SailPoint Technologies Holdings, Inc.
Q3 2018 Earnings Call Transcript

Published: 8 Nov 2018

[Operator:]

Greetings and welcome to the SailPoint Technologies' Third Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Josh Harding, Vice President of Financing Planning, Analysis and Investor Relations. Josh, please go ahead.

[Josh Harding:]

Good afternoon, and thank you for joining us today to discuss SailPoint's third quarter financial results. Joining me today are SailPoint's CEO and Cofounder, Mark McClain; and SailPoint's Chief Financial Officer, Cam McMartin. Please note that today's call will include forward-looking statements and because these statements are based on the Company's current intent, expectations and projections, they are not guarantees of future performance and a variety of factors could cause actual results to differ materially. Since this call will include references to non-GAAP results, which exclude special items, please reference this afternoon's press release in the Investor section of sailpoint.com for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. And now I'd like to turn the call over to Mark McClain.

[Mark McClain:]

Thanks, Josh, and welcome to everyone joining our Q3 earnings call. I'm pleased to report that the third quarter of 2018 was another strong quarter. In fact, our Q3 2018 results were well ahead of our guidance with total revenue growing 52% year-over-year to $66.4 million, and we delivered non-GAAP operating income of $11.6 million. We believe our results are due to a continuous demand for identity governance, our market leadership and our commitment to delivering innovative best in class solutions to help customers’ secure digital identities for all users, all applications and all data. In fact, Sailpoint has consistently been positioned as a leader by the major industry analyst firms. We have been a leader in every identity governance focus Gartner Magic Quadrant since the first report in 2011. We were also named the overall market leader in both KuppingerCole’s recent Leadership Compass on identity governance and administration, as well as the European analyst firm’s leadership compass on cloud-based identity governance, and most recently Sailpoint announced that we were named the clear leader in Forrester Wave for Identity Management and Governance. Sailpoint and our open identity platform received the highest score across all three evaluation categories strategy, current offering and market presence. We believe our positioning in these analyst reports validates our innovative platform, our strong execution and our comprehensive delivery strategy that provides customers with the freedom of choice to consume our solutions in any way they want to. And importantly, we continue to invest in our platform and recently delivered updated versions of both IdentityIQ targeted to large scale enterprises and IdentityNow, which we target at midmarket enterprises. In August, we shipped IdentityNow 7.3 to address the growing reality of digital identities managed by an organization are no longer limited to humans. In fact, enterprises are increasingly relying on non-human identities such as software bots to drive business efficiencies and to keep pace with digital transformation. IdentityIQ now allows organizations to govern bots and access all our enterprise applications and data just as they would with the access of a human identity. IdentityIQ 7.3 also deepens the functionality for governing access to mission-critical Amazon Web services and SAP environments, ensuring they are secured in the same way as the rest of an organization’s infrastructure. Finally as part of 7.3, we also released our new IdentityIQ accelerator pack, which helps organizations onboard the thousands of applications needed and requested by the users more efficiently and rapidly through pre-configured options and best practice use cases, enterprises can now onboard new applications and configured governance processes in a matter of hours versus weeks. As I mentioned, IdentityIQ is targeted for large scale enterprises. These organizations have incredibly complex hybrid IT infrastructures and need a highly flexible identity governance solution that can deliver the level of scale and performance necessary to manage millions of identities and tens and thousands of applications. In addition to the recent analyst validation noted earlier we continue to help the world’s largest companies achieve success with IdentityIQ, which is one reason hundreds of enterprises have migrated away from outdated legacy tools from CA, IBM and Oracle. For example, in Q3 we closed a sizable net new IdentityIQ customer, who wanted to replace Oracle Identity Manager because of its lack of functionality and non-intuitive user interface. This credit reporting agency decided it was time to migrate to our modern solution and will now use IdentityIQ to govern the identities of its 17,000 employees. Federal governments are also turning to IdentityIQ based on its scalability and performance and we are building on years of success in this vertical. This is especially true with U.S. Federal Agencies, the need to address the Department of Homeland Security’s Continuous Diagnostics and Mitigation, or CDM, initiative to help combat and prevent the risks associated with cybersecurity. In the third quarter, adoption of our identity platform by US federal agencies were stronger than we had expected, including both net new customers and expanding our footprint with existing agencies. For example, one of the executive departments purchased IdentityIQ in 2017 through the CDM initiative to replace a legacy tool being used for user access certifications. Last quarter, this agency added Sailpoint’s lifecycle management capabilities to its program in order to provision and deprovision access for 150,000 users. Sailpoint remains focused on the enterprise market. While large enterprises are heavily weighted towards replacing outdated tools most midmarket enterprises are new adopters of identity governance solutions. Companies in this segment face similar challenges around security, compliance and IT automation. However, they typically don't have a large dedicated identity team or extensive identity governance knowledge. We continue to see success in the midmarket with IdentityNow because the SaaS delivery model addresses these organizations' lack of identity experience and resources, while still providing the enterprise grade identity governance they need. In October, we announced the latest enhancements to IdentityNow to make identity governance even more accessible to midmarket enterprises. That point was validated by FTD, one of the largest online floral delivery companies in our recent IdentityNow press release, where FTD reported they had achieved quick wins on the audit compliance front and now have a comprehensive identity program in place with only one dedicated person on staff. Some of the new features in IdentityNow include the dynamic discovery engine, which allows users to easily and quickly create new policies, access reviews, dashboards and reporting by identifying and editing existing ones. It also includes a streamlined separation of duty policy management that drastically simplifies and speeds the process of investigating access, quickly uncovering any access related conflicts of interest and creating automated policies that ensure compliance. We believe IdentityNow is the most comprehensive true SaaS identity governance platform available today, which is what the midmarket organizations tell us they need. For example, in Q3 a midsized retail chain purchased the full suite of IdentityNow. The company was new to identity governance and had previously addressed their identity related needs manually, which was costly, time-consuming and frustrating to their corporate staff. With IdentityNow they will quickly be able to automate the entire user lifecycle in order to securely and confidently enable their employees. In summary, Sailpoint is the recognized leader in identity governance innovation. We continue to invest in our best in class solutions and they are being selected as the identity platform of choice for enterprises of all sizes that want to improve their overall security, compliance and IT efficiency. Now let me hand it over to Cam.

[Cam McMartin:]

Thank you, Mark, and thank you to everyone on the line for joining us today. SailPoint’s third quarter financial results beat our guidance on both the top and bottom lines, with strong revenue growth, positive non-GAAP operating income and meaningful cash flow from operations. Total revenue was $66.4 million, an increase of 52% over Q3 of 2017. License revenue increased 66% year-over-year to $28.1 million, and was well ahead of our expectations. This result was driven by exceptionally strong federal performance coupled with a balanced contribution from other verticals. As we mentioned on our Q2 earnings call, we expected our federal business to be spread across Q3 and Q4 in line with recent historical patterns. However, the large majority of our expected federal business closed in the third quarter of this year. Subscription revenue increased 54% year-over-year to $28.5 million. This was driven by a combination of healthy SaaS gross and strong IdentityIQ maintenance renewal rates that remain above 95%. In addition, we want to note that Q3 subscription revenue benefited from approximately $700,000 in nonrecurring catchups. Services and other revenue was $9.8 million, up 22% compared to Q3 of 2017 and was slightly ahead of our expectations. On a geographic basis, the United States contributed 69% of revenue in Q3 and the rest of world made up the remaining 31%. This compares to 75% in Q3 of 2017 and 25% for rest of world. We continue to be pleased with our performance on a global basis. The quarter’s strong results highlight the investments we’ve made over recent years in several new markets. With that said, our international business in the quarter benefited from several large deals and from an increasing revenue contribution from our SaaS business. Given this and the fact that our international business is not still at scale, we believe it is best to assess our international revenue growth on a multi-quarter basis as we have noted before. As I transition to the remainder of the income statement, I want to note upfront that unless otherwise stated, all references to expenses, margins and operating results are on a non-GAAP basis and are reconciled to our GAAP results in an earnings release that was just published before this call. In Q3, license gross margin was 99%. Subscription gross margin was 83%, an increase from 79% in the third quarter of 2017 due to improving scale of our SaaS business and increasing maintenance support efficiency. Within our services business, gross margin was approximately 26% in line with the third quarter of last year. On a combined basis, total gross margin for the quarter was 82%, compared with 77% in Q3 of 2017. Moving to operating expenses, we continue to make investments throughout the business in order to drive top line growth, deliver product innovation, and strengthen our leadership position. Total operating expenses for the quarter were $42.5 million, compared with $30.8 million in Q3 of 2017. Overall, our operating income was $11.6 million in Q3, resulting in an 18% operating margin for the quarter, which benefited from the license outperformance we referenced earlier and is well ahead of our prior guidance. This compares with an operating margin of 6% in the third quarter of 2017. Net income was $11.2 million for the third quarter of 2018, or $0.12 per fully diluted common share, compared to a net loss of $1.1 million or a loss of $0.02 per basic and diluted share for the third quarter of 2017. Adjusted EBITDA was $11.8 million in the third quarter of 2018, compared with $3.4 million in the third quarter of 2017. As of September 30, 2018, cash and cash equivalents were $83.4 million. During the third quarter of 2018, we generated cash flow from operations of $3.8 million compared to cash used in operations of $200,000 in the third quarter of 2017. In the third quarter, we added 69 employees and ended at 936 employees, a 22% increase over the third quarter of 2017. Before we turn to our Q4 and full year 2018 guidance, I’d like to update you on our adoption of ASC 606, which we plan to implement on a modified retrospective basis. Sailpoint is in a unique situation, where we are required to report our fiscal 2018 results and issue our 10-K under 606. However, in addition to 606 figures we plan to percent 2018 quarterly figures both on a 605 and 606 basis for comparability. We will continue to assess any impact from 606 and plan to update you when we report Q4 results. Moving to guidance. For the fourth quarter of 2018, we expect total revenue of $70 million to $71.5 million. We expect a non-GAAP operating income in the range of $8.5 million to $10 million, and a non-GAAP income per diluted share of $0.08 to $0.09. This assumes cash taxes of $800,000 and 91.5 million diluted shares outstanding. For the full year of 2018, we are raising our guidance and now expect total revenue in the range of $240.7 million to $242.2 million. We now expect our non-GAAP operating income to be in the range of $27.8 million to $29.3 million and a non-GAAP net income per diluted share of $0.25 to $0.26. This assumes cash taxes of $1.5 million and 90.5 million diluted shares outstanding. Let me now provide some additional color on our guidance, we continue to see solid momentum in the business and are raising our full-year revenue and profit targets. As I noted earlier, our third quarter license revenue was positively impacted by greater than expected Q3 deal closures within the federal vertical. These movements are reflected in our Q4 guidance, which assumes license revenue of $32 million to $33 million in the fourth quarter. When you look at Q3 and Q4 license revenue in combination, our guidance for the second half of the year implies greater license revenue than we expected when we guided in August and strong growth for the full year. We also expect subscription revenue to increase sequentially by approximately $500,000. With the continued growth in the subscription line, we are on track to exit fiscal 2018 with the majority of our product revenue coming from recurring sources. When looking at year-over-year comparisons for the fourth quarter in addition to the shift in timing of federal deal closures it is important to remember that we recognized approximately $4 million of license revenue and $1 million of nonrecurring subscription revenue in the fourth quarter of 2017 that came from contracts signed prior to that period. On the OpEx front, we continue to manage the business to balance growth with profitability and positive cash flow and we are meaningfully increasing our operating profit guidance for the full year. Finally, I would like to note one item specific to Q4 OpEx. We now expect to recognize approximately $2 million in one-time facilities expense related to our new Austin facility, which we had previously expected to capitalize and depreciate over an extended period of time. This change is reflected in our Q4 operating income and EPS guidance. In closing, we are pleased with our performance. We continue to believe we have the opportunity to drive strong top line growth for many years, while continuing to deliver non-GAAP operating income and positive free cash flow. With that we will now open up the call for Q&A. Operator?

[Operator:]

[Operator Instructions] Our first question is coming from Walter Pritchard from Citi. Their line is now live.

[Unidentified Analyst:]

It is actually Jeremy on for Walter. I have two questions. First, I saw I think in the federal vertical I guess can you talk about what drove strength here and are there specific programs where you are seeing a big uplift from – like EDM, and then, what would you attribute the earlier than anticipated closure of [indiscernible]?

[Cam McMartin:]

Okay, great. Thanks Jeremey. This is Cam. I appreciate the question. Yes, so the strength in the business as we highlighted in the prepared remarks was nicely beyond what we had anticipated for Q3, but overall for the second half of the year our expectation continues to be really fundamentally unchanged for the federal vertical for the second half of the year. As we have highlighted for you previously the federal vertical in total along with state and local and education is low double-digits as a percent of our total typical business mix. And again the second half of the year for us looks like it is going to be stronger than that overall for 2018, really driven by I think a continuation of heightened awareness and attention in the federal government around reach risk, and as we have highlighted in prior calls, we won the CDN program several years ago. We have delivered now to many of the federal government agencies on the civilian side, both department and agency business has been strong for the last several years and [indiscernible] really represented a continuation of that trend but as we've highlighted more concentrated in Q3 I think we attribute that fundamentally to an awareness of urgency coming from those agencies and departments that they need to accelerate their progress and in looking at where they were relative to the CDM goal timelines they felt like that purchasing in Q3 was the right accelerated decision and so again last year what I think I'd committed in the Q2 call was we were expecting a more balanced mix between Q3 and Q4 but it pulled all into Q3 not all but largely into Q3 as a result of this I think heightened awareness and urgency on the buying group.

[Unidentified Analyst:]

Okay. Guys it's helpful and then on the Q4 revenue guide license came down by roughly 5.5 million at the midpoint first [indiscernible] guys granted full year's total revenue did go up by about 7 million but should we think of 5.5 million as sort of the pull forward into Q3 from Federal? And then should we anticipate any further revenue referrals or flush in Q4?

[Mark McClain:]

Well, so a couple of comments, yes largely what the adjustment in Q4 from a guide perspective is reflects the federal acceleration out of Q4 into Q3 and that's essentially the move that you're seeing. Again we had expected in the way we had guided Q3 previously back in the summer that we would see if you will a balance or a split between Q3 and Q4 and we saw, what we really saw was a concentration in Q3. Again we will have federal contribution in Q4, I want to be clear on that, as we look at the mix of business that we're working to close for the quarter but we're seeing a bigger concentration in Q3 of this year and different from prior trend in terms of that business mix split. So we have guided in a way that we think reflects what Q4 performance will be reflecting that $6 million-ish pull forward into Q3 for federal. Overall, what you can see is that the business for the full year on a license basis is going up. At the end of the day we have increased our total license business several million dollars for the second half of the year. That's reflected in the way we've guided Q4 overall, and as we look at the business for Q4 we think we have properly reflected the overall federal contribution that we expect for the second half of the year in the way we've guided. What I can remind you of what we highlighted in prepared remarks is, last year we saw as the year -- as the quarter closed a bit of budget plus acceleration in the buying behavior as we told you last year in the results of the fourth quarter was we saw buying behavior accelerate. We're not reflecting any of that type of activity in our guidance at this point because it was a typically high for us last year. It moved to the high end of our typical close rate range in the way Q4, ‘17 performed and we have prepared our guidance for Q4 of ‘18 philosophically consistent with how we've guided quarters during calendar year ‘18. So I think that's important. So again it's an uplift of a couple of million dollars and the way we've guided second-half license revenue for the full second half of the year but effectively largely concentrated in Q4 based upon the way the pull-push worked.

[Unidentified Analyst:]

Okay got it. Thanks guys.

[Mark McClain:]

You bet, thank you.

[Operator:]

Thank you thanks to our next question is coming from Matt Hedberg from RBC Capital Markets. Your line is now live.

[Matt Hedberg:]

Hey guys, thanks for the questions and congrats on the strong results here. I'm getting a lot of questions obviously on the Q4 guide. I think sort of mid single digits, it seems to be all timing related to me, I guess Cam is the right way to think about this given the federal deals that pulled in, should we normalize by backing out the $5 million out of Q4 of last year and then really looking at the second half of ‘18 versus the second half of ‘17 that implies close to I think 29% growth but the second half of the year, is that's kind of the right way to think about normalize growths for you guys?

[Cam McMartin:]

It is Matt. I think fundamentally as you look at it there are a number of moving parts in all of this as we, in terms of the way we guided reflected our results for last year for Q4, ‘17 we talked about this four main of license revenue in the ‘17 period of Q4, $4 million coming into that quarter that's not expected. So you need as you think about your year-over-year growth rates remember to take that into account as well as a million dollars of non recurring subscription revenue falling into Q4 of last year. Obviously, I highlighted in the prior question that we also saw kind of an exceptionally high Q4, ‘17 close rate percentage that we attribute to budget flush and then for this year, the way we're looking at it Matt is it's about $6 million of total business that moved into Q3 out of Q4 and so you can normalize your growth rates that way and finally to your last point, yes I think the way you should think about this and looking at what the overall performance of the business is to look at it on a full to half, second half basis and, yes that gives you a healthy mid 20 to upper 20s growth rate overall which obviously we're very pleased with in terms of the strength of our overall license business. We continue I think Matt to see good performance across the vertical segments. We have talked today a lot about federal so far but in addition the rest of the verticals all contributing up in a pretty typical fashion. There are always ups and downs in a particular vertical for the quarter but historically strong financial services business was good in the quarter. Other verticals were strong as well. In addition, we saw a good contribution on the license side across the globe as well. So as I look at the underlying strength of the business I am pleased with the overall performance of the business taking into account that there's a bit of anomalous activity in Q3 of this year just based upon what we felt like in the buying activity that we saw late in Q3 was an increased urgency on the behalf of the federal buyer to get this product in their hands so they can get underway for deployment.

[Matt Hedberg:]

Super-helpful. That's great and then for Mark, in your prepared remarks you talked about the accelerator pact. And we've been hearing a lot about that as well. It seems like a really interesting way to get customers live quicker. Can you talk about some of the adoption that you're seeing there? What sort of customers are taking advantage of that and is there a way to kind of think about the monetary impact from the accelerator pact?

[Mark McClain:]

So yes, now let me split into two different thoughts there. One is kind of impact on the rollout because a lot of our focus here was to accelerate our customers ability to get value at a faster pace. I mean the truth is in these very large complex enterprises sometimes getting these apps onboard it is tricky because of the nature of the application and sometimes it was true that we required more technical expertise than we wanted and so what the [indiscernible] is it basically help business analysts answer a few simple questions that allow them to quickly, roll that next app on board and literally kind of cut on the potentially like an order of magnitude like from weeks or even a month or two to days or occasionally hours. And so I think our goal there is to really help our customers who are already committed and in the process of rolling out to rollout much faster. So that was kind of a thrust of it. Now that said obviously we're positioning it and pretty much all of our new business particularly those large complex enterprises because we know they'll get a good advantage from that. I will probably flip back to camp I don't think we would say that's going to noticeably show up in the financial results because it's a nice little add-on to the business it's not like a significant financial mover for us.

[Cam McMartin:]

Yes Matt, so this Cam just follow on a couple of comments I'd make, one first of all I think importantly and you and I talked about this out-of-band from this call, the accelerator pack I think is an important addition to the overall solution set we can deliver to our vendor to our customers excuse me, because it represents an accumulation of all the knowledge of now having installed and literally hundreds of large enterprises across the globe, across many verticals and so what it does is it takes all of the deployment knowledge, all of the architecture knowledge, all vertical industry knowledge and brings it into a new solution that a customer can use to help accelerate rollout of the application across their internal environment. From a financial perspective the way I think about it is much like you've heard us talk – spoken previously about excel about Pam module for instance or service pack integration models, all kinds of things like that. So it won't be a large contributor overall to revenue. It will be a positive contributor but we think more importantly is it will accelerate the customers' ability to get real value from the solution and therefore as you well know because we are a land and expand business model that is we don't sell the entire enterprise up front, it gives us a chance more readily to capture the next wave of buying from that customer because they'll be more readily able to address the first phase of implementation and therefore that second phase will come more quickly as our expectation.

[Matt Hedberg:]

Super, helpful guys. Thanks.

[Mark McClain:]

Thanks Matt.

[Operator:]

Thank you. Our next question today is coming from Rob Owens from KeyBanc Capital Markets. Your line is now live.

[Rob Owens:]

Wonderful. Thanks guys. Appreciate for taking my question. If we look at the CDM program, it actually seems like December and March quarters, could actually see kind of reasonable spend. So I guess there is a couple questions relative to your results. Number one, why do you think that your segment was accelerated, maybe relative to the rest of the market and number two [indiscernible] where do you think the opportunity is relative to the government spent?

[Cam McMartin:]

Yes. So again first Rob good to talk to you. Thanks for the question. I comment that our market read was that the federal buyer was as a result of the progress they've been making along other implementation cycles of our compliance manager product that some agencies wanted to go ahead and buy compliance manager through the CDM program. Others began buying lifecycle manager. Again our read of the market and our customers is that they are more urgently addressing what they saw to be their identity governance requirement in order that they have better control over who has access to what applications and they can manage that lifecycle more effectively than they can today and we saw that across many different departments and agencies in the way buying played out in Q3. We do believe to address like what I believe was your second question, portion of your question we do believe that there is additional buying opportunity in front of us. We have not fully addressed this segment and expect that we'll see business going forward. The timing of which is always a little difficult to project for you as we think in the first half of the year, as I mentioned earlier to a prior question we do have business in our pipeline for Q4 that we would expect to close. We did as we looked at the totality of performance in Q3 and the expectation for Q4, what I would tell you is that overall our belief is that the Federal government business contribution will be in line with our expectations that underpinned our guidance back in the summer time for the second half of the year. Across ’19, we think there's additional opportunity but we're watching and work with our partners in the Federal government to make sure that we're supporting the rollout of all the agencies that have bought today knowing that we haven't fully addressed that segment and we expect there to be a future buying behavior there.

[Cam McMartin:]

[indiscernible] kind of moving from guidance of the law?

[Rob Owens:]

Yes, directive to law. Thank you.

[Cam McMartin:]

Yes. Rob I don't know that we can speculate on exactly the impact that kind of thing might have. I think we're watching a lot of things in the legislative realm everything from GDPR kind of snuck across the [indiscernible] this way and showed up in California and probably would show up in other states and maybe show federally at some point that that's a factor we're watching. We're certainly watching like you said the directive around getting in our minds, the Fed response was largely because of the OPM breach way back whatever that was not three or four years ago and interestingly enough, although the federal government doesn't always lead the commercial market and technology and security they kind of do in some respects and, so I think to the extent that the federal government starts to move more aggressively on some of these things we would anticipate that would have a generally positive impact for us not only in the Fed but also in commercial but again I certainly couldn't try to speculate so we are going to have percentage impact there.

[Rob Owens:]

Okay, great and to ask my second leading question that I have relative to the federal surprise was it all timing related or was it some scale related as well?

[Cam McMartin:]

Largely timing related Rob. I think we feel like as we've looked at both the contribution that is reflected in the Q3 results, Israel as well as our expected Q4 contribution that overall the businesses as we looked at Q3 and guided for Q4 that our expectation is the second half will be largely in line with what we had anticipated the business would be when we guided back in the summer time for the third and fourth quarters.

[Rob Owens:]

All right. Thanks guys. Appreciate it.

[Cam McMartin:]

Thanks Rob.

[Mark McClain:]

Thanks Rob.

[Operator:]

Thanks. Our next question is coming from John DiFucci from Jefferies. Your line is now live.

[Unidentified Analyst:]

Hi this is [indiscernible] on for John. Two questions probably for Cam, actually one I want to circle back on the Q4 guide as well just look at it from a different angle I guess beyond the federal though was there any commercial business that might have also been pulled from into 3Q from 4Q? And then bigger picture too was there like any shift in business momentum positive or negative beyond federal just to clarify?

[Cam McMartin:]

Yes, Julian so I'd say overall we didn't see any meaningful business move out of Q3 and Q4 on a commercial basis. If they're always puts and takes from, basically out of Q4 to Q3 excuse me, so we didn't see a pull or there's always as you well know puts and takes deals move in deals move out, that's a normal course activity but overall there was not a meaningful commercial effect like we saw the very large federal government effect in the way to Q3 played out. To the macro question that you asked I think as we look at the market we continue to see good health, good buying trends, good demand, continuing strong interest from the, if you were the target customer sets that we're addressing both at the large enterprise size of the market as well as the mid enterprise. So we're very comfortable that we've got a healthy market moving forward based upon all the interaction that we're having with prospective buyers as well as with the success of our existing implementation lifecycle, a continued healthy contribution in the business from up-sell cross-sell activity for existing implementation. So we think those two factors pretend well as we look forward for future business performance.

[Unidentified Analyst:]

Okay, thanks. And just one more question on the gross profit on the subscription business the gross margin really, that has been ticking up sequentially quarter after quarter. What I guess, how should we start thinking at going forward for the gross margin on subscription, is that low-80s number going forward like or what's the right way to think about that? Really does it keep going up sequentially from here or what's the right way to think about?

[Mark McClain:]

So Julian I give you some general comments overall on a gross margin basis for subscription. The two factors that we've highlighted for you previously continue to play out. First we continue to find good operating leverage on the maintenance side of the business by virtue of the increasing scale of that business and the efficiencies that our internal team are really driving that it's been gratifying to watch our internal team be more efficient as we've scaled in terms of number of customers and global coverage and footprint. So that I think is a testament to the team's work that they've done to find ways to deliver high quality maintenance and support services with if you will more scale and more complexity of support. We think that's an important overall piece of the mix. In addition, with the continued growth of the SaaS business we are seeing improving scale and gross margin performance there and that has been a trend we've highlighted for you previously So now on to the substance of your question I think we believe we can continue to improve gross margins and not at a rapid pace but at a steady modest base much like you've seen in prior quarters. There's room on both revenue lines within the subscription line two, in fact make improvement still, the larger improvements given the relative scales of those two revenue contributors. The relative growth will be more on the SaaS side of the business than the maintenance side but there is room to improve on both.

[Unidentified Analyst:]

Okay. Perfect. Thank you.

[Cam McMartin:]

Thank you Julian.

[Operator:]

Thank you. [Operator Instructions] Our next question is coming from Melissa Franchi from Morgan Stanley. Your line is now live.

[Melissa Franchi:]

Thanks for taking my question. I wanted to hit on the international strength of the quarter. Cam I think you mentioned that it benefited from large deals to take sort of a multi quarter view but it doesn't sound like this in your commentary that there was necessarily pull forward that happened to be three internationally. So I'm just wondering if you could comment on what's working well for you internationally, I guess related to that are you seeing any traction in governments outside of the U.S. and maybe contributing to international strength?

[Cam McMartin:]

Yes, so I will tackle your second question first. I think we've had success outside of the U.S. in selling to governments at the federal level and at the equivalent of U.S. state level across the globe that's been part of our contribution. I would not say the recent couple of quarters represented in a typically large contribution from those non-U.S. governmental entities Melissa, that they're solid ongoing contributors and we're seeing an ability to go address needs in those countries similar to what we're addressing in the US. So on to the first part of your question the help in our international business we've highlighted for a couple of quarters now I think we fundamentally are pleased by that as we've highlighted you previously we've been making investments to expand both in ENMEA and an APAC and for that matter other countries of the world because we saw that the identity governance problem really is a global problem that large enterprises wherever headquartered really have the same identity governance challenge and we've shown an ability to sell to them now for many years. And what's really working well to answer your question is that we've taken our best learning really from especially the U.S. markets translated into our selling approaches and adapted for local market conditions across the globe and it's working productively. And that includes a very experienced direct Salesforce, a very tight coupling to our partners in those local markets and a quite frankly a very razor-sharp focus on customer success as they bought the product and deploy the product. We think those are key variables that really contribute to our overall global success in the business.

[Melissa Franchi:]

Okay, thank you. And one follow-up on the competitive environment. I know we've talked about Mark talked about displacing Oracle and other legacy vendors. Particularly interested to hear if you've seen any sort of benefits from the CA transaction in particular, if that presented more opportunities for you over the past few quarters?

[Cam McMartin:]

Yes, Melissa. I'd say nothing dramatically we would point to. I think, a lot of those customers, existing customers, so there's kind of two categories there when we're going in to compete on a new deal, the CA show up to compete. And in general, we don't see them as a real strong player in a kind of a net new environment. It's more about their install base. And I think a lot of those customers have been kind of in a wait state to see exactly how this would play out as the deal close. Number one, and the rumors have been all over as to whether that'll would be any significant movement in or out of Broadcom of all of the various assets that state they got with CA. So, I think until people see how that settles out, they're mostly kind of in a wait-and-see mode. I think we are certainly trying to engage in customer situations like that where the customer is at least considering making a change and try to position what we think is our superior offering, point to the 100s of displacements we've done with CA. And then, watch and see if there is probably more of a pickup of movement in 2019. I think we're hopeful for that I wouldn't say we're forecasting it yet but we're hopeful there may be a little more "unsettledness" if that's the word to that customer base in 2019 and we'll just have to see how that plays out.

[Melissa Franchi:]

Okay got it. Thank you, very much.

[Cam McMartin:]

Thanks.

[Operator:]

Thank you. Our next question is coming from Alex Henderson from Needham & Company. Your line is now live.

[Alex Henderson:]

Great, thank you very much. I was hoping you could talk a little bit about the international market in the context of the slower and conditions on a macro basis versus the benefits from GDPR and maybe parse between those two variables and your international build. Have you seen any slowdown in the international market in terms of your pipelines going into the fourth quarter because of the economy decelerating and can you parse between those three factors a little bit?

[Cam McMartin:]

Yes Alex, this is Cam. I'll start and let Mark jump in. I think firstly, let me start with GDPR. I think we said previously we continued as we assess our business to believe that GDPR for us is still an opportunity is in front of us today. That we are interacting routinely with many organizations about how they're planning to address their GDPR obligations. And we believe as they think about what they're going to do from a systems perspective than both our compliance manager solutions within the IIQ and ID. Now families as well as our security IQ solutions that we can add real value to their overall effort to address GDPR but I can't point you today to any meaningful business contribution and we had not expected there to be any. It hadn't reflecting any real contribution of significance in our business for 2018. As it relates to the economic impact, I would say in terms of the international markets, we haven't seen any impact to-date in the outlook of our business for as a result of changing economic conditions that is softening as you've used the phrase. I think our pipelines continue to be healthy there. We're seeing good business across the geographies. I won't point at any particular country. There are always puts-and-takes because of deal timing; given the scale of our business. But in general, we haven't seen any softening of the outlook as a result of what looks to be a somewhat less attractive GDP growth opportunity outside the U.S.

[Alex Henderson:]

Great. Just to clarify. When you book a sale to a U.S. Company but it's an international arm of that U.S. Company, is that booked as an international sale or a U.S. sale, that's an international sale I would assume?

[Cam McMartin:]

Well so, our general approach always has been we reflect revenue based upon the headquarters entity that we're selling to because usually it is a corporate buying vehicle that's getting bought. So, take a large enterprise that's domiciled from a headquarters perspective in the U.S., we would report that as domestic business because in general in that case they're going to deploy that solution both in the U.S. and for all their operating units across the globe. And likewise, if a business is domiciled in the EMEA region or in the APAC region, we'll report it there in terms of the numbers that we're sharing with you even though it's going to be deployed in the U.S. or deployed in EMEA if you will if you're thinking about it from an APAC perspective. So, we really look at it in terms of where the headquarters entity is domiciled. That for the most part that is how people buy.

[Mark McClain:]

Yes. The only add I'd give you there, Alex, is obviously sometimes there's variability in corporate structure is how independent a wholly owned sub is and so if the business is really being driven by wholly on sub and it's not an enterprise deal and wholly on sub isn’t a deal, we're going to probably reflect it there.

[Cam McMartin:]

Yes.

[Mark McClain:]

So, I think just to be clear, it does kind of depend on the buying structure and the scope of what the customer is actually purchasing.

[Alex Henderson:]

Perfect. Thank you, very much.

[Mark McClain:]

Thanks, Alex.

[Cam McMartin:]

Thanks, Alex.

[Operator:]

Thank you. Our next question is coming from Gabriela Borges from Goldman Sachs. Your line is now live.

[Gabriela Borges:]

Good afternoon and thanks for taking my question. This first one is for Mark, which is generally speaking outside of the federal vertical, when you're successful in displacing some of your own comments; what is the catalyst for that initial engagement and ultimately that displacement? Because it sounds like it's not GDPR yet to the extent that it might be. So, what do you think it is that catalyzes that installations and displacement? Thanks.

[Mark McClain:]

Thanks Gabriela, good to talk to you. I would say it does really kind of come from at all three of the kind of core value propositions we have reflected in some of our prior conversations, meaning sometimes it is a compliance driven issue where they are either failing or fear of failing audits and they are responding to that need and they saw the current solution is inadequate to address it. Sometimes it is security-related value proposition either again an actual breach or a threat of breach or a breach in a significant significantly similar vertical. I would like to say retail got caught for us after target. And then, the third is probably quite more common you might think and that's just a fundamental IT efficiency and operations of particularly the lifecycle management side of our offering. If you think about it, all these large organizations do have a tremendous volume of turn of identities coming and going and moving, we thought that's going to move a lever parameter on. And quite often these older legacy solutions have to simply run out of gas, their ability to continue to keep up with a rapid change particularly in the application infrastructure which is I think the more SaaS than Cloud. And sometimes that's a catalyst for dialogue. As I've pointed out in a couple calls in the past, no matter which of those doors to call them a door for a second that we enter through, we end up having a conversation about all three value props but the emphasis really can't come from any one of the three.

[Gabriela Borges:]

Very good. The follow-up is for Cam which is on the medium-term outlook for margin. Can you gives us a sense of where you are in your cadence of investment for enabling the channel system integrators partners all of that good stuff? I'm just wondering if there's a scenario where given the out performance on EBIT this year, we may be in a medium-term period where margins turned flat to maybe down a little bit before you start executing on the longer-term leverage in the model. Thanks.

[Cam McMartin:]

Yes. Thanks Gabriela. The answer is we certainly outperformed on a profit contribution basis that is operating profit on a non-GAAP basis margin basis this year. That's largely due to the outperform we see in the top-line business. We will continue as we've said historically our business model is to drive top-line growth first and then expansion and margin second. We are in fact investing in all of the things you talked about across all of the geographies. So, that would include additional sales representatives in each geography. It would include technical sellers, partner managers across our internal selling organization. It also importantly includes bringing on and enabling additional partners especially for us today in the middle enterprise market. That's a new market for us on, if you will, on a long-term basis that's relatively new to us and while we have a very strong stable partners in the large enterprise category of business. We have a smaller stable of partners in the middle enterprise base part of our business and we are recruiting and on-boarding partners across the globe to help us address that middle enterprise class customer which is largely a SaaS customer, as we've talked about. So, yes I would tell you as you think about the go forward outlook for margins I would not anticipate expansion and in fact you might see a bit of given the outperform this year relative to the guide that we gave you early in the year. You might see some, if your margin contraction into next year, not of any meaningful nature only that we want as we've said previously we want to keep overall operating profit performance in and around the range we are today, so that we can continue to invest across the globe in building real scale to capitalize on what we see to be the attractive market opportunity.

[Gabriela Borges:]

That makes a lot of sense. Thank you.

[Cam McMartin:]

Thank you. Good to speak to you Gabriela.

[Operator:]

Thank you. Our next question today is coming from Shaul Eyal from Oppenheimer. Your line is now live.

[Shaul Eyal:]

Thank you. Hi! Congrats on the quarter guys. May be building on Gabriela's questions specifically on your hiring plans. How do you look at it? Are you guys running in line, running a little behind, or a little ahead with one quarter to go to year end?

[Cam McMartin:]

Yes, Shaul so first of all thanks for the question. Appreciate your joining the call today. So I'll take a first cut at this and Mark will potentially add some additional color there. As we've highlighted for you earlier in the year we were a bit behind and are hiring, no real overall concerns they're just pacing. As we came through Q3 we were pleased with the overall net hiring position it did pick up across really all activities within the company and I think as we think about hiring going forward I think what we generally believe is the continued healthy pace of hiring in the sales organization will give us the incremental capacity and scale that we need to sustain overall growth rates. As we think about the company level hiring you've heard me say previously we're looking to get a bit of operating leverage out of the business from the rest of the business to help sustain the investment we're making in sales and marketing and we'll continue to do that because especially as we looked into next year a bit one of the things you've seen this year is we've made a big investment in G&A especially as we've become a public company there's been a lot of incremental spending there. We think that spending growth will moderate in the next year and we'll have some opportunity to redirect that if you will that spending expansion for going forward back into the rest of the business which we're excited by that possibility. So I think we're happy with where we are overall. I believe we're on track on hiring and we'll continue to focus first on growing capacity to sell across the globe and then the rest of the business incrementally as we've talked to you about we've got four product lines we want to continue to invest in all four and to continue to invest we're going to make incremental investment in people resources to expand and extend the leadership that we have across the product portfolio.

[Mark McClain:]

And a quick addition Shaul Eyal, time back to Gabriela's point question. Part of our goal obviously is to continue to invest in channel and partner coverage particularly as Cam said in that middle enterprise market that kind of 1,000 to 7,500 segments that we've highlighted since the IPO and in particular there we would hope over time to continue to see a bit more leverage as we have pure sale point people required to support the efforts of those partners. So I think we are seeing a good opportunity to create more leverage particularly in that middle enterprise segment. So we'll kind of keep your price on that as we go into 2019.

[Shaul Eyal:]

Got it. This is helpful and guys how would you characterize the current pricing environment regardless of this six million pull forward phenomenon?

[Mark McClain:]

Kind of a pricing competitively Shaul just to be clear do you mean –

[Shaul Eyal:]

Yes.

[Cam McMartin:]

Yes. This is Cam. I think overall we see the pricing environment continue to be healthy for us. We're able to get or to secure the kinds of pricing we want in telling both the – well really all the product lines. So I think the pricing environment globally has been strong for us. Nothing in what you saw on the Federal government buying dynamic reflected any changing our pricing approach for those deals. We've had a pretty established philosophy in the sector, the government sector for a number of years now, as you will know Shaul we've been selling into that sector both on the, if you will, the defense and DOE side of the business or that the government as well as the civilian agency side for a number of years and so that pricing philosophy has not changed and the pricing dynamic or environment for us across the globe has remained very good we think in terms of our ability to secure the kinds of pricing that we think are appropriate is the market leader.

[Mark McClain:]

Yes. I think as the leader quite often we feel attacked by a “lower priced alternative” that a competitor will often use is kind of a last-ditch effort to win and that the customer is very responsive to that. We will generally not chase them down as we like to say and sometimes those deals do come back if we do lose on a pricing situation. We've seen a number of customers who thought they wanted to save money and take the “cheap alternative” and two, four, six quarters later they recognized that it might not have been the right approach. So I think in general we feel confident that our pricing reflects the value we're delivering to our customers as Cam said. So I don't think we're feeling any tremendous – any significant price pressure at this point.

[Shaul Eyal:]

Thank you so much.

[Cam McMartin:]

Thanks Shaul.

[Operator:]

Thanks. The next question is coming from Andrew Nowinski from Piper Jaffray. Your line is now live.

[Andrew Nowinski:]

All right. Thank you. I just wanted to ask on the enterprise space. So if we normalize for the deals that pulled into Q3 from the Fed it looks like your seasonality to the first three quarters of the year were pretty similar to last year, but just wondering what you're expecting with regard to an enterprise budget flush in Q4? Do you think enterprises are sitting on a lot of projects or has the pipeline largely converted as you expected so far year-to-date?

[Cam McMartin:]

Yes, so I think, Andy first of all thanks for joining the call. Appreciate the question. Yes, as you understand we have a seasonality for our business it really reflects, if you will kind of a up ramping as we go through the year. That is the early part of the year is somewhat overall less strong, overall its contribution in the second half with Q4 always being our seasonally strongest quarter of the year. What we have seen is a little bit of flip-flop in the second half the year in terms of the seasonality contribution. I think you can attribute that largely to the federal highlights that we've given you previously. In terms of the opportunity for Q4 commercial business it is as I said a number of times it is our seasonally strongest period. It is a period generally when corporate America and the rest of the world are buying to complete their budget years and as we look at the outlook and the way we've assembled a guide for Q4 I think what we see is a similar buying pattern from an expectation perspective as we've seen in prior Q4. So no real fundamental change. Good help. Good industry vertical separation or segregation if you will, and then and the good strength across the three major regions of the world that we generally talk to you about.

[Mark McClain:]

I think just to be clear not seeing any indicators at this point of what ended up being in our minds at least partially a bit of a budget flush phenomenon last Q4. I mean we would be happy to see that happen and unexpectedly again but we don't necessarily see indications and I think last year there was a lot of reaction to the tax code changes and all that stuff, but I think this year unless we get a little bit of a freedom spending in the U.S. as people take a deep breath after the election or something I don't know that we would say this would be – this would be more like prior Q4s that last Q4 which we highly there was a fairly strong conversion and closed rate historically.

[Andrew Nowinski:]

Okay. Understood. Thank you and then I wanted to ask about the partnerships with active [indiscernible] How has that impacted your win ratio in deals that you go into a loan versus going into with partners, has that helped you in the federal market as well?

[Cam McMartin:]

I think it's too early to point to any of that federal result on that and these federal deals have been in process for a long-long time and our kind of active market partnering with both those two has been more or the less in the last few quarters. So I wouldn't point to the federal results as particularly tied to that phenomenon and I think we would hope to see that in the future. I think what has happened with that go to market partnership where we're kind of going into various marketing events, webinars, seminars, with the two and/or three of us in many cases. It just helps clarifying the minds of the customers that we are all solving fundamentally different core parts of the problem but I think it's just early in the pipeline building stage for us with that partnership in the market we're seeing a lot of interest in activity. I wouldn't point to a significant portion of the pipeline yet that's driven by that.

[Andrew Nowinski:]

Okay. Thank you.

[Cam McMartin:]

Thanks Andy.

[Operator:]

Thank you. Our next question is coming from Richard Davis from Canaccord Genuity. Your line is now live.

[Richard Davis:]

Thanks. If you think about it kind of at a fundamental level, identity is really is security right because if, who someone is you don't need arguably firewalls and anti-virus and a bunch of other stuff. So here's my speculative question. Why is it not possible for you guys to pitch your technology is not only kind of identity governance but as a way to help your customers be commissioned at least some of their redundant technology stack. You see what I'm getting at because it just feels like well I thought to see ourselves they're like dang I know I'm overspending I just don't know where, no thanks.

[Mark McClain:]

No. That's a great observation Richard. I think couple of years ago we were probably a little bolder and we'd say oh the perimeter is dead. And the truth is I think customers are never going to stop trying to protect the perimeter at some level. I mean Google went to the edge with their whole zero trust approach. Most customers today are still fairly traditional and they are going to put up some level of network defense right to your point and then worry about a lot of other dynamics particularly notably identity. I can't point you to a study. Our anecdotal that feel at times is that there has been a diminishing spend in other parts of security to make room for identity. Now budgets have been expanding in general, in security and I think identity is getting it's more than fair share of that if you look at the performance of Okta and Cyber Ark and [privileged account], all growing and doing quite well, I don't think we would say customers have said I'll stop spending in those other areas particularly firewall or the perimeter defense and shift all that spin. I think we're getting maybe some benefit there, maybe things get deferred and upgrades gets pushed out for a quarter or two to make budget room that kind of thing Richard, but it's a great case you make. I just think we're almost more of taking the stance now that the perimeter while not being irrelevant, is not sufficient and this concept of layers of defense is important and that customers need to ensure they have both a good understanding of how to protect the perimeter but also a very rich understanding of identity as a core control point in protecting their enterprise.

[Cam McMartin:]

Yes, and I think Richard, it's Cam I would follow-on with one other thoughts that market earlier relative our value propositions because one of the benefits we see in our selling is it because in general for the large enterprise we are replacing some incumbent system, almost without exception we're replacing. Our experiences that we can reduce the cost of operating their identity program by deploying IdentityIQ or IdentityNOW but generally IdentityIQ is the large enterprise and that benefits the CIO and the CISO in the sense that they don't have to take budgets necessarily away from other parts of their business in order to extend their identity governance program that the benefit that we deliver from an operational standpoint helps them fund a more comprehensive identity governance program and I think that's somewhat unique if you think about identity relative to other security spend and that's certainly one of the value propositions and value elements that we see come to the fore and are selling with our perspective customers and we think in that sense it can be very valuable, in terms of our overall ability to given the heightened awareness that identity governance is important to keep growth rate high.

[Richard Davis:]

Got it. Super helpful. Thank you.

[Cam McMartin:]

Thank you Richard.

[Operator:]

Thank you. We have reached end of our question-and-answer session. I will turn the floor back over to Mark for any further closing comment.

[Mark McClain:]

I don't think we have any additional comments operator but I would thank everyone again for your interest in Sailpoint for your time this afternoon and for the insightful questions and we'll look forward to seeing you out in the market. Thank you very much.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect the line at this time and have a wonderful day. We thank you for your participation today.