SSH Communications Security Oyj

OMXH:SSH1V

Earnings Call Transcript 2022-Q3

[Lauri Koponen;Communications Manager, executive]

So dear shareholders, investors, customers and media, welcome to our investor call SSH Communications Security's Business Review Q3 2022 results. The meeting will accordingly reconcile with the presentation will be available after the call.

My name is Lauri Koponen, I'm the Communication Manager here at SSH Communications and it will be presented by our CFO, Niklas Nordstrom; and CEO, Teemu Tunkelo. You can ask questions at the end of the event by raising hand or asking to speak or just writing in the chat your question and I will read out loud and we have still peoples joining us, welcome, welcome, dear guests. [Operator Instructions]

And let's start with the financial results, President and CFO, Niklas Nordstrom. So, Niklas, the floor is yours.

[Niklas Nordstrom, executive]

Thanks, Lauri. Jumping right into the first slide, you can go ahead, click, thanks. We are pleased to report good progress in the company in Q3, during which we grew 17% versus the comparison period. And we recorded a third consecutive quarter-on-quarter in a row, even though Q3 particularly didn't include new significant well size cost wins. Q4 is typically our strongest quarter and we'll, of course, focus on subscription sales, which is stable and more predictable revenue long-term.

During Q3, we controlled our costs in a very tough inflatory economy and we recorded a EUR 0.4 million positive EBITDA and now that we have started the commercial phase of NQX, we are recording the hardware component as cost of goods sold upon delivery. And this cost reflected to our EBITDA by approximately EUR 0.2 million. So that explains why our EBITDA was slightly below the comparison period in the previous 2 quarters. However, as you can see from the personnel line item on the slide, we have been able to increase our headcount and still maintain a relatively good EBITDA margin, while at the same time, attract critical part management sales, customer service and R&D talent in a very competitive market.

One more highlight to raise, our recurring revenue ARR reached EUR 17.6 million in September, growing 21% to the comparison period and our subscription ARR respectively was EUR 9.2 million, growing handsome 46% versus the comparison period. This growth was driven mainly by PrivX, the large EUR 2.1 million NQX order received in June was completed only during the last days of the quarter. So its revenue recognition impact was very small. We are pleased about this positive development in these numbers and they're of course fully organic numbers.

To highlight this, we have been successful in transitioning a number of our customers into the subscription model through the introduction of innovative additions and future-proof technologies to our portfolio and this can be seen in that our subscription revenue actually surpassed our maintenance revenue in Q3 and the reported ARR development backs that up.

Then a word on our liquid assets. As you can see from the history, our business is cyclical in terms of how our cash generation is distributed during the accounting period. And this time around, we experienced a couple of days delay in a larger payment, which resulted in the fact that this money, which is now received will be part of Q4 figures, which as I said we expect to be strong as the majority of our renewals along with the EUR 2.1 million cash from the NQX delivery will all hit Q4. I think that about covers this slide.

Moving on to the next slide, if you click also, thanks. Revenue grew across all of our regions, with EMEA being in the driver's seat. EMEA growth was driven by almost 30% increase in maintenance revenues, as well as subscription revenues. So both grew close to 30%. Like in the previous quarter, we did get some support from the strong dollar, but on a group level, this is in a single digit percentage territory for year-to-date. And the effect of the FX rates on our group figures is, of course, mitigated by strong performance in EMEA and the euros increasing relative weight in our currency mix.

Final word from the CFO, as some of you might have noticed, I'm moving towards new challenges in my career around the end of the year and this will be my final quarterly release and investor call at SSH. Therefore, I'd also like to take this opportunity to thank all of you, my investors, analysts for the past years. I think I'm leaving the company in my areas of responsibility in a good shape and the company is well positioned for continued growth. Thanks.

[Lauri Koponen;Communications Manager, executive]

Thank you, Niklas very, very much and thank you also for the numbers and let's move on to the effects behind the numbers. So our CEO, Teemu Tunkelo, you can start.

[Teemu Tunkelo, executive]

Thank you. I first want to thank Niklas for the almost 3 years of cooperation and it has been great and I wish you all the good for the future. So if we go back to the things behind the numbers, we again in Europe have been recognized as a leader not only by the industry analyst, but also by single customers, which are showing growth. And I think we are on a good path. The challenge for us is, we have increased the average size of our customers which means that in our current size, one customer coming in will -- with such future bottom growth will impact the next year, not this year. And if it comes in 2 weeks late, it impacts the last quarter and so I would -- I personally look at more 6 months running average than what actually happens in the last quarter, so that's just my own opinion. And we are in with partner more on the U.S. market now to also lead same position in their recommendation at the moment, we are a clear leader with our technology in the European market and that is also reflected in our numbers that customers better commitment from our customers are coming because our technology is solid.

What has happened during the summer and the latest month is that the competition has started to follow the investments and marketing relative quantum computing, quantum key exchange, post quantum computing. And it is still early stages to see the commercial results that our strategy with Zero Trust and now with Quantum Safe being other action. And I would say at the moment, we are getting into the professional services with quantum computing, post quantum computing and it will be repeat later in our numbers.

So if you take the technology keys, we started with SSH key, first digital keys that were permanent. Like in the hotel, when I was young, you actually got the physical key, now you get the key curve. Then when Internet came instead of digital keys, we started to put certificates, which have a life time nowadays only 825 days, so almost 3 years, so it's also very static. What we have done as our big invent in R&D has been PrivX and PrivX your keys add only 5 minutes, like in a key card, you have a central place in your reception we can switch of the key when it's not needed anymore. And the post quantum phase is coming with major investments in it. We are, I think one of the 2 leaders in Europe on quantum cryptography and on things doing quantum phase solutions without separate hardware elements, we do it completely by software where I think we are a world leader.

So we are Zero Trust, which means no keys, no passwords and we have an evolution pass for our customers then they want both quantum safe it's easy with us without any major changes. And that is highly respected by our customers because we do have a long history that we are proven in use with our software solutions and we are also very much hunger on being future-proof, Zero Trust quantum safe and also with all the helping factories, harvest, airports to protect themselves because critical infrastructure, especially with taking into account the geopolitical situation in Europe, healthy people, for factory people, critical infrastructure people are getting more aware of the things that banks and governments have been aware for years.

So we have the 2 technologies Zero Trust and Quantum Safe and we have a complete new market operational technologies, which is making good ground for what Niklas said, he is leaving the company in a good shape. We have a very solid base to grow because of the transition to subscription model and because of the key 3 elements of our strategy, Zero Trust, Quantum Safe and operational technologies.

We also want to more communicate about what we are because we have a challenge that our customers are not really excited to tell what we do for them. So we want to more clarify what we do and I want to focus on the guiding principles that we are using in the company. We want to be closer to our customers. We want to understand their issues and we want to help them to increase their safety in what we call defensive cybersecurity.

Very many people associate cybersecurity with hackers, which is a kind of a negative tone. We don't do hacking, we do the opposite, we defend and that's coming more and more important, people say, there we have internal threats, we have external threats, but what is important for us that we are safe. So we made digital fencings, we made digital gates, we follow who goes through the gates and when they come out and we provide that information to our customers.

Of course, from a more selfish side, we want to drive our profitable growth to a new level and withheld of the subscription and recurring revenue because we are a people business. We are really on a good track. We still have a challenge of single big orders, but at least people because people are our biggest assets, they get paid monthly. We need to get paid monthly by our customers, so we can keep though P&L in order. And we want to be better in the market to provide what the customers need when they need it at an optimal cost. And this is basically the driving force of how we implement defensive cybersecurity for our customers, with our customers in a changing world with future product solutions.

Our outlook remains the same. We do believe the market is favorable, we do believe we gain a strong base and we are continuing to invest in our R&D, which is our people are the biggest asset. And still we want to maintain the EBITDA and cash flow positive in our business. And I think at the moment, we are very well positioned to reach the target.

So moving forward, Zero Trust is a reality, it's making business for us, is coming to all our product lines where the PrivX is leading the game, being more and more the platform for our own products with older products. So we don't have to recreate new products. We use PrivX as a platform to make Tectia, NQX, UKM to be Zero Trust, so password less, keyless to defend our customers environment. I already mentioned the operational technology that for us, we have always been strongest in financial market. So banking and insurance, now the OT technology factories and harbors are coming up. And there we have a bigger and bigger role in our professional services to help them to understand what banking and governance have understood over the last 20, 30 years.

And looking forward, last but not least, is the Quantum Safe solutions that we have started to develop already years ago. We have created a strong team to understand the technology, working with key partners, universities, [ European ] to be the first one that actually we already have created 2 products that are Quantum Safe and we are helping our customers understand when and what they have to do with quantum safe.

Niklas was meeting one of our customers, I think probably a year ago and they told us that we don't know if Quantum compute has ever come, but we have to be prepared for it. And that trend is growing, so Zero Trust is here. OP is expanding and quantum computing has created a lot of market interest from the customers and we are helping customers to understand what does quantum computing and especially key exchange line encryption, what does it mean for them? And what is the optimal implementation schedule for them to come to quantum edge.

So with these comments from my side and Niklas comments on the numbers side, I would like to hand it back to Lauri that we can open the Q&A session.

[Lauri Koponen;Communications Manager, executive]

Yes. Thank you, Teemu. [Operator Instructions] And here is first question, Forbes, you can start.

[Forbes Goldman, analyst]

So I noticed subscription ARR grew by about EUR 1.3 million compared to the last quarter Q2 2022. Could you explain where this -- where you're seeing this growth? And also if the ARR from the EUR 2.1 million order that you received that you delivered now at the end of Q3, if that's in there as well? Thank you very much. First thing, especially the topic on the timing of the big orders and how do they reflect to our numbers now?

[Lauri Koponen;Communications Manager, executive]

Yes, Niklas, if you can start.

[Niklas Nordstrom, executive]

Yes, I'll comment that the subscription ARR growth is driven at this moment in majority by PrivX and the EUR 2.1 million NQX order is in the figures, but with a negligible revenue recognition impact. So when we deliver NQX, we can start revenue recognition only upon delivery of also the hardware component. And so that determines sort of in license business, typical revenue recognition pattern is that immediately when the PO comes, we release the license and we can record as revenue. But here since there is a hardware component, it's dependent on the actual physical delivery. And these deliveries or the majority of these deliveries happened at the end of the quarter. So there is some revenue, but the majority of the impact will hit Q4.

[Teemu Tunkelo, executive]

And that is a new thing, at least compared to what I learned when I did my PhD in economics, but is that nowadays with subscription business, the cash flow is separated from revenue. So we might get a lot of cash from the customers, but we have to live with that money for a long time because we are a people business, we pay people every month. So we also recognize the revenue over time, which means it makes our number smoother and we have to manage the business both by the traditional EBIT and all intake and by the cash flow because we get the cash at a certain time of the year and we have to live with the whole year with that money. So the traditional way to read P&L doesn't really apply now that we have transitioned to dominantly subscription business.

[Lauri Koponen;Communications Manager, executive]

Okay. Do you have more questions, Forbes?

[Forbes Goldman, analyst]

Yes, I have a couple and could we -- so I mean you report the subscription ARR, but going into the product to understand better how much of that comes from PrivX, NQX and Deltagon and so on, is that something you can share or what can you say about this?

[Teemu Tunkelo, executive]

Well, we don't share single product line numbers. What we can say that on a percentage growth, NQX is the winner because the base is old. I think I'd like to use the term that PrivX is now moving the needle. Earlier, PrivX was like NQX, so it was growing well, but it didn't impact the numbers. Now PrivX is our primary growth engine, NQX grows faster in percentage, but it still has time before it can catch the PrivX numbers.

With the post quantum computing, we can see that Tectia, which is our flagship product, the stability on profitable product line is getting revival because we want to move from static keys to Zero Trust keys, they want to move from Zero Trust keys partially to quantum over time. So we have a lot of growth there. Deltagon continues to grow. It's a different business that the average deal size is much smaller, so that makes it is more stable and it's our second biggest product line.

UKM is still -- is the one where we do most perpetual deals and those deals are typically 200,000 up to EUR 1 million or even EUR 2 million. So in our size, UKM is the one that shakes our numbers. So we are reviving Tectia, we are continuing to stay for positive development with Deltagon. PrivX and NQX will be driving the growth and UKM will be the one that until we are 2, 3 times better than today, UKM will shape the quarter in others.

[Lauri Koponen;Communications Manager, executive]

Thank you, Teemu. And we have couple of questions in the chat, so I will read them out loud. And first question or sorry Forbes, do you have any more questions?

[Forbes Goldman, analyst]

I have 2 more. I can -- so I can read them out loud both.

[Lauri Koponen;Communications Manager, executive]

Yes.

[Forbes Goldman, analyst]

So the first one is, has anything changed in your favor since NQX received this TL III level security certification. So that's the first. And the second is, what is your outlook for license sales because you received a very big license sale in Q4 2021, but since then it's been quite soft. So is there anything you can tell us about that? And that will be all from me. Thanks.

[Teemu Tunkelo, executive]

Well, I think on the latter side, we are working very hard on closing major license deals during the end of the year or early next year. So I still believe that our long-term average should be 20% license, 80% transcription, now we are at the moment, I think over 90% on subscription. So the big whales we might have on the hook, but they are not in the bulk. And the first question, maybe, Nik, you could lit.

[Niklas Nordstrom, executive]

Which one?

[Forbes Goldman, analyst]

The one about NQX and what has changed in your favor since the certifications.

[Niklas Nordstrom, executive]

Receiving the certification was a real requisite for getting those orders in. So as soon as we receive the certification, it was in the books, we received -- was 3 major orders, one of which exceeded the notification threshold, so the EUR 2.1 million order.

[Teemu Tunkelo, executive]

And we are in very early phases, so if you think that we base it we had half a year ago, one customer. Now we have in the books, Niklas, 5 or 6 customers?

[Niklas Nordstrom, executive]

6.

[Teemu Tunkelo, executive]

So that's 6 times more than half a year ago. So I think we have a good track and we have a lot of discussions ongoing, but before the fat lady thinks, they are not in the books.

[Niklas Nordstrom, executive]

Yes, we have 3 for example, foreign governmental customers who are sort of circling around NQX are very interested, we have demoed the product to them. So it's not just the Finnish securities critical customers who are interested in or can use this product. So it's a good position.

[Lauri Koponen;Communications Manager, executive]

Perfect. So next we have question, the NQX delivery is fully in ARR, but only a slight amount is Q3 top line, is this correct?

[Niklas Nordstrom, executive]

Incorrect. So the ARR is calculated by multiplying the last month of the quarter, the revenue recorded during the last month of the quarter multiplied by 12. So if there is a slight amount of revenue that is fully reflected in the ARR. So during Q4, when we report these figures, it would be in full, but not yet in Q3.

[Lauri Koponen;Communications Manager, executive]

Thank you. And next question, what happens with share or share options when he leaves the company?

[Teemu Tunkelo, executive]

Well, Niklas, you can correct me, but in principle domestic options will remain, but he has the right to execute the options, the unvested options will return to the company.

[Niklas Nordstrom, executive]

That's correct.

[Lauri Koponen;Communications Manager, executive]

Thank you. Then we have more questions and please write your questions in the chat or raise the hand if you have something to ask. So how many new customers did you get in Q2 and Q3? These numbers were released in Q4 and Q1, but seems to be missing for the last 2 quarters.

[Teemu Tunkelo, executive]

Yes, it's a little bit of our technicality reporting problem because we have reduced the number of customers we deal directly. We move them to partners. We are reducing the number of partner. So when we told the customers where we have a bill to address, that number actually has reduced because we sell through the partners. And we are still working on getting the reporting right that if we sell to a big telecom operator in Finland, they might have a lot of customers, but for us, it's one customer.

And many of these partners don't want to disclose to us the end customer. So we have kind of through our partnering strategy, we have lost the visibility of how many real bill to customers we would have if we would sell directly. And also with the number of private customers for us, we are constantly focusing on increasing the customer size that we deal directly. So we want -- we have moved and we are moving smaller customers to our partners.

So I haven't yet found a way to report in a way that would make sense that what does it mean, how many customers do we have? And if I take it in scale, the most customers we have with Tectia and then with Deltagon. And then PrivX third biggest one having customers directly all through partners, UKM plus and NQX asset fixed.

So giving a meaningful number is still something we are working on. Q4 last year, we were still working very much on the direct sales model and then it was easy to report how many bill to customers we have and now we have to find a meaningful way of reporting it in the future.

[Lauri Koponen;Communications Manager, executive]

Thank you, Teemu and please, we have still time for questions, I see there is yes. Just basic comment, good luck Niklas in the next challenges, have enjoyed these reviews. Thank you. Anymore questions? We'll wait 10 seconds if somebody wants to ask some. So I think at this point, we don't have any more questions. Thank you once more dear guests. Thank you, Niklas. Thank you, Teemu.

Materials for this call will be available on our web page later this day. We have a lot of different content, webinars, events and workshops now ongoing. So please visit our website, follow us, especially on LinkedIn, Twitter also, but LinkedIn is our main channel and join our events. SSH Communications Security will release its financial reporting calendar for 2023 during the quarter 4 in November. So please stay tuned. My name is Lauri Koponen, I'm Communication Manager here at SSH. I thank you and please have a good day. Bye.

[Teemu Tunkelo, executive]

Thank you.