Danielle Royston - Chief Executive Officer Anin Basu - Interim Chief Financial Officer

Thank you, good morning and welcome to our 2018 third quarter earnings conference call. I'm Danielle Royston, CEO of Optiva and I'm joined today by our Interim CFO, Anin Basu.

On today’s call Anin will provide a brief commentary on our financial results and then I will discuss my thoughts on our quarter. To remind you our plan for our company is three fold.

We need to fix customer success, we need to restructure our company and we need to invest $100 million to create market leading products. So with that I’m going to turn the call over to Anin.

Anin?

Thank you, Danielle and good morning everyone. Please note that our complete financial statement, management discussion and analysis and earnings release for the quarter are available on SEDAR and on our website and I encourage you to review them at your convenience.

As you can see from the release of the statement, our revenue for Q3 2018 has come in at 32 million with a net loss of 3.5 million. As many of you are quite familiar with the financial reports, I'm not going to go over the numbers on today’s call.

I would be happy to answer any specific questions during our Q&A portion of this call. Today I want to provide you with an update on our restructuring plan, gross margins and the related party contracts.

On restructuring, we have made good progress in the quarter in both workforce reduction as well as closing offices and reorganizing our legal entities. We have recorded a restructuring charge of 50.8 million year-to-date that includes a charge of 1.6 million in Q3.

While most of the expenses related to severance costs to outgoing employees, it does include costs related to exiting offices and data centers globally. Our restructuring liabilities at June 30, 2018 is 20.6million.

We paid approximately 19 million in the third quarter. Overall, our restructuring is progressing and we will continue to implement a plan.

I wanted to take a minute to talk about our gross margins. Our gross margin in Q3 2018 is approximately 70% compared to 57% in the same quarter last year.

The higher than normal gross margin in Q3 is a combination of a few factors. We are beginning to see the impact of our restructuring and resulting efficiencies in our internal operations.

Additionally in Q1 and Q2 fiscal ’18, we made provisions for expected losses on a certain contracts that resulted in lower gross margin in those quarter. We partially utilized this provision in Q3 as we made progress towards completion, which resulted in our gross margin being higher this quarter.

Finally the revenue mix this quarter also had a positive impact on our gross margins. I want to caution you that we do not expect our gross margins to stay at the level long-term as it is temporarily higher due to the factors I just described.

Now, I wanted to give you an update on our contracts with our two related parties, Crossover and DevFactory. The total cost included this quarter with Crossover amounted to 7.8 million.

As for DevFactory this quarter we incurred a cost of 11.4 million with majority of these costs being invested in customer success, restructuring and product innovation that Danielle will refer shortly. As I've said before we believe these investments contribute to our goal of having great products, great people and enable us to be a leader that helps us to bring innovative products and drive customer success to our customers.

That about covers it for my portion. And with that I'd like to pass the call back to Danielle.

Thank you, Anin. And I like to take a moment to thank Anin for his leadership and support over the past year.

He’s done a great job for Optiva as Interim CFO in addition to his VP of Finance role. As you may have read from our press release in late July, we have named Ken Taylor as our CFO who will be starting next week.

I’m excited to have him join the team. All right, the single most important question investors should think about when they’re thinking about Optiva is, where is the long-term revenue headed for this company.

The reality is, is that we continue to shrink. As we evaluate our forward revenue base, we are holding to our long-term revenue range of $90 million to $120 million.

There are three keys to our plan to fixing and turning the company around; the customer success, the structure of the company and invest $100 million to fix the products. So let’s take it one at a time.

First, customer success, the customer success program is our program that works with each customer to align our work to our customer’s most strategic goals, create a plan to deliver against those goals and then ask our customers did we achieve the goals. We’ve began to gather feedback for the first six months of the year and we expect to move up about five points from where we were before to the low 30s.

While this is a few points higher from our previous measurement of 27% as of December 2017, as I said before, this is a very long important process where you literally have to fix each customer one by one. We ask the notable customers that have moved across the line and into the yes territory.

We put together a plan, executed that plan and now that customer is really seeing us as a partner and not just as another vendor and we turned no customer to a yes. We have other customers where we have closed out big projects in the last six months, some of them only very recently.

If customers are not quite ready to give us the thumbs up they want their delivery and the change to care for a bit more. However, they are indicating that we are inching closer to the line and with just a bit more work they are seeing the change and the improvements we've made to reposition as a partner and an asset to them.

And then there’s still the other project still in the ditch. We still have a good handful of projects where customers aren't feeling the change and yes isn't yet in to beam.

For these customers we're still pushing hard every day doing what we can to get them across the line. And as I have said before revenue will converge with customer success, so this remains a big focus for our team to make sure we're fixing customers again to where they see us as a partner not a vendor.

Moving to item to two, need to restructure the company. We've invested $51 million in structuring and we’ve reduced our spend by about $30 million.

We continue to work to reduce our expenses and have an additional $20 million in line of sight. With the shrinking revenue base the restructuring side of our work has to do with managing our expenses.

If our revenue continues to shrink, we will continue to adjust our expenses and for a software company that means adjusting our headcount. As I said before our plan will work up to a 25% loss of revenue from $120 million, which brings us to the third item investing $100 million in our products.

Last year I announced the plan to invest $100 million to revitalize our product and so far we are about a third of the way into our plan. If you have been following us closely you have noticed we have pivoted our product roadmap very strongly towards cloud.

In fact, with each passing day I'm more and more convinced that the future of telco lies with moving them to the public cloud. This is hugely disruptive and for our investor community I want you to know that this also hugely risky.

We are leading the industry with the move to the cloud in an industry where everyone is saying that it won't work. On top of that even if it does work this is an industry that moves notoriously slowly with sales cycles easily taking 18 to 24 months.

As an innovative disruptor it will take time to convince the telcos that not only will it work, but that our performance and total cost of ownership savings claims are achievable. So we are starting to go out and share this message with customers and prospects, but I want you to understand that expect growth will take years to materialize.

For all of our investments we've gotten some nice advancements in our products, beside from a big investment in quality, we made a couple of significant announcements. The first announcement was for the Optiva Charging Engine and the work we've done to move the application to Kubernetes.

Kubernetes is Google’s product for containerization of applications to make them more efficient deployments on servers allowing organizations to speed their time to deployment and optimize every last dollar from their hardware investment. This announcement means that Optiva Charging Engine is now cloud ready and can work in any cloud private or public.

This is a first step to prove to the world that we are not only talking about the cloud, we're making the investments we need to make cloud a reality for telco in 2018. The second announcement was regarding the availability of the charging engine on Google Cloud Spanner, Google’s distributed, highly available transactional database.

This development and innovation is key to delivering on our promise at ten times the speed at a tenth of the cost. With this database we can replace or close our database and leverage a new innovative database that is not only better, it's cheaper for telcos to provision and capacity plan many, many months in advance, to be able to give them the ability to auto scale, not only the compute power but also auto scale the database provisioning.

No other database in the world is able to do that. To be able to reduce the tens and sometimes millions of dollars, hundreds of millions of dollars telco has spent with Oracle is disruption that everyone is excited about.

Investors and customers alike asked me about our partnership with DevFactory and if we were getting the expected value from the relationship. Let me tell you, we could not have done these advancements without them.

Their Sweden scale coupled with their ability to deliver has allowed us to accelerate our innovation. To have that partnership in our tool box is a competitive advantage we need to revolutionize our products and accelerate telcos moving to the cloud by ten years.

And so how is it playing out with our customer base? Last year one of our largest customers it's going to kick us out.

From their perspective we were a critical vendor managing their monetization strategy for their millions of subscribers and we were in trouble. On top of that we didn't have a great vision for them for why they should stick with us.

For this customer the cloud vision and progress has allowed us to get our foot back in the door. We still don't know if it will be enough to save them in a long-term and as I mentioned this is a hugely risky move.

The upside is that we started a project around cloud for them and we may be successful, if not we will lose them. Like I said the stakes are really high.

Finally, as you know I've been pushing to get the cash flow break even by the end of our fiscal year. We are continuing push hard for this goal investing as much as we can in our products to take advantage of the cloud opportunity, cutting costs aggressively for restructuring to fund our investment while at the same time trying to deliver customer success.

We are pushing as hard as we can to get to that goal, but it will be close. I remain encouraged about our progress and where we are headed.

And with continued focus and execute with the advancements this quarter and the encouraging news from the customers I feel we are on a great path. At this point we're ready to open up the call for Q&A.

Good morning guys, so recurring revenues increased quite substantially this quarter, so what is the trend there?

Hi, it's Anin. The recurring revenue currently is still trending at around 20 million, 21 million a quarter.

This is – I wouldn't say it’s a substantial increase. It’s pretty flat if you kind of look at it for the past few quarters and it's a matter of renewals and the timing of renewals with our customers that have the support arrangements with us.

We do expect that number to actually decline knowing some of the customers that have already notified us that they are leaving our platform. And what has happened is because our software is very sticky and their implementation with our competitors systems are likely delayed, which is why they're kind of extending it pretty much on a quarter-to-quarter basis.

So we do expect as part of the overall revenue to – that to decline as well in the future quarters. I would say that it’s kind of holding steady at around 20 million, 21 million at the time.

And just to add to that, I think the percentage mix has changed and I think that is due to us wrapping up and finishing on some of our professional services deliveries. And so the recurring revenue from a number perspective is relatively flat.

The percentage has change because professional services has reduced.

Okay, that helps. And I guess now that you’ve been at Optiva for some time, where do you see margins next year?

The margins historically – again if you look at our past few quarters have been around the mid 50s. We believe that with our restructuring efficiencies and other – if you kind of take out the noise, it'll be around – in the range of low 60s initially.

We do – we are still working through our restructuring plan. I wouldn't say we are at steady state.

There will be some amount of volatility resulting from the product mix, revenue mix that we have every quarter, but somewhere higher than what it was in the past, but I would say low 60s.

Okay and in terms of a contract loss provisions, does that impact gross margins going forward and what's the long term gross margin? I guess more specifically, you mentioned after the restructuring you're going to be at low 60s, but is that your ideal gross margin going forward?

Sorry, let me correct you. Not after the restructuring – after the restructuring is way out there in the future.

While we restructure, I would say the gross margins would be in the range of low 60s. In terms of – what impacts our gross margin the most is really the product – the revenue mix in any particular quarter, the higher the recurring or support type revenue with higher margins the margins tend to pick up.

The impact of last or provisions we made in the last contract is that the quarter in which we book these provisions, the margins were lower. And because as we complete these projects the costs are you utilized against that provision, it’s not charged to cost of revenue and that is why as we draw down these provisions the margins look better in the quarter in which we are drawing down these provisions.

So there is still about a couple of million left in those provisions, the drawdown will be dependent upon progress made in those projects in those quarters and I would expect that the provision will be drawn down for probably the next couple of quarters.

Okay thanks, Anin and next year do expect to be cash flow breakeven as well or positive?

At this point we’ re – kind of the only message that we put out there is the goal to run cash flow breakeven in our Q4 and we haven't – and we don't give guidance for the future year, so that’s about as far as we're willing to comment at this point.

That makes sense Danielle. On the multi-million renewal of the Tier 1 APAC CSP you press released earlier, what's different to Optiva?

I know you touched on this, but more specifically when it comes to this renewal, what made that CSP decided to go with Optiva, does it renew with Optiva again? And you also mentioned in that press release that there's some consolidation in their market, is M&A disruption an issue – could be an issue for Optiva there?

Okay there are two parts to your question what’s different about Optiva. A couple of things with this customer, I think this customer is excited about the customer success message, they’re seeing the change in our organization and typically when I came in to this organization, most customers were renewing 12 months at a time, most of our contacts were like that.

We had a few handful multi-year but this product is a multi-year commitment, this isn't something that you can rip out within 12 months and Swap out. It's a voluntary heart transplant, so our customers take Swap out about project very, very seriously, very consuming and very disruptive.

And so I think one nice sign from this commitment is that it's a multiyear agreement and I'm hoping that more and more customers start to realize that, so that clarity of [ph] financial standing that we had in the relatively recent past those days are over. And they're willing to commit to us for multiple years and so that that's really exciting.

I think they're listening to our vision around our products and I think they're willing to give our vision a try, right they agree with that and I think it's right and so that's very encouraging. Now, it’s exactly the amount of time you would need to Swap us out, so if we are unsuccessful there may not be a renewal after that, so I think there is still that risk, but at least where we are right now they're like okay, we're listening, we like what we're hearing, we like your vision, we're willing to sign a contract that’s longer than the 12 months that we signed before and I think it's still a little bit of a wait and see and see how you do.

And so like I said in my message, it's all about execution, there's a lot of things that need to come together. This is a long process that is not going to be quick and I keep trying to encourage the investor community to have a very long term outlook on turn – this is not going be a quick turnaround, right.

If I had Pixie Dust I would use it, but it’s – I don't – and it's going to take a long time. And then your second – what was your second question again do you remember?

Yeah, so you mentioned that there's some consolidation in that market in the press release, so I was wondering whether M&A disruption in that market would that be an issue, like I’m not sure which market in APAC that you are referring to, maybe India, I’m not quite sure but, yeah.

So any time there's some consolidation anywhere not just in AsiaPac, but anywhere. There is a risk that you're the losing vendor, right.

And we see it all the time, I mean, there's a new person that comes in and he or she likes their system. You may lose based on that, just based on the relationship.

That's why I think customer success is super important because it’s a differentiated relationship, but if you're really seen as a strategic partner when those kinds of events happen you have a slightly – you have a little bit of an edge there, they really do believe that you are focusing your company for their benefit and their gain. And yes, there are that risk at this account, right.

So there is a competing product, it is one of the major competitors of ours, company that is very, very large and they could pivot to the other vendor. So back to it’s a three year agreement that's exactly the amount of time you would need to swap out.

So it’s kind of like the sort of bad way of looking at the situation. On the positive side, I think they are responding to our messages and they like what they're hearing.

So it is good news bad news, I think I don’t know, but it’s a little bit of both.

Okay. Yeah that helps Danielle.

I guess last question for you would be you’re talking a lot about customer success and that certainly seems like what you should be focusing on, but Danielle, like how should we see licenses going in? What’s the timeline for that just because want to get an idea of whether a potential new license for new software or subscriptions sales offset those declines with existing customers.

Yeah while we've been focused on primarily fixing and working with our customers on the customer success and then certainly fiscal year ’18 has been heavily focused on the restructuring plan. I’ve not really pushed the sales team to go get new licenses and new sales from new customers.

We certainly have been servicing the customers we have, right and there's been expansion there and as Anin mentioned, customers are leaving, extending and leaving a little bit more slowly. But it's a little bit like walking and chewing gum at the same time, it's really hard and I stress this is with my team a lot.

It’s very difficult to fix a company and at the same time go chase growth because they kind of are orthogonal to each other, right. If you're focusing on growth you want a lot of stability and not a lot of change at the company.

If you're working on fixing the company you want a lot of change really fast, right and so they kind of work against each other. So I have purposely taken ’18 and said take your foot off the gas in chasing new customers, let’s focus on fixing our customers too.

If you recall year ago, we were about 20% customer success, which is a horrible score. And we had a ton of restructuring to deal.

As I said in my message, I see customer success coming up, I see higher numbers coming into view, I think we have a unprecedented opportunity to take advantage of the message of moving telco to the public cloud and I feel I am unique on this message. I think I am ready with my products and so we're going to try to push on that gas, but – the pedal there to start to get new customers and sell the cloud products and features to our existing customers.

Like I said, this is not going to take months where you’re going to start to see that revenue tick up, it may be years out. So I think when you guys are thinking about your models my revenue goal post of 90 to 120, I'm going to still hold to that.

I mean, we are still shrinking, I still expect us to shrink. We're going to start to push on that gas taking this as a temporary window of opportunity, but it's really risky.

It's kind of all or nothing, we're betting the company on this idea and obviously we think it's going to work, but it's going to take time and I caution you to think in years not in months.

Okay, that’s helpful to Danielle. Thanks so much, I’ll pass the line.

Cool.

Alright, well everyone thanks for listening. Always great to talk with you look forward to our next call which is in December our Q4 and fiscal year.

And good luck with their earnings season. Thanks again.