to our directors and

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officers, and the outcome of derivative or any other litigation may require that we indemnify some or all of our directors and officers for expenses they may incur in defending the litigation and other losses.
We are subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these other claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on our consolidated financial position or results of operations.
Item 1A. Risk Factors
We operate in a rapidly changing environment that involves certain risks and uncertainties, some of which are beyond our control. You should carefully review and consider the information regarding certain factors that could materially affect our business, financial condition or future results set forth under Part II, Item 1A (Risk Factors) in our Quarterly Report on Form 10Q for the period ending February 28, 2007. No material changes have occurred since the period ending February 28, 2007 to the risk factors previously presented, although we may disclose changes to such factors or disclose additional factors from time to time in our future filings with the SEC.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Items 2(a) and 2(b) are not applicable.
(c) Stock Repurchases
(In thousands, except per share data)
 
                                 
                    Total Number of     Maximum Number of  
                    Shares Purchased     Shares That May  
    Total Number     Average     As Part of Publicly     Yet Be Purchased  
    Of Shares     Price Paid     Announced Plans     Under the Plans or  
Period:   Purchased     Per Share     Or Programs     Programs (1)  
 
June 1, 2007 – June 30, 2007
                      9,295  
July 1, 2007 – July 31, 2007
                      9,295  
Aug. 1, 2007 – Aug. 31, 2007
                      9,295  
     
Total
                      9,295  
 
(1)   The maximum number of shares that may yet be purchased listed in the table above relates to our repurchase program which expired on September 30, 2007. In September 2007, the Board of Directors authorized, for the period from October 1, 2007 through September 30, 2008, the purchase of up to 10,000,000 shares of our common stock.

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Item 6. Exhibits
The following exhibits are filed or furnished as part of this quarterly report on Form 10-Q:
     
Exhibit No.   Description
   
 
31.1  
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act – Joseph W. Alsop
   
 
31.2  
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act – Norman R. Robertson
   
 
32.1  
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PROGRESS SOFTWARE CORPORATION
(Registrant)
         
Dated: October 10, 2007
  /s/ Joseph W. Alsop
 
Joseph W. Alsop
   
 
  Chief Executive Officer    
 
  (Principal Executive Officer)    
 
       
Dated: October 10, 2007
  /s/ Norman R. Robertson    
 
       
 
  Norman R. Robertson    
 
  Senior Vice President, Finance and    
 
  Administration and Chief Financial    
 
  Officer (Principal Financial    
 
  Officer)    
 
       
Dated: October 10, 2007
  /s/ David H. Benton, Jr.    
 
       
 
  David H. Benton, Jr.    
 
  Vice President and Corporate Controller    
 
  (Principal Accounting Officer)    

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