Absolute Software Corporation (NASDAQ:ABST) competes in a fast-growing cybersecurity sector that is going to continue to grow for many years. It had some decent numbers in its latest earnings report, but there were some cracks in the armor starting to appear, which if they widen, could become problematic throughout 2023.
Among the concerns are some changes in length of contracts, conversion of perpetual licenses to term, and an increase in non-renewals of end-of-life product.
At this time, these headwinds are modest in nature. They could easily accelerate in 2023, which would push the growth trajectory of ABST down.
While the company has provided guidance for fiscal 2023, I’m concerned there because of the lack of visibility on the macroeconomic side of things. Even though the company does have contracted ARR, there are a number of headwinds that could quickly change the growth trajectory there, including top management delaying and/or reprioritizing spend.
In this article we’ll look at some of the recent numbers, some headwinds the company faces, and why I think it’s premature to offer guidance in the current economic environment.
Some of the numbers
Adjusted revenue in the first fiscal quarter of 2023 was $54.2 million, up 10.6 percent year-over-year.
Total ARR in the reporting period was $215.7 million, up 15 percent from the first fiscal year of 2022.
ARR in Enterprise & Government revenue of $169.1 million accounted for 78 percent of total ARR and was up 18 percent compared to the first fiscal quarter of 2022. Education ARR revenue of $46.6 million was 22 percent of total AAR and was up 7 percent year-over-year.
Adjusted EBITDA was $11.5 million, compared to $12.8 million in adjusted EBITDA in the same reporting period last year. Adjusted EBITDA margin was 21 percent, down 5.1 percent from the 26.1 percent margin in the first fiscal quarter of 2022.
Adjusted gross margin in the quarter was 88 percent. With the company’s ongoing transition to the public cloud, it is resulting in higher costs which the company believes over time will lower adjusted gross margin by 100 basis points to 200 basis points.
Operating cash flow in the fiscal first quarter of 2023 was $15.2 million.
Cash and short-term investments increased from $67.6 million from $64 million in the prior quarter after servicing its debt and paying out its dividend. After its coupon increased by 125 percent sequentially, the company had to pay out approximately $900,000 more in interest expenses in the reporting period.
Even though there have been some economic headwinds that had an impact on the performance of the company in the reporting period, specifically in education, the company sees growth in the enterprise space and growing activity in its Secure Access product line offsetting that and keeping its adjusted revenue and adjusted EBITDA guidance for full fiscal 2023 in place.
While it’s possible it’ll be able to offset the headwinds, I’m not convinced in the current economic climate that there’s enough visibility over the next several quarters to confidently provide that king of guidance, even with Education accounting for only 22 percent of total ARR. Not only that, but in Enterprise & Government there are a lot of things that could downwardly adjust, such as contract length and slowing in the conversion of perpetual licenses, which are already happening.
Probably the headwind that had the most immediate impact on the performance of ABST was in Education, where supply chain issues resulted in either a number of deals being pushed out or school districts changing from PCs to Chromebooks.
As for the deals being pushed out, management says it expects to sign some of those in the second fiscal quarter. Concerning Chromebooks, the mix has a much higher percentage of Chromebooks now because of their availability to school districts.
The problem for ABST is Chromebooks has a lower ARR per endpoint and represents a headwind for the company. While management sees endpoint population in Education to continue to grow, it expects it to contribute to ARR growth at a slower pace.
As mentioned above, Education revenue was up 7 percent year-over-year, and as a percentage of total revenue it is declining. I think that’s going to continue on in the future, and the impact on the performance of the company will be determined by whether or not the headwinds in Education from supply chain issues are the catalyst, or growth in Enterprises & Government is. If it’s the former, it could be a drag on Absolute Software Corporation in the first half of calendar 2023.
Even with the headwinds, the company sees Education growing at a high-single-digit, low-double-digit pace. If supply chain issues continue to have an impact on Education, I think those numbers, at best, are going to come in at the low side of expectations, and most likely, lower.
Some of the areas macroeconomic factors came into play in the quarter was in regard to length of contracts and conversion of perpetual licenses to term. At this time contract length didn’t have a negative effect on ARR, but it did have a small negative impact on revenue. If the economy gets worse in calendar 2023, this is probably going to result in an increase in shorter contracts as well as conversion of perpetual licenses, which combined, should have an impact on revenue and possibly to a modest degree, on ARR.
For now, the visibility isn’t there to know which way it’ll go, but the economy and ongoing supply chain constraints are definitely headwinds investors need to watch concerning the impact on the performance of Absolute Software going forward. The question that has yet to be answered is whether or not expected growth in the enterprise space and increasing activity in its Secure Access product line will be enough to offset the headwinds in Education, especially if projected growth in Enterprise and Secure Access is lower than expected based upon unforeseen responses to a weakening global economy, if that’s how it plays out in 2023.
We may already be seeing some of that coming from its Enterprise business, which while improving sequentially, started to see some drag from non-renewal from legacy customers at the end-of-life product.
What’s happening in those situations is many management teams are taking tighter control of spending at the top, and the usual result is spending contraction at some level, which in the case of ABST could transition into a significant headwind if non-renewals increase.
Absolute Software Corporation has had some consistent growth over the last year, growing ARR from $187.4 million in the fiscal first quarter of 2021 to $215.7 million in the first fiscal year 0f 2023, but it looks like macroeconomic weakness is starting to have an effect on the company.
And even though the company offered guidance, it concerns me that it did so in light of the lack of visibility concerning the global economy over the next year or so. With the exception of a very few companies, management teams have stated they weren’t going to provide guidance for 2023 because of the lack of clarity on how things are going to play out over the next 12 months. I think that’s the correct way to view it.
As mentioned above, there are already several things emerging in the market that are having a slight impact on the company, such as supply chain issues, length of contracts, conversion of perpetual licenses to term, and non-renewals of end-of-life product.
These aren’t things that should be brushed aside simply because they’re not having a strong impact on the performance of ABST now, aside from supply chain. With all of these things happening at the same time, it suggests it could be in the early stages of a weaker market. If so, these things are going to show signs of increasing in impact on the company, and that will bring about a weaker performance in 2023.
Absolute Software Corporation is trading close to where it was in early June 2020, and I think that reflects uncertainty from the market in the sustainability of its long-term growth trajectory. As the company stands today and the unpredictability of the global economy in calendar 2023, I think it’s going to struggle to gain traction in the near term, by which I mean over the next six months to a year.
Over the long term, with Absolute Software Corporation competing in a sector that is in a growth trend that should last for many years, the prospects for the company look good. However, Absolute Software Corporation is going to have to work through this current period of volatility and have a better economic climate to operate in before it has a chance to achieve its potential.