OneSpan Inc.
Q2 2018 Earnings Call Transcript

Published: 29 Jul 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the OneSpan Q2 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Joe Maxa, Director of Investor Relations. Please go ahead.

[Joe Maxa:]

Thank you, operator. Hello, everyone and thank you for joining the OneSpan second quarter 2018 earnings conference call. My name is Joe Maxa and I am the Director of Investor Relations. This call is being broadcast over the Internet and can be accessed on the Investor Relations section of OneSpan’s website at investors.onespan.com. With me on the call today and speaking first will be Scott Clements, OneSpan’s Chief Executive Officer. Also on the call is Mark Hoyt, our Chief Financial Officer. This afternoon after market close, OneSpan issued a press release announcing results for our second quarter 2018. To access a copy of the press release and other investor information, please visit our website. Following our prepared comments today, we will open the call for questions. Please note that statements made during this conference call that relate to future plans, events or performance, including the guidance for full year 2018 are forward-looking statements. We have tried to identify these statements by using words such as beliefs, anticipates, plans, expects, projects and similar words, and these statements involve risks and uncertainties and are based on current expectations. Consequently, actual results could differ materially from the expectations expressed in these forward-looking statements. I direct your attention to today’s press release and the company’s filings with the U.S. Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard. Please note that certain financial measures that maybe discussed on this call are expressed on a non-GAAP basis and have been adjusted from a related GAAP financial measure. We have provided an explanation and reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in the earnings release that can be found on the Investor Relations section of our website. In addition, please note that the date of this conference call is July 26 and any forward-looking statements and related assumptions are made as of this date. Except as expressly required by the federal securities laws, we undertake no obligation to update these statements as a result of new information or future events or for any other reason. At this time, I will turn the call over to Scott.

[Scott Clements:]

Thanks very much, Joe and hello everyone. Good afternoon to you. Thanks for joining the call here today. The second quarter marked a significant turning point for OneSpan. We re-branded our company to reflect the significant shifts in our strategy and solution offering. We launched our Trusted Identity platform to enable companies to reduce customer on-boarding and transaction-related fraud while securing and enhancing the end-user experience and we acquired Dealflo, an innovative provider of identity verification and end-to-end financial agreement automation solutions. Our new OneSpan messages are resonating well with customers around the world. And they are telling us that our Trusted Identity solutions are highly relevant to their evolving needs for more agile, identity, security and processed digitization. We see a growing pipeline of opportunities, which we expect will result in additional proof-of-concept projects this year and material revenue in 2019. As a result of this expanding set of opportunities during the second half 2018, we will further accelerate our R&D investments in our Trusted Identity platform in our e-signature solutions. We also continue to look for relevant acquisition opportunities that shorten time to market and expand our offerings. Turning to the second quarter results, revenue grew 8% to $49.6 million driven by continued growth in software, subscriptions and maintenance revenue. Non-hardware accounted for 50% of revenue, gross margin was 73% and adjusted EBITDA totaled $5.3 million. Mark will provide additional details on the second quarter during his financial review. We believe the investments we are making in our business both organically and via acquisition are driving shareholder value. We are growing our software and subscription revenue and see no shortage of opportunities for continued growth. Our strong pipeline of opportunities provides us with confidence in our 2018 guidance and that 2019 will be a strong growth year. I will now turn the call over to Mark Hoyt, our Chief Financial Officer, to provide details about the quarter. And then I will come back to comment on our outlook before opening up the call for questions. Mark?

[Mark Hoyt:]

Thanks, Scott. Total revenue for the second quarter of 2018 grew 8% year-over-year to $49.6 million. Product and license revenue grew 2% to $35 million and services and other revenue grew 30% to $14.6 million. Software licenses and subscription revenue increased 21% to $14.2 million. Subscription revenue grew 53% for the quarter and 47% for the first half of the year. Software licenses grew 13% year-over-year, but declined sequentially after a very strong first quarter. Let me remind you that the timing of large orders can affect our quarterly revenue. Year-to-date, our software licenses grew nearly 40%. On a more granular level through the first 6 months of 2018, our e-signature solutions grew approximately 40% and our mobile security software offerings grew approximately 60%. Maintenance support and other revenue increased 25% to $9.6 million during the quarter. The strong growth in our maintenance revenue is due to the timing of customer renewals and large term deals signed in the first quarter. We believe our current maintenance revenue provides a good baseline for future quarters. Hardware revenue declined slightly year-over-year in line with our expectations. Gross margin for the second quarter of 2018 was 73% compared to 70% for the second quarter of last year. The increase in gross margin percentage is primarily attributed to an increase in software, subscription and maintenance revenue and a favorable mix within our hardware product line. We anticipate gross margin to be 70% to 71% for the second half of the year subject to normal variations. Operating expenses for the second quarter of 2018 were $38.6 million, an increase of 19% from $32.4 million reported in Q2 of last year. The year-over-year increase includes 1 month of Dealflo operating expenses and ongoing investments in R&D and sales and marketing. The increase also includes $1.9 million in non-recurring items related to that acquisition of Dealflo, re-branding and other one-time costs. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation, amortization, long-term incentive compensation and non-recurring items, was $5.3 million, an increase from $3.4 million in the second quarter of 2017. Adjusted EBITDA was 10.7% compared to 7.5% for the second quarter of last year. GAAP loss per share was $0.03 in the second quarter of 2018 compared to breakeven in the second quarter of 2017. Non-GAAP diluted earnings per share, which excludes long-term incentive compensation, amortization of purchased intangible assets, non-recurring items and the impact of tax adjustments, was $0.09 for the second quarter of 2018 compared to $0.06 in the second quarter of last year. Geographically, our revenue mix for the second quarter included 43% from EMEA, 30% from Asia-Pacific and 27% from the Americas region. This compares to 48%, 24% and 25% in the same regions from Q2 last year. Moving to the balance sheet, as of June 30, 2018, our net cash balance, including short-term investments in commercial paper was $101 million, a decrease of $57 million from the $158 million at the end of last year. The acquisition of Dealflo accounted for the majority of that difference. I will now turn the meeting back to you, Scott.

[Scott Clements:]

Thanks Mark. In the coming quarters, we will continue to rollout new TID solutions and integrate Dealflo’s technology into our platform. Dealflo’s open, API-based identity verification platform, integrates multiple third-party solutions and we believe it will prove to be a major differentiator for our e-signature offerings and allow us to accelerate the launch of our TID platform-based on-boarding, identity and fraud, antifraud solutions. We are already seeing strong interest in intelligent Adaptive Authentication and customer on-boarding and believe these offerings will be strong contributors to growth in 2019 and future years. We are deepening our technology capabilities and are building a performance-oriented culture with a focus on driving value for our shareholders. For the full year 2018, we are reaffirming our guidance as follows. Revenue was expected to be in the range of $201 million to $211 million and adjusted EBITDA is expected to be in the range of $15 million to $19 million. Thanks all of you for joining the call today. Thank you to our shareholders for your confidence in us and certainly also thank you to our OneSpan colleagues around the world who are helping to deliver the performance that you saw in the second quarter. So with that, Mark and I will be happy to take your questions. Operator?

[Operator:]

Thank you. [Operator Instructions] First question comes from the line of Saliq Khan with Imperial Capital. Please go ahead.

[Saliq Khan:]

Great, thank you. Hi, Scott. Hi, Mark.

[Scott Clements:]

Hi, Saliq.

[Saliq Khan:]

From a revenue contribution perspective from Dealflo, can you talk about how much revenue came from Dealflo and what do you anticipate the growth rate could be for Dealflo in the ongoing quarters?

[Mark Hoyt:]

What are we going to say about it? I am not sure what we want to say about Dealflo revenue. I think we can give you an idea. I think when we announced the acquisition we talked about the – we adjusted our guidance to account for the revenues that we expect in 2018, that was about a little over $4 million change to our guidance in the year and in the – but in the second quarter, we really only had 1 month of Dealflo in the numbers. So it’s really about $400,000 to $0.5 million roughly of revenue contribution in the quarter. Dealflo as a standalone company had been growing pretty consistently in north of 25% range for the last few years sometimes significantly higher than that. We would expect that it will continue to certainly grow at that rate perhaps a little bit better, but one of the things that I think it’s important to understand about Dealflo is it’s very quickly going to be absorbed into our other solutions. We really view it not only as a good company, but as an important technology contributor to our Trusted Identity strategy and the on-boarding components of the Trusted Identity strategy as well as some other areas. So, this business will be integrated pretty tightly into the rest of the company and so we would hope to see the effects of that in terms of the growth of our on-boarding solutions when we launch those – some of the newer versions of those solutions in 2019.

[Saliq Khan:]

Scott, this was the first acquisition the company has done in quite sometime. So how should we be thinking about rather from a timeline perspective or gross margin or cross-selling perspective and how do we think about that as it relates to 2018 and then a portion of 2019 as well?

[Scott Clements:]

I am sorry, Saliq, I didn’t catch that, Joe, did you understand the question? Just try me again, I just couldn’t understand you just because of the telephone I think, so please just try one more time.

[Saliq Khan:]

Sure. So this is the first acquisition the company has done in sometime. And I am just curious how should we be thinking about your ability to integrate Dealflo into the remainder of the company and the cross-selling opportunities that, that brings about?

[Scott Clements:]

Yes, okay. I got you. So when we acquired the last acquisition we did was of course Silanis, which the eSignLive product line back in the end of 2015. I joined the company about a week or two after the acquisition of eSignLive. And one of the first things I did was take on the project of integrating eSignLive and that was a somewhat different situation than what we have here with Dealflo, but we have done that before. And when we did that integration, we created some IP in the company in terms of the integration process that – some of which I brought with me from my prior roles where I had done acquisitions and integrated those acquisitions. And so we have – if you look at the leadership team and the structure of the company now even versus 2 years ago, when we did Silanis, we have a much deeper management team now even than we did then. And so we have taken what we did with Silanis. We have built on that with new process and new tools. We have clear accountabilities around the integrations with respect to cost and with respect to growth. And so we have a process that goes on every week with management joined together to look at the integration process and that is all on track. And so I really – I think that a lot of the integration will be done certainly in the next 60 days. There will be some additional work to be done from a technology platform integration that will go on in [Technical Difficulty], but from a business point of view, I think it will be pretty well integrated quite quickly. We have already done a lot of work around sales, cross-training and other things like that to begin to recognize some of the growth opportunities. We have a team of our technology people who are meeting up in Montréal this week that are working further on the technology integration of Dealflo and in our Trusted Identity platform and our e-signature business. So, I think we have a very, very good handle on the integration. I think it will be pretty transparent from an operating point of view and we feel very confident we will meet the numbers that we – certainly this year that we put in the transaction financials and that we used to adjust our guidance. So, I think it’s on track. I think we have got a good process. We are continuing to build, I think our IP and our capability and experience in the company about how to do acquisitions and how to acquire companies. And so I feel pretty good, I think when we do our next deal that we are going to be ready for it and then we will handle it very effectively.

[Saliq Khan:]

Great. Scott, just one last question on my end, when you guys have done the name change from VASCO over to OneSpan, what is the reception that you are getting from the customers and the channel partners? And then do you see that being translated into meaningful dollars for you as well?

[Scott Clements:]

Yes, I think that we do continue to seek feedback from both investors and customers with respect to the change in the company’s name. I would say from a customer point of view, we had a couple of I think longer customers who like the DIGIPASS brand, like the VASCO name and are used to it and have made some comment about that, but I would say in the large majority of circumstances, we have seen customers who liked the name change, because it helps them really internally tell the story about this company and what we can do for them and we really came up with that name through a bottoms-up process of really understanding what are the customer attributes of our company and our solutions. What does our company mean to our customers? And so it wasn’t sort of a top-down list just like for a cool name. It was really a very bottoms-up very detailed process that led to that. So, I think we were pretty confident that the name would resonate and would have meaning. And I think it wasn’t really important that we announced the name change right at the same time as we announced the launch of the Trusted Identity platform and did the Dealflo acquisition. I think those things all happening and being announced right at the same time really reinforced what the meaning of the company name is and what it means in terms of how we are going to be a different company going forward than we have been in the past. So, I don’t know if I can quantify more on that. I know Joe and I have had a discussion just this week about the investor response to the name change. And I think it was very much the same as customers. We had a couple of maybe longer term investors who had kind of been – liked the VASCO name and been around it. But I think by and large, the process by which we rolled the name out, which continues by the way, we continue to do a lot of work around deploying the new branding and the name and explaining it to people. But I have had other than a couple of offhand comments, like I just mentioned, I have heard no pushback and a lot of positive feedback around the meaning of the name and what it symbolizes for the company and where we are taking the company.

[Saliq Khan:]

Great. Thank you guys. I appreciate it.

[Operator:]

[Operator Instructions] Next question is from Zack Turcotte with Dougherty. Please go ahead.

[Zack Turcotte:]

Hey, guys. Firstly, just wondering kind of what you see the target market to be as far as size with the Trusted Identity platform, I know you had mentioned in the past these sort of complementary solutions being more targeted towards Tier 2, Tier 3 banks, but also some interest from Tier 1 banks to have applications in the private cloud, so just wondering your viewpoint on that?

[Scott Clements:]

Yes. So, we sort of at launch planned to really try to focus Trusted Identity on Tier 2 and Tier 3 customers, because we wanted to be able to roll it out in some of those first instances in somewhat less complex environments, I would say than we might see it at Tier 1 institution. I think that like they say about a battle or about a work as soon as you engage, your assumptions turn out to be incorrect. We have had a lot of interest from Tier 1 customers around Adaptive Authentication and around the fraud analytics capability. A number of the customers that we are engaged with right now and talking about proof-of-concept for pilots are – many of them are Tier 2 and Tier 3, but there are a number of them that are large Tier 1 banks that we are all familiar with. So, it’s early yet and we will see how those things proceed, but I think that as I said in my comments during the presentation, the amount of interest that we are getting is significant, not only with the medium size of smaller banks, but also with the large banks. And so these are the reasons why it’s our intention to accelerate our R&D investment in the second half of this year so that we can really continue to develop the platform capabilities, the ability to make the platform more configurable and more adaptable for different customer used cases. So I think in terms of the size of the market of course it’s very – little difficult to put a number on that, but it’s in order of magnitude larger than the market that we have dealt with in the past. When we talk about Trusted Identity, we are talking about a platform capability, right and so when we think about market sizes, we have to think about use cases or applications. And the thing about Trusted Identity is that it’s a core platform that will enable many different types of applications. That’s why it’s a little bit difficult to size the market exactly, but it’s clearly a multibillion dollar market, which has very limited penetration. A lot of things that we are doing with Trusted Identity, I think are pretty innovative. We are creating some new market opportunity I think. It’s really reflective of what’s happening with large banks. They are under a lot of pressure from non-traditional competitors, from new regulations, from FinTech companies, things like that from the changes in demand from consumers. And so they really are in a position where they have to become more agile and both in their business operation and the ways in which they manage a very dynamic fraud environment and so the Trusted Identity platform is very focused on this issue of agility and how we can have a platform that is very responsive to that evolving environment and help those customers with the digitization of their processes. So, it’s easily a multibillion dollar market. It’s pretty hard to say exactly what number that is. I mean, we know when we looked just at e-signature and that it’s a north of a $20 billion market. And so security is certainly of a similar order of magnitude. So as I said, I began in my comments, we don’t see a shortage of opportunity here. The challenge for us is to continue to evolve our company into a software company and to deliver these solutions in a compelling way.

[Zack Turcotte:]

Okay, perfect. You have kind of answered one of my second questions as well. So it’s still a little early to see the material impact from things like Adaptive Authentication I assume, but how much up-sell potential do you see in current customers with these solutions coming out in 2018?

[Scott Clements:]

Well, yes, I think what we have been saying is that we don’t expect that to deliver a lot of revenue in 2018. We do expect to see a number of pilots and proof-of-concepts with key customers. We already have three or four of those underway and we expect to see several more of those yet this year. And I think what we – I guess I would put it this way, we have indicated that this year we were going to see improved growth in our company something in the mid to upper single-digits, that’s consistent with the guidance that we have given you. And then we have set our goal as to have the company get into the double-digit growth category in 2019. Our ability to do that will hinge on our success with not only our existing offerings, but also the Trusted Identity offerings. So that’s why we say we expect that some material contribution from Trusted Identity in 2019 and that’s really a key part of how we bridge the gap from what our revenue guidance is this year to what we are targeting is a double-digit growth in 2019.

[Zack Turcotte:]

Got it. And one last thing I want to touch on is M&A opportunity, so you made the Dealflo acquisition it seems like a great technological fit. Just what are your thoughts on how the market is for M&A right now and whether you would be looking to acquire technology once again to further expand the Trusted Identity platform or since you are doing R&D for that are you looking for more of a land grab kind of quickly expand your customer base?

[Scott Clements:]

Well, I think we do plan to continue to be active in the acquisition space within the capacity that we have available. We really start with our strategy and we want to use both our organic investments and our acquisition investments to amplify and accelerate our strategy. Sometimes that means that we buy a company like Dealflo that has some revenue, but it’s, from our point of view, more important from the technology that it brings to us and then we can work with that team to really amplify their business as part of the Trusted Identity strategy. As we look at additional acquisitions, ideally I would like to be able to acquire things that bring us technology, but also bring us some revenue, maybe a little bit more revenue than we have got out of the Dealflo transition, but then that really comes down to the economics of the deal and making sure that we are buying companies at a price that allows us to get a return on the investment and we love to get technology and revenue and maybe some adjacent market penetration opportunity and things like that. And we look for those and if he can find them at a reasonable price then we will proceed. I would acknowledge that in the current environment, that’s not always easy to do. A lot of the targets that are out there are quite expensive right now in the current environment and so we are aware of that. And so I think as I have said before we want to buy things where we have confidence that we will get a return on investment and then we want to make sure that we are paying a reasonable price or a market price, certainly not overpaying for something in a way that it would make it hard for us to get a return. So, we have to live in the world around, but we want to be disciplined, we want to be balanced, and I would like to see us get some things that deliver accelerated revenue growth one way or another.

[Zack Turcotte:]

Perfect. Thanks.

[Scott Clements:]

Thanks, Zack.

[Operator:]

[Operator Instructions] Nothing further from the phones.

[Scott Clements:]

Alright. Thank you very much, operator and thanks again to all of you who joined in and I look forward to talking to all of you in the hours and days ahead. Thanks for your interest in OneSpan. We are really excited about our future and where we are headed. I know as a management team and we are glad to have the opportunity to share that with you today. Everybody, have a great day.

[Operator:]

And ladies and gentlemen, that does conclude your conference call for today. We thank you for participating and you may now disconnect.