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Edited Transcript of ABT.TO earnings conference call or presentation 6-May-19 9:00pm GMT

Q3 2019 Absolute Software Corp Earnings Call

VANCOUVER Jun 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Absolute Software Corp earnings conference call or presentation Monday, May 6, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christy Wyatt

Absolute Software Corporation - CEO & Director

* Errol Olsen

Absolute Software Corporation - CFO

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Conference Call Participants

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* David Kwan

PI Financial Corp., Research Division - Technology Analyst

* Douglas Taylor

Canaccord Genuity Limited, Research Division - Director

* Thanos Moschopoulos

BMO Capital Markets Equity Research - VP & Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to Absolute Software Corporation's Third Quarter Fiscal 2019 Conference Call. (Operator Instructions)

Before beginning its formal remarks, Absolute would like to remind listeners that certain portions of today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these forward-looking statements. Any forward-looking statement contained in today's conference call are made as of the date hereof and Absolute does not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable security laws. For more information on the company's risks and uncertainties relating to these forward-looking statements, please refer to the appropriate section of its quarterly MD&A and quarterly financial statements, both of which are available on Absolute's website or SEDAR. I would also like to remind everyone that this conference call is being recorded today Monday, May 6, at 5:00 p.m. Eastern Time.

I would now like to turn the call over to Christy Wyatt, Chief Executive Officer. Please go ahead.

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Christy Wyatt, Absolute Software Corporation - CEO & Director [2]

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Thank you. Good afternoon, and thank you all for joining us on Absolute's Q3 Fiscal 2019 conference call. Joining me here on the call is Errol Olsen, our Chief Financial Officer.

Q3 was a period of further progress for the company with $24.9 million in total revenue, up 7% over last year. Underlying growth is being driven by new customers as well as within our existing customer base where we are seeing both expansion to new devices as well as upsell to our higher priced service tiers. As a result of our continued focus on execution, we saw adjusted EBITDA of $5.8 million, which grew 139%, representing 23% of Q3 revenue, up from 10% in the same quarter last year. We continue to balance growth-focused investment for the future with healthy profitability.

During Q3, we saw $1.1 million of new customer ACV and while we saw growth in our government sector, the net ACV across the business remained relatively flat. Errol will cover this in more detail.

Our top 3 Enterprise verticals remain health care, financial services and professional services. In Q3, we closed significant deals across all 3, including new business, new customer business with a leading provider of health insurance in the U.S.; as well as expansion deals with one of the world's largest financial services corporations and one of the largest multinational professional services firms. We were thrilled this quarter to be recognized as a leader in the Gartner G2 Crowd Grid Winter 2019 Report for the Best Overall Endpoint Management, Best Mid-Market Endpoint Management and Best Customer Relationships with an overall customer satisfaction score of 97% stating that 91% would recommend Absolute as their endpoint security solution.

Looking more broadly as we shared in our recently released 2019 Global Endpoint Security Trends Report, the endpoint security market continues to evolve and we have an exciting growth opportunity in front of us. Gartner estimates that security spending will top $124 billion before the end of 2019. Forrester reports that 24% of security spending is being invested on the endpoint controls, and yet 70% of all breaches still originate on these endpoints as reported by IDC. Our recent report analyzed data from 1 billion change events to reveal that the average enterprise has 10 security controls in place and yet struggles to ensure these controls remain installed and effective due to malfunction, misconfiguration or end-user interference, a trend we refer to as the dark endpoint. It is clear that endpoint security tools and agents fail reliably and predictably and that complexity is driving vulnerability.

Absolute's unique opportunity as the only provider of cross platform BIOS-enabled persistence is to leverage our self-healing or resilience capabilities to address this dark endpoint challenge. In my first full quarter as CEO, we've spent much time reviewing this market and our ability to grow our value within it, and I am incredibly excited about our road ahead.

As we look at the significant market opportunity in front of us, we have identified 4 key pillars around which we are organizing our efforts. The first of these pillars is our persistence platform. Our ecosystem of partners and OEMs is the foundation of our core capabilities. Our continued investment in our installed base and with our OEM partners is an important part of our strategy to connect or land with new customers. This quarter we added a new OEM contract to our portfolio and continued our support of our OEM partners' efforts such as the Dell Security Suite and the Lenovo ThinkShield. Our resilience pillar represents our Enterprise products and the go-to-market efforts focused on our more than 12,000 Enterprise customers that strengthen Enterprise resilience and solve the dark endpoint challenge.

Consistent with last quarter, in Q3, we saw strong interest in our higher price point product tier with 77% of our Q3 new ACV being in resilience licenses. We believe this represents a strong growth opportunity for us in the coming year, both with new customers as well as in customer expansion. Also within our resilience product, we saw the library of custom reach scripts surpass 70 custom scripts and have seen over the past year this library invoked over 2 million actions on end devices.

Our intelligence initiative is focused on enabling our customers to receive valuable insights from their data, such as the efficacy of their endpoint controls and the truth state of their devices and software as we shared in our Intelligence Report. This pillar represents new opportunities to demonstrate value to our customers and our partners.

And finally, our education pillar is our initiative to support and grow our value in the education sector, which continues to represent 35% of our ACV base. Our education customers have unique product and market requirements which we are responding to with our Student Technology Analytics feature. This quarter we saw a number of new site licenses as we continued to gather customer feedback on the product, and added to our proof points that customers are receptive to student technology analytics.

Execution is key to seeing results within each one of these pillars. Internally, we have organized our product management, development, operations, marketing, sales and support teams around each of these pillars. As we are deep in our fiscal year '20 planning cycle, these 4 areas are the focus of our discussions.

And finally, we have made a number of additions to the senior team, including our new CTO, Dr. Nicko Van Someren, an industry thought leader and innovator in security solutions, formerly the Chief Security Architect for Juniper Networks, the CTO for the Linux Foundation, CTO of Good Technology and the Co-Founder of nCipher.

As well, Karen Reynolds is our new Chief Communications Officer, formerly of HP, BMC Software, Good Technology and Centrify; and John Robinson is our new Chief Human Resources Officer, a former Marine with a long-standing HR career who was most recently with Tapestry Solutions.

We remain focused on what Absolutely (sic) [Absolute] does uniquely well: solving customer problems around the dark endpoint through persistence, resilience and intelligence, and we remain focused on the execution of our strategy.

With that, I'll now turn the call over to Errol for a review of this quarter's results.

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Errol Olsen, Absolute Software Corporation - CFO [3]

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Thanks, Christy, and good afternoon, everyone.

I'll now walk through our Q3 financial results which were highlighted by continued improvement in both revenue growth and adjusted EBITDA margins.

Q3 commercial recurring revenue of $24 million was up 8% year-over-year, while total revenue of $24.9 million was up 7% year-over-year. This compares to year-over-year total revenue growth of 5% in the previous quarter and 1% in Q3 of fiscal 2018. Adjusted EBITDA for Q3 was $5.8 million or 23% of revenue, up 139% from $2.4 million or 10% of revenue in the prior year period. Q3 operating income was $3.5 million or 14% of revenue, up from $1.1 million or 5% of revenue in Q3 of fiscal '18.

The improvement in profitability reflects revenue growth coupled with lower marketing program spending, reduced headcount and a weaker Canadian dollar as compared to the prior year.

Total headcount at March 31 was 466 compared to 495 at June 30 and 501 at March 31, 2018. Our Commercial ACV base at March 31 was $95.2 million, representing an increase of 5% year-over-year and relatively unchanged from December 31.

During Q3, we secured $1.1 million of ACV from new customers, while the net ACV retention rate from existing customers was 99%. The net ACV retention rate in Q3 was influenced by a contract reduction from a large Enterprise customer, which singularly accounted for a roughly 2% reduction in our Enterprise ACV base. This long-standing customer had purchased a significant number of expansion licenses in Q3 of fiscal 2017 but due to conflicting internal priorities, had not yet deployed those expansion licenses.

And as a result, during our Q3 renewal this year, the customer opted to delay the renewal of these expansion licenses until they are ready to deploy them.

In spite of this setback, we were pleased by the fact that new customer acquisitions and expansions and upgrades across other Enterprise customer accounts were sufficient to offset the impact of this 1 renewal.

The Enterprise portion of the ACV base, which represented 53% of the base at March 31, increased 9% year-over-year and was flat sequentially.

The government vertical, which includes state, local and federal government customers, represented 12% of the ACV base at March 31, and increased by 19% year-over-year and by 2% sequentially.

Together, the Enterprise and government verticals represent 65% of the ACV base and were up a combined 11% year-over-year.

The education vertical represented 35% of the ACV base at March 31, and was down by 3% year-over-year and by 1% sequentially.

As Christy mentioned, during Q3 we saw continued adoption of the recently introduced site licensing model for education customers, with a number of smaller site licenses completed in the quarter. We remain encouraged by the opportunity presented by this licensing model where an existing or new customer can have full access to our education-focused solutions at a compelling cost per endpoint.

Looking now at performance by geography, our North American ACV base was up 4% year-over-year and down 1% sequentially. Internationally, the ACV base was up 15% year-over-year and up 5% sequentially.

North American customers now account for 88% of the ACV base.

Turning now to cash flow. Our operating cash flow in Q3 was $900,000 compared to $2.3 million in Q3 of last year. Year-to-date cash from operating activities was $6.8 million compared to $7.6 million in the prior year period. The decrease in operating cash flow was attributable to lower total billings in the current year periods, related to shorter average prepaid contract terms as well as to working capital fluctuations.

Looking now at our expectations for the remainder of fiscal 2019, we're narrowing our expectation for revenue from between $96 million and $99 million to between $97.5 million and $99 million. We are increasing our expectation for adjusted EBITDA from between 16% and 19% of revenue to between 18% and 20% of revenue. We are decreasing our expectation for cash from operating activities from between 10% and 14% of revenue to between 8% and 12% of revenue, reflecting the impact of greater ELA and site license activity.

And finally, we are decreasing our expectation for capital expenditures from between $3.5 million and $4 million to between $3 million and $3.5 million.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Doug Taylor with Canaccord Genuity.

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Douglas Taylor, Canaccord Genuity Limited, Research Division - Director [2]

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I want to center my questions around your desire to drive higher growth versus EBITDA margins. First of all, the outperformance of EBITDA margins has been impressive this year. I want to ask first, is -- I mean, to what extent is this conscious effort to either reduce costs or hold the line or is this due to your inability to fill all the headcount requisitions that you have right now, like it has been in previous quarters?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [3]

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Doug, it's Christy. I'll start. Thank you for the question. I would say it's a combination of both. I would say there has definitely been a concerted effort across -- around the table to make sure that we stay focused on efficient operations. And at the same time as we're going through our own sort of strategic evaluation, I think we've likely been a little slower to backfill some of the existing headcount, as we want to be very careful about where we place those investments. So I'd expect to see us reinvest at least some of that back into the business as we're locking in our 2020 strategy.

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Douglas Taylor, Canaccord Genuity Limited, Research Division - Director [4]

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So further to that second point, Christy, now that you've had the benefit of a full quarter and then some in the seat. Are you comfortable reducing EBITDA margins to drive a higher top line growth expectation?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [5]

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I think that we're -- so I think if you look at the average of where we've been over the past four quarters, I think we're very comfortable operating within that envelope. And I think that right now our focus is on where we reinvest some of the additional efficiencies we've seen over the past quarter, back into the business to accelerate that growth. So as I spoke about on the last call, I think we have a very balanced view on profitability versus growth, and I think we're very comfortable operating sort of within that envelope.

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Douglas Taylor, Canaccord Genuity Limited, Research Division - Director [6]

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Okay. And then on that internationally, I know it's a small -- relatively small proportion of your ACV base, but you seem to be having a lot of traction there. Can you expand a little further on where it is you're seeing that traction internationally, and whether that's one of the areas you'd like to reinvest in building out your international sales organization or go-to-market strategy?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [7]

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So as I mentioned, we're sort of midway through our 2020 planning discussions, and so I want to be somewhat cautious that we're not yet fully locked in. I think we are seeing good results from the investment we're making in international markets. Very specifically, we see that when we go to market with a really invested partner, we see very positive return. And so I spoke a little bit about how we land with partners and then sort of expand and accelerate direct. I think you'll continue to see us do that, but it'll be very selective and very focused on those areas where our partners want to go and open new markets with us.

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Operator [8]

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Your next question is from Thanos Moschopoulos with BMO Capital Markets.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [9]

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Maybe as a follow-on to Doug's question. As we think out towards 2020, and I appreciate it might be early to ask this, but when you think about investments that need to be made and the key positions you're hiring for, would they be more weighted on the sales and marketing side versus R&D? Or would it be the converse or is it both areas that really might need to be a focus of investment in the coming quarters, relative to current spending levels?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [10]

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Sure. If I look at sort of where we have open capacity right now, I'd say it's a blend across go-to-market, specifically sales as well as within R&D. As I mentioned, I think, in my comments, we're shifting the focus on execution into some very narrow spaces. And so this past quarter, we spent quite a bit of time verticalizing and looking at taking our resources and sort of aligning them behind those pillars, and I think our focus in the coming month or 2 will be sort of reinvesting in any gaps we see around any of those critical areas. So I would say it's relatively evenly distributed across R&D and sales as we sit here today.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [11]

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Okay. And as we head into the critical education selling season, you talked about some of the traction with student analytics, would your sense be that given some of the new functionality you have, you might be able to keep that revenue base or that ACV base stable heading to the new -- the upcoming school year and the upcoming [selling] season? Or is it kind of a -- maybe a bit challenging to say until you get further into the process of getting those deals?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [12]

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I don't want to overstate some of the early success proof points we've seen. I think we've seen a number of customers really resonate with both the site licensing model as well as student technology analytics. And I think that gives us reason to be optimistic about the longer-term effect of what we're doing in the education space. As you pointed out, this is a very -- the coming quarter is a very big education quarter for us. I think we're going in cautiously optimistic. But I don't want to overstate any sort of optimism. We still have the dynamics occurring in the education space where we see the increasing presence of Chromebooks, which brings the price point of the operating platform down. Our focus, as we've mentioned before, is with analytics looking more broadly across the education as an enterprise and really looking at what we can do to create value, not just in the classroom, but across all of the educational seats within there. And that's what we're getting a lot of great feedback on.

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Thanos Moschopoulos, BMO Capital Markets Equity Research - VP & Analyst [13]

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Great. And then one for Errol. The G&A expense was lower than I was expecting this quarter. Is this a good run rate for G&A kind of in the very short term? Or are there any puts and takes during the quarter that you'd call out?

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Errol Olsen, Absolute Software Corporation - CFO [14]

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No. I would say that what you saw in Q3 is a good expectation for a run rate on G&A. It was, as we talked about on the last call in Q2, G&A was somewhat anomalous. We had some CEO transition costs in there. And now we've normalized in Q3 so I'd model that number out going forward.

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Operator [15]

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(Operator Instructions) Your next question is from David Kwan with PI Financial.

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David Kwan, PI Financial Corp., Research Division - Technology Analyst [16]

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We saw a nice uptick again this quarter on the gross margin side. I was wondering to what extent the level that we're seeing this quarter and even last quarter are sustainable?

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Errol Olsen, Absolute Software Corporation - CFO [17]

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Yes. Gross margin I would characterize as unusually high in Q3, at about 88%. I think what you should expect on a normalized basis is somewhere around a 85%, 86% mark. And really what happened in Q3 was, we just -- we had several positive balances on the cost front which all sort of accumulated to make our gross -- our cost of sales lower than I would've expected for the quarter.

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David Kwan, PI Financial Corp., Research Division - Technology Analyst [18]

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In terms of the customer response, I guess, with Christy now in the seat, can you maybe talk about some of the feedback that you guys have been getting about, not just the platform but also kind of the outlook in terms of where you guys would like to go? I think one of the things that you guys are looking to do is to make it kind of more of a compelling solution for enterprises, which is obviously important given the -- I think the Enterprise ACV has slowed down that growth. Can you comment on that, please?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [19]

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Sure. I've commented, I think on the previous call as well as this one, that I've spent a quite a bit of time with customers, really looking at how they use our technology and where we're adding the most value. I think this research report we put out most recently about the state of the endpoint is really a result of that. It really is sort of based on what are the hard questions that both CSOs and CIO customers are trying to answer about their environment, and how difficult it is for them to actually get those answers, given the complexity of running these stacked endpoint controls. I think how that's sort of shaped our thinking has really sort of crystallized these 4 key pillars. And very specifically, focusing on our core capabilities and persistence and resilience as a platform, and then building on our intelligence capabilities. And I know that, as a company, we've had a history talking about the value of data and what useful insights we could glean out of that data. So I don't want this to be confused with sort of overfocus on any specific security area like insider threat. I think there's a lot of useful data Enterprise customers already have about their environments. And what we're working very closely with them on, is how do we surface those insights beck into usable information for them. So which of their security controls are working and in what instances are they failing and then how can we apply resilience and self-healing to actually strengthen the Enterprise resilience across the organization. That's not just been something we've talked about in our research report. We've actually taken it to specific customers and run some more analytics exercises within their specific environments and then presented those reports back to them and that becoming sort of a replicable learning tool for our Enterprise customers. And so I think everything we've learned as we've sort of stepped through this process with our customers is really kind of captured in those 4 key pillars I talked about in the comments and how we intend to go better productize and scale those efforts.

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David Kwan, PI Financial Corp., Research Division - Technology Analyst [20]

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And then one last question, just getting back on the growth side. Like in terms of trying to help accelerate the growth, obviously you can look to add headcount and that number has come down in recent quarters. Where have you found it? And where do you think you can get the most bang for your buck if you wanted to try to drive a much faster growth rate in the next few quarters here?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [21]

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So again, I'll caveat with we're in the middle of our 2020 plan, so it's probably a little early for me to give you sort of a definitive outlook. But I see some really interesting opportunities, I think. I spoke a little bit about the customer's attraction to our resilient software and the intelligence we can build around it. And I think that represents a significant expansion opportunity for us, even across our existing customer base. I spoke in the comments about the mix we're seeing in terms of new ACV we're selling, but I think there's still an interesting opportunity to take that back to our customers who are leveraging our legacy products and our existing products and show them sort of the valuable insights that they, too, could be getting from their environment. So I think that is both, I think, an interesting ACV growth opportunity as well as a retention exercise in certain markets as well. As we look at 2020 planning, we're absolutely looking at new product lines in terms of how do we take some of our existing capabilities and turn those into potential new lines of revenue, but I think it's extremely early in the process for us to be talking about those externally right now.

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David Kwan, PI Financial Corp., Research Division - Technology Analyst [22]

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Is there much more that you can do driving business through your OEM partners?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [23]

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Absolutely.

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David Kwan, PI Financial Corp., Research Division - Technology Analyst [24]

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[Without] increasing the marketing spend?

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Christy Wyatt, Absolute Software Corporation - CEO & Director [25]

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So what's interesting about our focus on marketing and again, we've been a bit of a hybrid company. We've had sort of a channel model and an enterprise model. I think we've had this moment of clarity where we really understand how effectively we can be introduced and sort of effectively land and attach with new customers through these leverage partners. And I would say, in partnership with our OEM partners. And so where there's an area, a geographic market or a customer segment that's a high-growth area for them, we're very interested in continuing to deepen our investment in those spaces with our partners. And we have a number of those examples going on as we speak today and we'll continue to look at our marketing spend, I think, selectively as we open those new markets. I think a more horizontal play, right, I think that the interesting opportunity for us is to really show customers in a more horizontal fashion, the valuable insights and the valuable use cases we can solve with some of the other products in our portfolio. And while that may feel a little bit more direct, we are still partnering with our OEM partners at every step across that. So I think that we're very focused on how we sell and grow our book of business with our OEM partners, even in the cases where we may be leading some of those conversations with the customer and then still connecting back with our ecosystem.

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Operator [26]

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This does conclude the Q&A portion of the call. I will now turn things back over to Christy Wyatt for any closing remarks.

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Christy Wyatt, Absolute Software Corporation - CEO & Director [27]

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I want to thank all of you for joining us this afternoon, and we look forward to our next update at the end of Q4.

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Operator [28]

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And this concludes today's conference call. You may now disconnect.