Clavister Holding AB

STO:CLAV

Earnings Call Transcript 2020-Q1

[Sam Coleman, Director of Marketing & Corporate Communications]

Hello, everybody. Welcome. Thank you for joining us this morning for this Clavister Interim Report Q1 2020. John Vestberg is here and will be showing you this, but I'll take you through the first part of this just to make sure everybody gets online okay.Next, John?

[John Vestberg, Co]

Thank you, Sam.

[Sam Coleman, Director of Marketing & Corporate Communications]

Take it away.

[John Vestberg, Co]

Absolutely. Thank you, Sam. So good morning, everyone. This is John Vestberg, Co-Founder, CEO and President of Clavister. Obviously, these are peculiar times. Everyone presenting and working from home these days, and Clavister is no exception to that rule, obviously.So we're here today to present the first interim report for 2020. But before we dig into the actual numbers and the results of the quarter, I would like to take a few minutes just to reflect or share our reflections on the current COVID-19 pandemic and how that affects the cybersecurity industry or potentially affects the cybersecurity industry.We have been conducting a number of research activities over the past month to really try to understand how will this industry be impacted and what more -- what can we as a supplier do to support the community in these times. One of the research data we've been looking at comes from a global analyst called GlobalData. They've been mapping out the potential impact of the COVID-19 pandemic on the technology sectors. And as you can see in this graph -- or chart, there are a number of industries which are obviously being forecasted to be heavily impacted, some as much as 60% negative impact.Software and security-related network, security-related industries in general are actually forecasted to be nominal impacted or definitely no impact at all. This is obviously good news for Clavister, and we're seeing similar type of data coming from other research as well. What we've been anticipating is that there are sort of 3 timestamps on this. One is the immediate timestamp where we see a -- actually a spike, a short -- or a slight increase of demand on security products and security services. I'll get back to that in a while. We see a long-term effect or we anticipate a long-term effect where the entire community will be used to work in new ways when this is over and that, in our opinion, will absolutely drive demand for secure locations, secure identities and basically, all matters of security.If we look at the impact from a pure cybersecurity standpoint, it's quite some amazing numbers we've been seeing over the past month. So just over the past few weeks, we've seen a 600% increase of cyber threats. The traditional cyberattacks attacking the infrastructure and attacking the data centers and so forth, they are, of course, still there. But what has happened really is that when people have started moving their remote working platforms to home, there is a completely new attack vector that can be exploited. And that's obviously the home infrastructure, the IoT infrastructure and everything that is related to that. So a massive increase on threats, massive increase of phishing attacks and obviously, a lot of ransom there happening as part of this.As everyone knows, obviously, remote working is key right now, so we see a strong uptake in various types of applications, remote office, remote working applications and tools. And this obviously drives not only usage on the actual tools, but more important, for Clavister, it drives network load. So basically, the statistics we've been seeing is that in capacities like SD-WAN, secure -- software-defined wide-area networking, for remote working and remote infrastructures, it's actually a 700% increase of load. That's obviously amazing. And it -- as a consequence, it require that companies and organizations do additional investments, complementary investments into infrastructure products and network equipment and, obviously, security products.If we then jump right ahead and into our first quarter of highlights, a very good quarter all in all. All our key metrics are showing significant improvements. As a note on metrics, we are, from this quarter and onwards, moving towards a more industry-normalized type of reporting in terms of metrics. The reason is that in 2018, Clavister were doing a massive transformation from a pre-IFRS world to an IFRS implementation of all our metrics and all our accounting. As a consequence of that, our reporting initially was not possible to compare with previous years, unless we implemented additional alternative metrics, which we did back then, order intake, invoice sales and a number of others. Now as 2 years have passed, we are past those -- the major effects of those implementations, which means that now, we can start using in a more traditional way key metrics that are relevant to the industry and comparable and benchmarkable against the industry as well. So what you see in our report, our new report format, is a slightly different way of presenting, other types of metrics, which you will also find on -- at our peers' reports, which is obviously a perfect situation to be able to compare.In this quarter at a glance, what we saw, and I alluded to that already in the introduction, that we've seen an increased demand across the board on our solutions. And we've taken a number of important steps as well in developing our larger business opportunities even further. We are, of course, continuously monitoring the corona situation, and I'll come back to that in a while as well.On some financial highlights, strong revenue growth. I'll come back to that as well in a second. We've seen the metrics in terms of gross margins and operational margins improve quite good in the quarter. We have introduced an alternative metric called Contract Retention Rate, and this is particularly interesting and important for a software-dominated company like Clavister. A metric like this explains or illustrates how many of the existing commercial contracts that Clavister has entered into with clients are still in place after the end of the period. So it's a typical classical retention rate number, and we apply it on the contracts that we have. And as everyone is familiar with, obviously, having a solid base of recurring contracts with fairly or relatively low sales cost and relatively high accuracy and predictability, that's a strong foundation for any software company. So all in all, good metrics. And as a consequence of those metrics, also a good cash flow in the period.Looking at revenue. So what we can note obviously here is 2 things. First of all, that we now, again, because of the IFRS impact behind us to the greatest part, we can now start using revenue as a top line key metric indicator, which obviously is much easier to comprehend. If we see this graph here, we see the rolling 12 months of revenues since 2018, with Q1 being quite a good spike. So we were able to grow our revenues in the quarter with 25%. And actually, the underlying growth was even higher than that, 29%, if we adjust for the Chinese operations, which we divested last year. So we had some revenue obviously coming from China in Q1 2019, which we do not have in 2020. So all in all, SEK 33.2 million of revenues for the quarter.And the other thing which is important to highlight, and we have been not so transparent on this metric before, but from this report, we will also explain better what we have on our balance sheet in terms of so-called deferred revenue. And basically, this is the revenue that we collect from the prepaid contracts where the revenue gets recognizable over the longer contract term. And on our balance sheet per 31st of March, we had deferred revenue amounting to SEK 52 million, which is a strong increase. This is obviously a balanced item that will be distributed and will be visible as a recognized revenue over the periods to come, in addition to the new sales we're doing. And as well, all our markets, Nordics as well as Germany as well as our global key accounts and obviously, rest of world, all of them contributed with growth in this quarter.If we then look at how our revenues are distributed by type. This is an important metric as well, again, from a software company perspective where we obviously have an ambition to drive as much recurring revenue as possible. And as you can see in this pie chart, our recurring revenue for the quarter amounted to more than 50% of our total revenues, which is good. We have an ambition to drive this even higher going forward. And the growth of those recurring revenues was actually 27% in the period, so a good growth also in numbers. But as part of the total, it's still about 50%. Some 25% comes from our product and perpetual license revenues. That's basically -- let's refer to it as one-off sales, basically selling a product, a perpetual license and perpetual licenses or licenses that are evergreen. They do not require an additional contract renewal per se. That's a slightly smaller part of our business but still an important part.And then the third part, representing the final water of the revenues or the final flow of the revenues, that's our professional services and others. In others, we include training and other one-off items. Professional services is for newcomers to Clavister, our consultancy brands where our consultants support our clients, our partners with implementation and integration activities and support.If we then move ahead to the next metric, we then look at our gross margins and gross profit for the quarter. Also in this graph, we can see the development since a number of years back. We had communicated earlier, in earlier years, a target gross margin of plus 70%. And as you can see, we were above that over the period. In the past, I would say past quarters, we've made a number of structural changes to the way we use third-party technology licenses and third-party components in general. And that has resulted in quite a strong uptake or uplift of our gross margins. And we saw that in this quarter specifically, where we increased our gross margins to over 85%, and this is an increase from 79% or 80% same period last year. And this increase relates mainly to the fact that we've been able to lower our third-party costs for technology licenses and some of the hardware appliances that we source. The fact that we divested our Chinese operations have contributed to this increase in gross margin. It was a lower gross margin operations in China. And as an underlying reason, and this is true for all quarters as well going forward, the product mix can, of course, have a substantial impact.But given these changes or these improvements, we have as well been able to lift our target or raise our targets. So from this quarter onwards, our assumption -- our planning assumption is based on gross margins in excess of 80%.This takes us to gross profit. And also here, we saw a strong increase, combination, obviously, of better top line and better gross margins. So SEK 28.3 million for the quarter, that's an increase of 33% year-on-year.Then looking then at the more number crunching slide, the key financial metrics. We spoke about revenue gross profit and gross margin already. All this takes us down to our operating profit before depreciations, and that's our EBITDA metric. That was improved in the quarter from minus SEK 8.6 million last year to minus SEK 5.8 million this year. A comment to that as well is that, obviously, the EBITDA metric, EBITDA result is improved by the stronger gross profit, that's clear. We had operating expenses in the quarter which was slightly reduced compared to last year, so a bit less operating expenses. As you might recall, we did some structural changes during 2019, one included the divestment of our Chinese operations, another one included a closedown of one of our R&D sites, or our R&D site in EMEA. As a consequence of these changes, we have been able to invest further in sales and marketing capacity, which we obviously require and need to drive further growth. But we have been able to do this within the boundaries of our total operating expenses.So for the full year of 2020, despite the fact that we have increased our sales and marketing platform, we are targeting to still be within the same operating expenses as last year, maybe even slightly reduced. Now as a consequence, again, of our closedown of an R&D site, where from a financial point of view -- or accounting point of view, rather, we are -- we were activating or capitalizing a good part of those development costs. Obviously, this has, from an accounting perspective, a negative impact on our EBITDA result for the quarter and for the full year, but that's from an accounting perspective. And you see more detail on this in our actual report as well.Same thing happens, obviously, on the EBIT line. We are doing higher levels of depreciations, specifically from our capitalized development expenses. So basically, we are capitalizing less, and we are depreciating and amortizing more of those. So you will see from an accounting, again, point of view that the EBIT line is not gaining as much momentum as the other metrics, but again, that comes from high depreciations and basically getting a better balance in our balance sheet. The result of the financial items, I will come back to that in a very short while.Looking at our operational cash flow, obviously, a very strong improvement on cash flow -- operational cash flow in the quarter. That improvement from minus SEK 12 million last year to plus SEK 11 million this year comes mainly from both, of course, the improved operational result, that's one parameter in it; secondly, from quite favorable movements of working capital. So we had strong invoicing in Q4 last year. We had a lot of customer projects or significant, I would say, customer projects over the course of 2019 that could be finalized and receiving customer payments in this quarter. All in all, that takes us to a cash position at the end of the period being SEK 69 million, which is a bit stronger than the same period last year, where it was SEK 54.1 million.An additional note on the financial items because as you can see, the result after financial items are more than SEK 10 million worse than the previous -- than the same quarter previous year despite the fact that all the top line and operational metrics are in the right direction. Now what you see in this extended table here is a breakdown on the financial items, financial income and expenses, and we'd like to point out a few important items among those. The biggest item for the quarter is actually currency revaluations of the long-term liabilities that we have at hand, specifically the one with the European Investment Bank, which is a euro loan. And obviously, given the euro-SEK exchange rates developments over the past period, this has a revaluation effect on the company with minus SEK 30 million. This is obviously a nonrealized effect. So it's noncash, it's accounting purely. If we just make a recollection of last year, we had less than SEK 1 million in full year 2019 as an effect of that.We have another -- other item which is related, again, to our long-term liabilities, and that's the IFRS 2 impact, so-called amortization of warrant costs. Basically, as we are -- part of our long-term liabilities providing warrants, downside protection warrants to the lender, this comes with an accounting cost in terms of an IFRS 2 expense. Again, this is noncash.The final larger component in this, that's our interest and leasing costs. The interest costs in this case, again, relates to long-term liabilities. They are so-called PIK payments, pay-in-kind payments, that will happen after the loans have mature, which is a number of years away from now. However, we, of course, need to record the costs associated for them during the period. Again, those are noncash costs. So that takes us to a total financial income and expense of actually minus SEK 22 million. Quite a substantial amount, but out of those -- out of that amount, only SEK 0.1 million has a cash impact for the company. We know from previous discussions and reports that this item has caused a lot of confusion and a lot of questions to us, so this is the reason why we would like to take the opportunity to be more transparent on that one.Moving ahead to some outlook and planning assumptions going forward. So if we start at looking at the market, we have a number of market segments that we are addressing as the Clavister product portfolio. One is the traditional network security equipment of firewall products and similar type of products. That market has an anticipated growth of close to 8% for this current year. The identity and access management product family has a predicted slightly stronger growth potential with over 10%. And the cloud security market really stands out in this perspective with close to 45% growth. We, again, are addressing all of these 3. Our traditional products are -- if you call it, our historical data comes basically from the network security equipment market, but the 2 others are fairly recent and absolutely growing for us.If we then look at our planning assumptions and our outlook. So we have established a midterm ambition. Keep in mind again that we do not give guidance and concrete forecast, but we do give some planning assumptions and some outlook. So our ambition for the midterm is to come into a profitable growth situation where we have a sustainable breakeven level. What this means is basically that we are in a position where we'd like to harvest as much market share as possible. It's a growing market, and we are still compared with the big incumbents on the market. We are an underdog that takes and grabs more market share. And obviously, we'd like to continue this journey. So any growth, any -- rather, any profit we bring to the table will, to the largest extent, in the midterm, be reinvested in additional growth and additional sales capacity and additional top line.We are basing this outlook on a number of assumptions. There are some assumptions related to revenue and gross margin. So we anticipate, obviously, an increased revenue growth in this year versus last year. We see a quite normal seasonality in this year as well, with quarter 4 always being the strongest quarter. That has been the case historically as well, and we don't see any exception to that rule this year. We see that the second half of the year will have a higher growth than the first half of the year, and this is mainly due to how our customers have planned their product rollouts and their network deployments.As indicated earlier, we anticipate an 80%-plus gross margin. There might be variations over the quarters due to product mix, but the other changes we made, they are sustainable, so this is a level we should be able to meet. Of course, we are also assuming for the time being that we have a close to 0 or a very limited at least impact by the COVID-19 pandemic. Again, in the first quarter, we even saw a slight improvement, a slight increased demand for our products, and we obviously hope that this will be sustained as well.On the operating expenses side, I mentioned already that we anticipate to see the same levels in 2020 as for 2019, maybe even slightly reduced. I've already alluded to that because of our shift from R&D expenses into sales and marketing expenses that also entails a reduced capitalized development expense for the year, and we estimate that impact to be approximately SEK 10 million for the full year.As a conclusion of all those assumptions, those will lead to in our outlook and considerable improvement of all the operational metrics, the EBITDA, the EBIT and, of course, our operational cash flow. We specifically excluded the net profit here. Of course, net profit will be derived as well. But as you saw in the previous slide, we have financial items that, again, are noncash, but they have a substantial impact on the absolute bottom line.To round off, we stick to our growth study. And I think what you've seen in this quarter is that the strategy is absolutely deeming a good business fundamentals right now. We are scaling this business further, and we do this by continuing to make our sales and marketing structure. Regardless if it's our internal sales resources or our partner network, we make them more productive, more efficient by supporting them with additional product marketing and go-to-market enablement tools. And of course, as we go, we are also scaling that business with additional head count, additional partners, stronger partners across the board and over time, of course, even more geographies, even though we have a focused operations to fewer geographies this year.We are speaking to our combination of a 2-tiered channel model, which is a quite traditional distribution and reserve model. That gives us a foundation of good, recurring, quite predictable business. We're combining that with a technology licensing sales, a global key account type of sales, which has a higher growth potential but comes with longer lead times and because of that, a slightly increasing risk as well. But combining those 2 gives us the best of 2 worlds.We will, of course, continue to drive efficiency improvements across the board, so that entails continuous strict cost control, improvement of margins additionally, and as you can see in this quarter, that also has a good impact on our operating cash flow. All in all, this together is absolutely helping us to strive for our long-term company objective, which is to become the leading European cybersecurity expert.So with that, I'm thanking you and handing over now to Sam for opening up the Q&A session.

[Sam Coleman, Director of Marketing & Corporate Communications]

Perfect, John. Very nice report. Congratulations. Actually, we have a live question that we're going to do from one of our participants in one second. We'll have that. And I'm going to unmute [ Eric ].

[Sam Coleman, Director of Marketing & Corporate Communications]

Okay, [ Eric ], you're unmuted now. Go ahead and ask your question that you wanted to ask.

[Unknown Analyst]

Can you hear me, John?

[John Vestberg, Co]

Yes, [ Eric ].

[Unknown Analyst]

So I just had one question on the second line item in the P&L, other revenue of SEK 3.9 million. Can you explain what that is?

[John Vestberg, Co]

That's a combination of a number of individual items. It includes currency effects. It includes other type of revenues as well. I can have a more in-depth description with you on the later session, but it includes currency and other income basically.

[Sam Coleman, Director of Marketing & Corporate Communications]

Perfect, [ Eric ]. Thank you. Feel free to throw a question to the chat, if you like, or put your hand up. I've got the next question. I'd give it a minute on that.

[John Vestberg, Co]

So in the meantime, Sam, maybe we can take one of our questions that we received earlier from another viewer, and that is a question related to our Communications Service Provider business, how that is developing and what type of rollouts we've been seeing so far. And that's a very good question.So basically, also as we indicated in our report, we are tightening our collaboration with our communications service provider partners even stronger in this past quarter and in the past half year, I would say. We've been extremely busy and active supporting the operators that have embarked on the virtual firewall solutions from Clavister, started deploying them over the past period. We have been extremely active in supporting them, engaging with them to finalize their rollouts. And as a consequence of that, we have now one of the operators being in full action, in full live action. And as far as we know, this operator includes -- or has the largest installation of virtualized security products across the globe, basically. And that's all Clavister products for the firewalling parts. That's some 300 or even 400 products being installed.So we see a good uptake. We're in a period now where a lot of the -- or several of the initial engagements from initial license purchases has been converted or are converted into live operations, and we expect that to continue over this year as well. And as we indicated in the report, we are, together with our partners, now as well exploring how our extended product portfolio that we gained in 2019 can be used to support our partners' additional use cases and basically help them to be even more successful in their security offerings.

[Sam Coleman, Director of Marketing & Corporate Communications]

Great. Yes. That's a good question. And there was a question about on the interim [ report ] that we've now exceeded 18,000 active commercial licenses, which is a strong increase from 2019. What do you attribute that to?

[John Vestberg, Co]

Yes. So I attribute that to a number of things. One of the parameters that we continue to be really proud of -- and we're making strong efforts into having a customer support, customer satisfaction that should go beyond the normal. We know that as an underdog in this industry, we can't compete with the biggest brand in the market or the biggest marketing budget, obviously, but what we can compete with is genuinely good customer support. And that has shown to be an extremely valuable asset to Clavister historically. And especially in the past, I would say, past year or past 2 years, we've seen a good retention rate where a lot of the contracts we have with our customers, they are being renewed.And when we ask our customers what they appreciate the most, it's -- first of all, the products are working, that's a no-brainer. If that would not be the case, they would not have been extending, but mainly, it's the customer support and the quality of service they are experiencing. And because of that, we see this constant increase of active contracts that we wrote in the report. That's a good 8,000 new contracts being active just in a year's time. And to us, it's in our ambition to build us massive amount of commercial contracts being current at the same time because, obviously, that drives our recurring revenue, and that's built a very sustainable base of income for us to build the business on. So that's a super important and super positive development for the company.

[Sam Coleman, Director of Marketing & Corporate Communications]

Great. Great. Okay. And here's one last question, which is how is the geographical split up?

[John Vestberg, Co]

This is one of the key changes we made to this new report format, where we are not exposing the individual markets anymore. And there is a very good and simple reason for that. I think the audience that have been following us for a while now have seen that there is quite some volatility between the individual markets and between the quarters. And the underlying volumes in each market are still quite limited, which means that an individual order of some size that falls on the right or the wrong side of the quarter, depending on the perspective, will have a quite dramatic impact on the year-on-year growth rate.And what we've come to understand is that instead of being able to present and represent the company from a bird's eye perspective, from a top line perspective and comprehensive perspective, from that point of view, instead, the discussions tended to be suboptimal in looking at either over performance or so-called underperformance on an individual market. So we decided to remove that and instead look at the complete picture because that represents the company in a much better way. The comment that we made in the report and in this presentation is that all of the underlying markets contributed with growth. All of them are healthy. All of them are building a good pipeline.

[Sam Coleman, Director of Marketing & Corporate Communications]

Okay. Good. I think that's -- well, yes. We'll let it be that. The other questions are not on the interim report topic, but I'll answer them privately. John, thank you so much, and thank you, everyone, for attending. Of course, the quarterly report is online now. And of course, the press releases are also put out there. So engage in those if you'd like. And if you have any questions, you can always reach out to us afterwards.

[John Vestberg, Co]

Thank you very much.

[Sam Coleman, Director of Marketing & Corporate Communications]

All right. Thank you.