Absolute Software Corporation

Geoff Haydon - CEO Errol Olsen - CFO

Doug Taylor - Canaccord Genuity Michael Kim - Imperial Capital David Kwan - PI Financial Richard Tse - National Bank

Thank you, Operator and good afternoon everyone. Welcome to our Q3 fiscal 2017 conference call.

Joining me is Errol Olsen, our Chief Financial Officer. Q3 represented another quarter of substantial progress across all facets of our business.

Our commercial ACV base exiting the quarter was $88.2 million, increasing 9% year-over-year and 2% sequentially. ACV growth was driven by strong renewal expansion activity with existing customers ACV of 102% coupled with new customer ACV of $600,000.

Absolute’s self healing endpoint security solution continues to resonate strongly with the market, as a result Q3 represents our sixth consecutive quarter of sequential growth in ACV and recurring revenue. Importantly, our pace of growth continues to accelerate driven by those specific geographical and vertical markets we have been concentrating our investment in most notably, ACV from enterprise and health care customers in Q3 grew 14% year-on -year and 5% sequentially.

Absolute through its entirely unique and broadly embedded persistence platform remain uniquely positioned to overcome one of the most prominent impactful and enterprise security challenges the dark end points. This refers to computing devices that are unobservable to the corporate IT functions because they are off map work or dependent on endpoint management and security agents that have become ineffective or disabled.

This endpoint points that typically effects are significant percentage of an enterprises total endpoint population and represents a breeding ground for security breaches. Absolute’s unique capacity to enable our customers to see, assess, and remediate endpoint related risk across their entire enterprise drove our largest Q3 transactions.

A Fortune 100 healthcare services for example expanded and upgraded their Absolute deployment in Q3 where we now secure over 200,000 endpoint globally. Through this deployment, Absolute plays a central role in ensuring the compliance and security of patient data and corporate IP residing on endpoints in over 125 countries around the world.

This Q3 expansion reflects organic and inorganic growth, the addition of desk tops to their ELI and the adoption of valuable new product features centered on data protection. We are also developing a custom integration with this customs human capital management system in order to increase the security of data associated with GAAP’s due to personnel changes making Absolute’s technology even more strategic.

We also expanded our business in Q3 with a large U.S. healthcare provider comprised of eight hospitals in over 36,000 employers.

This customers deployment of 7000 DDS Agents increased by over five times in Q3 extending Absolute’s presence across all endpoint device types. Through this deployment, our customer has substantially improved their overall security postures through off-network, device and data visibility and the capacity to remediate endpoint agents that have become disabled or damaged.

Additionally, through our endpoint data discovery offering we are helping to address sensitive data compliance vulnerabilities on both desktops and remote ambulatory offices. Finally, the customer is realizing quantifiably improved operational efficiency and cost containment through hardware assets and software license management.

The strong growth of Absolute’s business with both existing and new customers is largely being driven by enhanced innovation and strengthen to sales execution against new feature opportunities. I’ll now review specific accomplishments in these areas.

Our plan to increase investment in product development during fiscal 2017 is on track with a focus on accelerating innovation in two specific areas, our cloud based platform and insider threat defense offering. Our Vietnam operation is now an established legal entity, almost fully staffed and productably operational.

Our user behavior on analytics development team is also almost fully staffed with critical additions occurring both in Vancouver and the U.S. Errol will elaborate on planned hiring activity during his comments.

Given our progress to date, we expect to enter 2018 essentially fully staffed across all functions of our business. Only expressions of our cloud based platform work including the introduction of role based access control.

This has been an outstanding request from several of our largest enterprise customers. We are also expanding our integration with other major enterprise technologies.

These integrations allow enterprise customers to leverage Absolute’s rich telemetry and remediation capabilities across complimentary applications, substantially enhancing the usefulness and value of these applications. In Q3, we completed the integration with the [IDMQ] security and certain event management platform and are now integrated with the majority of the Gartner Sim Magic Quadrant Leaders.

Our user behavior offering was also unreached recently through the announced integration with Microsoft [Indiscernible] rights management. This enables enterprises to control user access to and the sharing of sensitive data and to enforce policies around the adoption of Shadow IT.

On educational application of our developing use behavior capabilities was reflected in the introduction of our student technology analytics feature which enables educators to absorb the relationship between students and technology and to associate these usage patterns with students performance. The ultimate objective of our R&D investment plan remains to substantially increase our total available market and to enable the introduction of rich, monetize able new features as a key driver to accelerating growth.

Our most notable Q3 announcement in this area was our application persistence offering. This extends Absolute’s embedded persistence technology to any endpoint, security and management agent and is available as an incremental upsell to our core DDS product line.

To date, we have extended persistence to 15 different endpoint agents. We continue to believe this unique Absolute concept of self-healing and endpoint agent has the potential to emerge as a de facto standard for enterprise endpoint security architecture.

We continue to see sales productivity improvement throughout our entire global field organization and across each of our key growth drivers, the renewal, expansion and upsellling of existing customers and the acquisition of new customers. In Q3 existing customer renew expansion played particular prominent role in accelerating growth, with existing customer ACV expanding to 102%.

In addition to the two large customer wins I’ve referenced earlier, we have substantial renewal expansion wins with Facebook, Capital One, Charles Schwab, Advocate Health Care and Baylor Scott & White The number of ELAs we closed with existing customers also increased from zero one year ago to nine in Q3 this year which also reflects broader customer adoption trends and absolute deployment independent of device sale. Expansion within our 20,000 existing customers will continue to play an important role in realizing our growth objectives.

We estimate that within our 100 largest enterprise accounts as a representative sample of this segment that less that of the total available endpoints are activated. Our rich set of product features in now providing the impetus for productive conversations with these exiting customers regarding the activation of the remaining endpoints.

Additionally, many of our newest features are being productize and priced as incremental addition to record DDS platform enabling upsell opportunities and a higher ACV yield per endpoint. New customer acquisition also continues to play a central role in accelerating growth.

In Q3 we expanded new customer ACV by $600,000 added 100s of new customers and deployed our technology at well-known brands such as PWC, NTT Accretive Health, and Exxon Mobil. New product features and functions continue to drive this new customer activity with 97% of our new customer ACV represented by premium features and priced versions of our DDS solutions.

In summary, we are executing strongly against our innovation agenda and our objective of leveraging new product features as a primary accelerant to growth. Secondly, we continue to demonstrate a substantially strengthen go-to-market capability, improving renewal rates, igniting expansion opportunities and acquiring new customers.

As a result we continue to deliver sequentially improved ACV and recurring revenue growth rates an accelerated pace. Moving into Q1 at our new fiscal year we will continue to focus on improving executive, accelerating growth and expanding both our EBITDA and cash margins.

We’ll remain firmly on our path to accomplish our long term operating objective of 20% revenue growth and 20% adjusted EBITDA margins. I’ll now turn the call over to Errol to discuss our financial results in more detail.

Errol?

Thank you, Geoff. Good afternoon everyone.

Q3 DDS segment revenue of $23.1 million grew 7% year over year. Commercial recurring revenue of 21.5 million increase 9% year-over-year, while commercial non-recurring and consumer revenue was $1.5 million compare to $1.8 millions in the prior year period.

Our Commercial ACV base with $88.2 million at March 31, representing a 9% increase over March 31 of last year and a 2% increase over the December 31 balance. This presents acceleration over the 8% annual ACV growth that we’ve reported last quarter and these are highest growth rate since we began measuring this metric.

The $2 million sequential increase in the ACV base was driven by improved customer expansion and upsell performance within existing customer quarterly retention rate of 102% in Q3 which added $1.4 million to the ACV base. This included a significant expansion with the North American Healthcare Services organization which represented an incremental ACV contribution of more than $500,000.

We also added $600,000 of ACV from new customers. From industry vertical perspective the enterprise and healthcare ACV base increased by 14% year-over-year and by $2 million or 5% sequentially.

The education and government ACV base increased by 5% year-over-year and was flat sequentially. At March 31 enterprise and healthcare customers represented 49% of our commercial ACV base compared to 47% at March 31 of last year.

Geographically North America remains our dominant region with 9% year-over-year ACV growth and represents 90% of our commercial ACV base. Turning to expenditures, we have continued our planned expansion of our research and development capabilities.

Our R&D headcount at March 31 with 204, up from 150 at June 30 and 165 at December 31 including Vietnam contractors. During Q3 we completed the incorporation of our Vietnamese subsidiary and all local contractors were converted to permanent employees.

We expect to achieve our targeted R&D headcount of approximately 250 by June 30. At that point our R&D expansion plan will be complete, and we expect to move into fiscal 2018 fully staffed.

Total Q3 adjusted operating expenses which exclude reorganization and non-cash charges and which are detailed in our press release and MD&A were $20.7 million, relatively flat with the first two quarters of this year. Within the research and development line item during Q3 we recorded a $1 million dollar positive accrual adjustment related to historical investment tax credit claims.

Prior to this adjustment our adjusted operating expenses were $21.8 million. The increase over the prior quarter reflected the increased R&D headcount and the timing of marketing programs.

Our total full-time headcount at March 31 with 486, compared to 463 including Vietnam contractors at June 30. And 448 counted on a similar basis at December 31.

Adjusted EBITDA for the second quarter with $2.3 million or 10% of revenue, up from $1.7 million or 8% of revenue in Q2. Prior to the R&D tax credit adjustment previously referenced our adjusted EBITDA would've been $1.3 million or 6% of revenue, which was in line with our plan.

Turning to cash flow, reported cash used in operating activities during Q3 was $400,000. This was net of 1.1 million of reorganization related payments which were charged to income in prior quarters and which were paid in Q3.

Cash generated from operating activities with a positive 700,000 prior to these payments. On a year-to-date basis cash generated from operating activities was $300,000 and was $6.3 million prior to the payment of prior year income taxes and current year restructuring charges.

DDS segment billings in Q3 were $21.6 million and the average prepaid contract terms was 33 months, slightly lower than our historical average of 36 months. The average term was impact by a significant annual renewal in Q3 as well as the previously mentioned large healthcare customer expansion which also a one year reneweable ELA.

Looking forward now to the remainder of fiscal 2017, as detailed in our press release and MD&A. We have narrowed our revenue guidance to the low end of the previous guidance range reflecting lower than expected professional services and consumer revenues.

Fiscal 2017 revenue is expected to be between $91.4 million and $92:4 million, representing 6% to 8% annual DDS segment revenue growth. At the same we are increasing our fiscal 2017 adjusted EBITDA guidance to 8% to 9% of revenue and we expect fiscal 2017 cash from operations to be between 7% and 9% of revenue.

This concludes our prepared remarks for today. Operator, please open up the call for questions.

Yes. Thanks.

Good evening, the upsell and resell renewal activities are very impressive this quarter. You recently announced the security posture dash board, seems like another sweetener to get your customers to move up to higher tiers of your products.

Can you talk a little bit about the customer expectance and feedback of that product and also how we should be thinking about the breakdown of your customers between the different peers of your DDS sweet right now, so we can think about the opportunity going forward?

Doug, it’s a great question at the great point. And the security posture report is a very good example of the feature that is catalyzed some expansion in upsell opportunities very specifically within existing customers, essentially what it does is it provides a very comprehensive snapshot across and entire customer endpoint population of their security posture.

the extent to which security technologies that they have invested in are effective in doing what they’re supposed to do. And in many cases the exposure of the deficiencies of those technologies and the vulnerability that they represent act as a compelling event in terms of materializing a new opportunity for us.

So there’s been a very strong conversion rate of security posture report deployments and new upselling expansion conversations. Now to your second question about how we envision the breakdown.

One of the only stages of understanding what the respective growth rates are going to be between new customer ACV and the existing customer expansion and upsell. Over the last couple of quarters we have introduced our medium term growth model which identifies really four vectors of growth, the renewal opportunity, the expansion of our technology to additional endpoints within existing customers, the upsell of new features and of course the acquisition of new customers, the most development this quarter was obviously the fact that we activated and really validated this expansion opportunity for the first few quarters.

This year you’ll notice that our existing customer ACV remained at 100%. So the fact that we were able to inflect the tune of 102% then at $1.4 million of ACV to our existing customer ACV base was very exciting to us.

But we were also pleased that we continued to deliver strong new customer ACV performance, 6,000 in ACV, over 500 net new customers, many of whom are large enterprises that represent very substantial expansion and upsell opportunities over time. Now, we do expect both new customer ACV and the existing customer expansion upsell to contribute to our growth performance and we do expect both of those metrics to improve over time.

But the complexion of the new customer versus expansion performance is going to variable from quarter and quarter and I think the reason for that largely is the fact that we have a common customer acquisition team that is targeting both customers that we’ve never sold to before, so new logos or new customer ACV as well as very large established enterprises where we’ve activated very small percentage of the total available opportunity. And so each quarter each member of that team is going to take a look across their comp portfolio and determine where they feel the most immediate return on an investment will be.

And for some reps, it will be oriented towards new customers, for others it will be to the expansion of existing customers. So its early day, so it’s hard for us to comment specifically on how we expect the performance to breakdown those two vectors, but we expect both of them to feature very prominently in our short and long term goal story.

Okay. But as we’re thinking about the renewal and upsell opportunity, I think in the past you’d said something like 40% of your installed base was not yet on the premium tier, the products and obviously a lot of your new development has aimed at getting people to that tier.

Could you talk, just confirm if that metric still roughly accurate or if that’s change. And also I’d be curious to hear the penetration of that you see your product on some of the 15 third party endpoint agents that you’ve now got integrated with your platform?

So just some metrics on trying to model the expansion or upsell opportunity, I reference in the call our top 100 enterprise accounts, in those accounts we’ve activated less than 40% of the total available endpoints, and I would submit those are most covered account. So as we go beyond our Top 100 customers I think you’ll see activation rate quite a bit below that.

So that is a very substantial expansion opportunity. And in terms of upsell you’re right, the 40% is still a relevant figure in terms of customers that have bought DDS but not premium versions of DDS, so there are upsell opportunities within those accounts.

There were also opportunities for us to sell application persistence for example, which is an offering that is monetized incrementally on top of DDS, and we’ve said before just to provide some context that on average we realized about $13 of ACV per existing customer endpoint today. The application persistence offering represents rough and tough a couple of dollars per agent per endpoint per year.

So just to give you some context, there are opportunities for us to quite significantly increase the volume of ACV that we realize per endpoint over time.

All right. That’s helpful.

I will hop off line.

Thanks Doug.

Hi guys. Good afternoon.

Just wanted to follow up on the technology integrations, you have talked a little about the SIEM vendors, but I'm curious about on the role-based access controls, how you're working with some of the identity and access management vendors for [Indiscernible], some of the platform vendors, and lastly not too get too far into the user behavior analytics and how you maybe integrating with AWS in the future?

So, I think all of the applications and technologies that you have referenced represent integration opportunities with us, and that is one of the reasons that we have identified restful APIs as one of the primary drivers behind the elevated level of investment that we are making in our cloud-based platform this year. Today we can extend DDS to just about any complementary application, but it requires discreet professional services or development effort.

What we want to be able to do is enable customers to extend DDS to other applications or architectures within their environment seamlessly and independently. So whether it is the role-based access controls, identity and access management, whether it is cloud providers, whether it is IT service management, whether it is the SIEM vendors, all of these surrounding technologies Michael benefit from three things that DDS provides; one is to [Indiscernible] every end point so just that rich comprehensive view across the entire endpoint population; secondly our ability to remediate risk on an endpoint, even if its agents have been disabled or even if that device is off the corporate network, and finally the ability to extend persistence to other complementary agents that may be subject to attack or being disabled.

So right now these partnership integrations are being announced incrementally quarter-to-quarter, but as we start to express the API family more fully in 2018, we are really putting customers in a position to extend DDS to applications that they are choosing in their environment.

And through this API program do you see an opportunity for co-marketing arrangements and being able to perceive some joint customer opportunities?

Yes, we do. And I expect that in Q4 moving into the New Year, you will start to see some of those announcements.

But the primary focus to date has been on the integration of the technologies either at customer requests or in service of identified customer requirements. But whether it is RSAs, Splunk, HP ArcSight, Service Now, any of the integrations that we have announced to date, in effect we are enriching the functionality of their technology in a customer environment, and so we do intend to leverage programs that they have got to drive go to market collaboration.

And ideally put us in a position to realize some leverage from their sales and go to market capability. That is the ultimate objective.

Great. And then just switching over to existing customer ACV, are you seeing EDD continuing to drive the shift from professional premium pricing, and then also to what extent is expansion into additional endpoint devices driving some of the existing customer ACV growth?

It is both. It really is both and I haven't got a specific figure.

But I would say it is probably very evenly divided between expansion – it is probably a little bit more weighted towards additional endpoints but there is a lot of up sell activity from existing to premium versions of DDS, and also with the new customers I mentioned earlier, but I will just emphasize 97% of our new customer ACV was driven by premium versions, premium priced versions of DDS. So that also reflects the extent to which we are getting traction with features like EDD.

Great. Thank you very much.

Thank you Michael.

Can you talk about the weak performance in the consumer education market, just some of the dynamics going on there that led to the revision in the revenue?

Yes. So we didn't reference any weakness in the education business.

In fact our education business, ACV, is up 5% year-on-year. We continue to see strength in that business and expect to finish strongly in Q4, which is seasonally a strong education quarter.

the non- recurring items that Errol referenced included professional services, which simply the performance of which didn’t meet our expectations in Q3, and secondly the consumer business, which is a business that we have been deemphazing, I mean we have been very explicit about our focus on our commercial business and really investing in the acceleration of its growth, which we saw obviously across the board in terms of the year-on-year 9% expansion, but most notably in the healthcare and enterprise business, which was up 14% year-on-year.

Thanks Geoff, and on the education market, just the news out of Microsoft with their new offering system, and there I guess drive to help regain market share in that market, can you talk about where you guys are related to this particular opportunity, I know it is still quite early…

Yes. It is a new technology that we do intend to support.

It is early days obviously. It was just announced last week, but it reflects a new development in this lower-end category of education devices, the Google Chromebook being another example.

Just with respect to education generally I mean we are seeing a general reduction in device pricing in the education business. Thankfully we have only seen virtually an immaterial reduction in our average selling price to education customers, but we do anticipate that as the price of devices in education continues to erode there will inevitably be some impact in terms of our average selling price.

What we are doing to confront that is really shifting and enriching our value proposition to schools away from simply the recovery of a lost or stolen hardware device to more meaningful, more valuable offerings like our student safety, our safe schools initiative. Our student technology analytics, which I referenced earlier, which is a very powerful vehicle in terms of helping schools optimize the adoption of technology in terms of the impact on student performance.

We are also seeing interest in the security, information security emerging as a more prominent require in large school districts. So we are investing very heavily in the innovation of our education solutions in the spirit of not just maintaining pricing integrity, but looking for ways to up sell our education customers over time.

The positive impact of this device price erosion is that it is making one-to-one computing programs more accessible to more schools and we are definitely seeing a more substantial increase in just the sheer number of school districts deploying endpoint devices to students in the shipment of education devices across the board.

Thanks Geoff. Have you had, I guess, had any or I guess probably early discussions with your OEM partners about being positioned for these cheaper laptops, Windows-based laptops that are going to be coming to market?

Yes, very actively. I mean, there is still a very substantial volume of Windows-based shipments going to education, and that is where we are most focused on to monetize.

We are working very actively with all our OEM partners on education bundles and on growing our business together across the education segment taking advantage of the fact that one-to-one computing is becoming more accessible to schools.

Thanks, and just two more questions here, the incremental ACV from new DDS customers was below it has been in a few quarters here, just wondering if you comment on the reasons behind that, was it just lumpiness or something else because I think…?

What, I think to a very small extent a little bit of a seasonality. I mean the first calendar quarter of each year, or Q3 tends to be certainly in the enterprise and education to a large extent seasonably slower, but I think what really happened is we have substantially enriched our product offering over the last few quarters, and our customer acquisition reps have recognized that they can leverage these new features as a means of going back to existing customers and engaging those customers in very productive conversations regarding the expansion and up sell within those existing customers and I think what you saw is just a shift in sales cycles from new customer acquisition activity to the expansion of existing customers.

The positive thing is that the net result of both new customer and expansion was sequentially ACD was up 2.4% and most concentrated in the enterprise business, which was up 5% sequentially. So what we are most focused on is ensuring that the overall performance of the organization is strong and we believe that we saw that.

I mean we still think that there is substantial under-realized opportunity both in new customer and expansion, but we were just pleased that they were starting to see that combination of levers being applied more productively.

Okay. Just I think last quarter you talked about kind of over a million bucks a quarter type numbers, so I just backed in, it sounds like your expect to get north of that in the coming quarters here?

No. As I said earlier, it is just not clear to us.

We didn't expect that we would have seen 1.4 million in expansion in Q3. Just the volume and extent to which that materialized as quickly as it did was something that we were – we didn’t model that level of expansion performance and so, what is clear is that, as I said earlier, that customer acquisition team is going to make their own decisions each quarter in terms of where they are going to realize their highest return on investment, and it will be a combination of new customer ACV and expansion.

We do expect both of those ACV figures to increase over time, but from quarter-to-quarter there is going to be some variability.

Last question just on the guidance for this year, I guess towards the higher end of the guidance suggest that you are going to exit the year close to the double, if not the double-digit range, looking out to next year, is that something that you expect to be able to generate double-digit growth?

So just to clarify the current guidance, from a revenue standpoint as we have guided to the lower end of our previous guidance range. What we expect for next year is number one, continued revenue acceleration, and number two, a corresponding expansion in EBITDA margins.

So from a spending standpoint, we should exit this year fully staffed in R&D. We are not expecting any step increases in expenditures next year.

There will be inflationary type expense increases, and some smaller internal initiatives but we expect that overall we will see margin expansion next year. I am not in a position to comment on specifics on what growth rates will be next year, but certainly we do expect it to accelerate off of the 9% that we completed Q3 at on a commercial revenue basis.

Okay and I guess then you adjust out that million dollars from the shredded accrual, you talked about last quarter about margins picking up in Q4, I guess talking about that would you still say [Indiscernible]?

For the margins to hit – sorry, I don't understand the question.

For the margins to pick up in Q4…?

Yes, we do. We expect that Q3 was very likely the trough from a margin standpoint and it should expand in Q4.

When you exclude that million dollar accrual?

Right. Good clarification.

Yes, perfect thanks.

Great. Thanks David.

Hi guys. Thanks for taking my question.

It's actually Andrew in place of Richard. Just wanted to talk about the solid up sell activity that you saw in the quarter, could you help me understand how I should be thinking about the sales and marketing line when it comes to new customer wins versus renewals and up sells, and how that might vary on a quarter-to-quarter basis or if at all?

Sure. You won't see much direct correlation between the sales and marketing spend versus the activity between – the split of the activity between new customer acquisition and existing customer expansion.

Most of the variability on a sales and marketing line is really the timing of marketing programs, and then we have sales conferences, or annual global sales meeting in Q1 of each year, but other than that the way that our commissions are expensed is actually we capitalize. We are required to capitalize sales commissions.

They are amortized in line with revenue. So the commissions actually do not fluctuate from an expense standpoint from quarter-to-quarter.

They do, of course, fluctuate from a cash flow standpoint.

Okay that is helpful. And then on the new customer wins, if I think about the business internationally, I'm wondering if you can help update on some of the initiatives and the progress that you’re seeing outside of North America, and then maybe even if you can help put some context in terms of how that pipeline is developing for new customers?

Yes. It is improving.

This year we really focused on re-establishing fundamental strength in some very specific international markets, the UK for example, prominently in Europe, Mexico and Latin America, Japan and Singapore and Australia in the Asia-Pacific region. We are still at the early stages both with investing in those markets and realizing their growth prospects.

To date in Q3 the international business represented probably about 11% or 12% of our total ACV base and it was positively accretive to our ACV growth. So the growth of the international business exceeded the growth of the North American business.

Now it’s a much smaller base obviously, but it’s no longer dilutive. So we’re starting to see some early indications of improved international performance.

We do expect in 2018 that the international performance will continue to improve, and certainly over the coming years we expect the international market to play a very important role in our growth story. I mean, they still represent Greenfield opportunities for us.

So modest progress, but they are contributing to our accelerated growth and we expect in 2018 they will feature even more prominently.

Okay. Thank you.

And just last quick one here on the R&D line for this kind of last leg of your stopping expansion. Is the bulk of that going to be in Vietnam or will that be in North America?

It will be split between the two. We have about roughly 70 employees in Vietnam right now, I expect we’ll end the year at roughly 100 and the rest of the expansion will be in North America.

Okay. Thanks very much and I’ll pass the line.

Thanks.

Thank you, operator, and let me just thank everybody once again for your time this afternoon and for your interest in and support of Absolute. We look forward to speaking with many of you in the coming days.

Thank you again.