Clavister Holding AB

STO:CLAV

Earnings Call Transcript 2019-Q4

[Jenny Ramkrans, Chief of Staff]

Welcome to Clavister Interim Report Q4 2019 Live Presentation. With me, I have our CEO, John Vestberg; and our CFO, Håkan Rippe. We will start this session with a live presentation and then move into a Q&A session. Over to John.

[John Vestberg, Co]

Thank you, Jenny. So it's time to conclude a fourth quarter of 2019 and as well the full year of 2019. In essence, 2019 was about continuing to execute on our strategy. And as a gentle reminder, the strategy of Clavister is a focused growth strategy through which we scale our underlying, highly profitable business with high gross margins and strong recurring revenue. We scale that to greater volumes through a 2-tier channel model in combination with a selected number of high-growth global key accounts or high-growth technology license opportunities. If we look at the full year, we grew our order intake to SEK 147 million, which corresponds to a growth of 24% (sic) [ 22% ] in the year and 15% in the quarter. These numbers are adjusted for the divestment of our Chinese sales operations that we divested in Q3. Looking at some particulars, the key accounts sales were particularly strong in the Communication Service Provider segment throughout the year and consistently so throughout the year. We saw a weaker growth in Nordics for the full year, and this is obviously due to the restructuring that we executed in Q2, which I will come back to. And as an underlying theme for the year, we see good fundamentals across the business in general. The revenue came in a bit lower than expected: full year, 10%; and only 1% for Q4. This is obviously affected by the weak order intake in Nordics, the divestment of the China operations and the very extensive deferral of revenues we have.Talking about that. And this is a reminder, as we're moving from a fully recognized revenue model in 2017 and before, moving over to a more term-based revenue recognition model in '18 and onwards, so that means that we have a substantial deferred revenue on our balance sheet, SEK 50 million approximately; and on top of that, an order backlog of additional SEK 10 million, that both will support our revenue growth in 2020 and obviously onwards. We saw some great improvements to our gross margin, so for the full year, improved by 5 percentage points from 76% to 81%; and a similar trend in Q4, 72% to 79%. These gross margin improvements are mainly due to some sourcing savings and as well supported by the divestment of the Chinese operations which was, to a great extent, a low-margin operation. We believe we assessed that these improvements, they are sustainable. And as such, we are increasing our gross margin assumptions for 2020 to plus 80%. If you recall, previously, we have been communicating plus 70%. Looking at bottom line, our adjusted EBITDA was improved with approximately SEK 17 million for the year, minus SEK 37.3 million versus SEK 54.2 million minus in the previous year. Looking a bit more specifically on some of the markets with a quarter fall -- a waterfall model for the quarter, the fourth quarter. With Nordics, we saw a very good traction, especially in the public administration segment. So among others, we onboarded a customer, a larger capital in the Nordics, which decided for our identity and access management solution, a deal worth approximately SEK 4 million. In addition, we added a number of new municipalities to our customer base in the Nordics. And for you who have been following Clavister for a while, you know that we have a lot of municipality customers in Sweden, and we're continuing this trend with adding even more this quarter. In addition to that, we, as mentioned, made a restructuring in the Nordics back in Q2. We made that restructuring to be able to build a platform that would support higher growth going forward. The new team that we built was onboarded fully at the beginning of Q4. It's sizable and has a vast seniority level to it. So we expect that this investment in a larger, more sizable team in the Nordics will yield good traction for us going forward. In Germany, we continue to build a very robust pipeline, and we add new customers and new partners as we speak. Especially in the Critical Infrastructure segment, being utility, energy, water, et cetera, we are adding several new customers. And the trend we see is the new EU directives supporting European Union vendors have a strong effect, especially in Critical Infrastructure. We believe that we have a good possibility to build a good market share especially in that segment. Other segments that seem to be growing well is in the finance segment with new directives coming on board, new regulations, supporting -- or requiring, rather, identity management and multifactor authentication, new laws and regulations that will take place this year, 2020. We also saw in Germany that our expanded portfolio gains traction. So with multiple customers, we now have sales where the customers are choosing not only one, but several products from the portfolio. To us, this is a strong indication that our strategy moving from a single product vendor to a portfolio vendor is sound and solid. In Japan, we are refocusing our resources to a single global key account player, which -- with whom we have good traction. We are, as such, reducing our efforts to our other customer in Japan, and this is due to the channel margin pressure we've been seeing with that customer in a multi-tier, not only a 2-tier, but a multi-tier channel model towards the SMB segment. As a consequence of that, we have been also seeing quite low margins on that sales. So this refocusing allows us to support our other customer better and, as a consequence, increase our margins as well. With Rest of World, we're seeing good momentum, especially in selected EU markets, supported by our security by Sweden and independent EU vendor positioning. China, as mentioned, was divested in Q3. Obviously, in Q4, we see a strong impact of that compared to last year.With Global Key Accounts, very good growth with all customers in that segment. And again, continued good traction with the Communication Service Providers, where we continue to sell license extensions, license upgrades as well as professional services, supporting the customers that have now started the rollout of their 5G networks.In that segment, as an important emphasis, is the fact that the 5G rollout that now starts to take place is a strong potential driver for our growth in that segment. Up until this point, there has been a vast number of 5G deals announced in the market. The strong majority or the vast majority of those deals are initial, limited-sized radio 5G deployments, whereas the Clavister products are currently deployed in the mobile core networks, meaning the next step of the 5G rollout. So when the 5G rollouts come into the next step, they complement their radio network with 5G mobile core networks, then virtualization is a prerequisite for those type of networks. And as a consequence, virtual security is naturally a key component. Similar review on the full year. Again, obviously, Nordics impacted due to restructuring in Q2. Again, the go-to-market team and the supporting infrastructure, not only in sales, but also in product marketing and product management and lead gen in general, is built and in place supporting a growth onwards.Especially the product family identity and access management gained a very strong momentum in Nordics during the full year. We now see several millions of authentications happening with -- through those products. We have millions of users using their products to authenticate and being used in everyday applications that probably most of you, especially in Sweden, are being used to on a daily basis, communicating with the Swedish agencies.Again, with Germany, solid inflow, new customers and partners. We already discussed that. And of course, Japan as well refocusing. In addition to the CSP segment, what we also noticed in 2019 is an inflow of new customers and strategic partner wins. We've announced a number of them throughout the year, and we are already in final technical delivery phase with several of them. And they expect their products with Clavister technology embedded to reach market commercially during 2020. Just as a quick 3-year perspective on the order intake development. These numbers are not -- the growth numbers are not adjusted for any divestment of China or else. So what we see is a growth in the north of 20%. Our expectation for 2019 was a bit higher, to be honest. We see, obviously, that the Nordic restructuring is tempering the growth down. However, as mentioned, the underlying fundamentals in the business looks very positive. Some very important selected business metrics. For any software company, obviously, our share of recurring revenue is an important metric. And looking back at 2019, we saw approximately 55%, 56% of our revenues being recurring, meaning support and maintenance contracts that keep on renewing, term-based licensing with a very, very high probability of customers renewing their business with us and likewise. And this is a strong change going back from 2017 when a lot of our revenue at that time were purely perpetual. The other metric important for a software business is obviously our customer retention rate or in our particular case, the software license retention rate, namely how many of our deployed software deployments or software instances are being renewed and reused from time to time. In the enterprise software industry, in general, 85% is a highly relevant benchmark. We have seen over the past many years, in this graph, '17 through '19, that we are above 90% of retention, meaning 90% of our customers, they stay with us for a very long time and keep on renewing their software. The growth in underlying licenses is obviously a key parameter as well. The accumulated growth number over the past 3 years is 18%. So -- and this is for one of our firewall products in our network security family of products. So 18% growth and reaching approximately 20,000 active products with support contracts in the field right now, generating revenue and, of course, protecting those customers. Finally, maybe one of the most important metrics, our gross margin that you've seen have been increasing year-over-year for a period of time. And 2000 -- sorry, the years are incorrect there, 2019, we are above 80%, and that's our sustainable but planned assumed level for the business going forward. With that, I'm leaving the word to Håkan.

[Håkan Rippe, Chief Financial Officer]

Thank you, John, and good morning, everybody. So I'll be happy to summarize from a financial perspective where we are after Q4 and after 2019. And adding to John's business summary, I'd like to mention that we're building the company on several different fronts to make a better and healthier company going forward. And we came out of Q3 with the China restructuring, which dilutes a little bit of order intake and revenues in Q4 and full year '19. After that, we started the quarter with drawing down the third tranche from the EIB loan, adding EUR 5 million to our cash flow, which -- and cash position, which is very positive and important for us going forward. Next action item that is also a measure, a tough decision to prepare for the future was the Umeå site restructuring. It's something that we took all the charges in Q4 and finalizing the actual work as we speak. All this makes it relevant to not only look at the business from an EBITDA perspective, but from an adjusted EBITDA perspective, as we have several restructuring and unusual one-offs charges.And the order intake revenues, we had a little bit of slowdown in Q4. We built a healthy backlog and a healthy deferred revenue. Full year numbers are better. But maybe most important I'd like to point to is that from an adjusted EBITDA perspective, we cut the operational loss basically in half. And with the measures that I mentioned, the company is taking significant steps forward to continuing to build a healthy business and to optimize for the future.Thank you.

[John Vestberg, Co]

Thank you, Håkan. Looking forward, we have a number of planning assumptions for the new year 2020 and going forward. Starting, however, looking at the underlying market, so we basically operate currently in 3 submarket segments within cybersecurity. Our traditional network security equipment, including firewalls, IDP products and so forth, has, according to Gartner, an estimated growth this year, 2020, of approximately 8% for the period up until 2023, a growth of approximately 7% year-on-year. Identity and access management, with our identity products, authentication products and so forth, has a slightly higher growth prospect this year, 10%, and a bit above 9% for the accumulated growth until 2023. A very interesting submarket for us is obviously cloud security. It's a recent market where we take our current technology. We cloudify that technology, and we make it available for both SMB customers, service provider partners and our Communication Service Provider customers in general to operate our technology in either public clouds, hybrid clouds or even private clouds. That submarket is expected to grow very strong this year, 45%, and over the longer period of time, 41%. Looking at our own planning assumptions for the midterm, our ambition is obviously to create a profitable growth, and we'd like to achieve a sustainable breakeven level. The market is growing. And as long as we can outperform the market, we should, of course, reinvest any profits into continued growth. That's no doubt about that. However, it has to be done on a sustainable breakeven level. In terms of order intake, revenue and gross margin, we anticipate, we plan for an increased order intake and revenue growth in the full year of 2020 over last year. We obviously see the same type of normal seasonality, Q4 always being the strongest quarter due to budgetary situations from our customers. The second half of 2020 will see a higher growth in our planning over H1, and this is due to the customer rollout plans and the seasonality in growth in general. And as mentioned before, 80% plus of gross margins naturally with variations over quarters, and this is, again, due to the regular product mix. With our operating expenses, we aim to maintain them on the same levels in 2020 as for 2019. As Håkan mentioned, due to our restructuring of our Umeå site, we have significantly reduced our capitalized development expenses. And this will, of course, affect EBITDA, but it will positively affect our cash flow for the year. And finally, all of this taken together will, of course, in our planning assumptions create considerable improvements on our EBITDA levels, our EBIT levels and our underlying operational cash flow throughout the year. A few final words. So again, coming back to the focused growth strategy. The proof points so far, not only in the external communicated business metrics but also the underlying fundamentals, we see a good yield of return in those. We continue to scale the business model. Again, the underlying business model is highly profitable, 81% growth, 56% recurring revenues and a very solid retention rate.We need to scale that, though, and we do that again through a larger and a more efficient go-to-market operation. And that includes our own sales people, which, by the way, we have increased our sales and go-to-market organization with approximately 50% during 2019. So keep in mind that a majority or a big part, at least, of our sales force has been on the job less than a couple of quarters. So from that, we expect as well an uptake in growth. We see the combination of a 2-tier channel model and technology licensing sales or global key account sales. That combination is a healthy combination. It allows us to hedge low-risk and high-probability type of sales with a bit higher risk but also higher growth potential. Those 2 together make a very sound strategy.We will, of course, drive continuous efficiency improvements across the board in the company, so that entails strict cost control. It entails removing impediments. It entails us focusing all our efforts and all our resources in building growth and create a healthy, long-term company. As such, we expect to improve our margins and, of course, improve our cash flow. And we have our standing vision to become the leading European cybersecurity expert.So with that, we'll leave for questions and answers.

[Jenny Ramkrans, Chief of Staff]

Yes, exactly. [Operator Instructions] I will wait for some minutes, and then we'll start the Q&A.

[Jenny Ramkrans, Chief of Staff]

So Havan Hanna has raised his hand, and I will let him in.

[Havan Hanna, Equity Analyst]

Can you hear me?

[Jenny Ramkrans, Chief of Staff]

I can hear you. Can you hear us?

[Havan Hanna, Equity Analyst]

Perfect. Yes. I guess we can start with the last slide and the more efficient go-to-market operation. Could you elaborate a little bit more on that, give some more details, besides a more valuable sales team?

[John Vestberg, Co]

Absolutely. So in terms of building growth through a channel and as well a high-touch sales operations with the type of products and technology we have, it's a multitude of things that we have been implementing and that we are continuing to implement. So one is obviously just the sheer size of the go-to-market operation. That's a very numeric type of metric. And as mentioned -- as I mentioned, we have been growing the go-to-market team with 50% in 2019. The other side of this is obviously that in a channel-based or in a 2-tier sales model, there is a substantial need for partner onboarding, partner enablement and supporting our partner base through product marketing, through collaterals, through all of the practical things that are needed besides the actual product in order to support growth. And that's an area where we have been executing and investing heavily over the past 2 years. The result is, among others, the security framework, the positioning and a multitude of tools, collaterals and partner enablement tools that our partners now start to see the benefit from.

[Havan Hanna, Equity Analyst]

Yes. And when you're looking into 2020, are there any, I don't know, sort of major changes or restructuring that's to be done?

[John Vestberg, Co]

For the year 2020, no, we are not planning any changes. We're continuing with the same business model, the same strategy. We might do fine-tuning, as always, throughout the year if we detect deviations from our plan. That's natural. But in terms of the underlying strategy, we remain loyal to that strategy.

[Havan Hanna, Equity Analyst]

Yes. And I'll take 2 more questions, and then I'll get back in line. You have been investing heavily on your sales force and go-to-market. Is it reasonable to expect sort of accelerated growth during 2020? Or will the Nordics and China and Japan continue to put some pressure on order intake? Or is that like over?

[John Vestberg, Co]

Yes. So as I mentioned in our planning assumptions is that we expect a higher growth in 2020. And the reason, obviously, we can do that is we built a stronger and more sizable go-to-market organization across the company, again, in our focus markets. So keep in mind that we are sort of -- we've been doing 2 things at the same time. We've been increasing our go-to-market presence in Nordics and in Germany and with our Global Key Account sales. And at the same time, we've been consolidating or removing focus elsewhere where -- in areas which is not part of our strategy. So that includes the China divestment. And as you might remember, we had some activities in Africa before. So those were unwinded. And at the same time, we started building and we built teams in our focus markets instead.

[Havan Hanna, Equity Analyst]

Okay. And then just the last one, and I'll get back on the line. Looking at the pipeline, John, I don't know, in lack of better words, would you describe it as healthy in terms of type of deals, deal sizes, customer types, et cetera?

[John Vestberg, Co]

Yes, absolutely. So we see 2 different -- a pipeline with 2 different types of customers, if you like. We have decided to follow a principle whereby we put our largest investments, largest costs, if you like, within sales but also within R&D on enhancing business where we believe it is low risk, high probability for growth, but where the growth is not -- it's not a hockey stick growth, if you like, but it's a sustainable steady growth distributed over multiple partners, multiple transactions and multiple orders.And just as a side note, last year, 2019, we processed approximately 5,000 orders, which gives you a good hint on the sort of the distribution of risk, if you like. We combined -- and in that area, we see a buildup of, I would say, a regular pipeline, a regular funnel. And with all the tools and go-to-market and partner on-boarding activities we are doing, we see return on that in terms of pipeline already. Now the other type of pipeline is the, if you call it, the high-growth potential pipeline with key accounts and technology licensing partners where the quantity of leads is, of course, by nature, much smaller, but the high -- the growth potential is much, much higher. But there also comes the risk with fewer accounts and longer lead times. We absolutely see a very healthy uptick in that pipeline as well. Clearly, we cannot share details, but our ambition is to be able to announce key wins from that funnel and the other funnel as well in this New Year.

[Jenny Ramkrans, Chief of Staff]

Any further questions? So if no more questions, then I will conclude this session. And I want to thank you for participating. Thank you.

[John Vestberg, Co]

Thank you very much.

[Håkan Rippe, Chief Financial Officer]

Thank you.