OneSpan Inc.
Q3 2018 Earnings Call Transcript

Published: 30 Oct 2018

[Operator:]

Good afternoon ladies and gentlemen and welcome to the OneSpan Third Quarter 2018 Earnings Conference Call. At this time all participants are in a listen only mode. [Operator Instructions] As a reminder this conference call is being recorded. I would now like to turn the conference over to your host Joe Maxa, Director of Investor Relations. Please go ahead.

[Joe Maxa:]

Thank you, operator. Hello, everyone and thank you for joining the OneSpan third 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 our results for our third 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 may be 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 press 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 October 30th 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. Good afternoon everyone. And thank you for joining us today. Security for financial institutions and their customers is more important than ever. Because hacking attacks are constantly evolving and losses or fraud continue to increase. At the same time consumers are demanding a pleasant and low friction user experience with security that is mostly transparent to the user. Delivering this has become a top priority in the financial services industry as institutions drive growth in the digital channel; our cloud based Trusted Identity solutions are designed to enable banks to provide a positive customer experience while detecting and mitigating fraud at every step of the customer journey, and helping institutions comply with regulatory requirements. We’re making significant progress in executing our Trusted Identity strategy. We have a number of pilot concepts and initial deployments worldwide and a robust product release roadmap over the next several quarters. Now I’ll summarize third quarter results; revenue growth in the third quarter was below trend line at 3% due to order timing, resulting in approximately $2 million of revenue shifting into early Q4. The timing of this revenue does not affect our full year 2018 outlook. We also saw an acceleration in the plan to transition from on premise to cloud deployments in our e-signature product line impacting e-signature license revenue. We believe this shift will continue to be a headwind to overall e-signature revenue growth in the near term though it will begin to benefit e-signature subscription revenue growth in the coming quarters. Mark will provide additional details on our third quarter financial results during his review. During the quarter we went live with a number of initial Trusted Identity intelligent adaptive authentication and risk analytics deployments in financial institutions in Europe and the Americas. We received from a major Asian bank the first order for our new FIDO compliance software authentication solution that encompasses server-side and mobile security suite components that support the increasingly popular fast identity online standards, and we saw continued broad adoption of our mobile security suite software. Now turning to guidance for a moment. We expect to return to stronger revenue growth in Q4 and as such we reaffirm our full year 2018 guidance; revenue is 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. I'll now turn the call over to Mark Hoyt, our Chief Financial Officer to provide more details about the quarter and about our outlook. Mark?

[Mark Hoyt:]

Thank you, Scott. Total revenue for the third quarter of 2018 grew 3% year-over-year to 52.5 million. Product and license revenue declined 4% to 36.9 million and services and other revenue grew 23% to $15.6 million. Subscription revenue grew 38% for the quarter and 43% for the first nine months of the year. Software licenses revenue, which includes mobile security, server and e-signature licenses declined 17% in the quarter. Mobile security itself grew a robust 50% but as Scott noted due to the transition of our e-signature customer base from on premise to cloud deployments, our e-signature software licenses revenue declined. Year-to-date total software licenses grew 17%, including 60% growth in our mobile security software. [Indiscernible] revenue growth including subscription, licenses and services moderated to 10% year-to-date due to the transition from on premise decline deployments. Maintenance support and other revenue increased 18% to $9.9 million during the quarter. Hardware revenue grew 2% as expected year-over-year and 10% sequentially in the third quarter of 2018. Gross margin for the third quarter 2018 was 66% compared to 72% in the third quarter of 2017. This decline in gross margin percentage was due to lower software license revenue and the hardware mix. We anticipate the fourth quarter gross margin will be similar to Q3's and the gross margin for the full year 2018 will approximate 70%. Operating expenses for the third quarter of 2018 were 37.7 million, an increase of 19% and $31.5 reported in Q3 last year. Year-over-year change includes the full quarter of deal close operating expenses along with increased R&D and sales and marketing investment. Our third quarter 2018 operating expenses benefited from a $900,000 accrual reversal based on a favorable result in a legal matter. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation, amortization and long-term incentive compensation and nonrecurring items, was $1 million a decrease from $8.8 million in the third quarter of 2017, adjusted EBITDA margin was 2% compared to 17% for the third quarter of 2017. GAAP loss per share was $0.02 in the third quarter 2018 compared to earnings per share of $0.07 in third-quarter 2017. Non GAAP diluted earnings per share, which excludes long-term incentive compensation, amortization, nonrecurring items and the impact of tax adjustments was $0.04 for the third quarter of 2018 compared to $0.14 in the third quarter of last year. Geographically, our revenue mix for the third quarter was 48% from EMEA, 31% from Asia-Pacific and 21% from the Americas region. This compares to 45%, 27% and 28% in the same regions last Q3, respectively. Moving on to balance sheet. We headed the third quarter with $92 million in cash and cash equivalents and short-term investments as compared to $158 million at the end of 2017. The acquisition of Dealflo accounted for a majority of that difference. I will now turn the meeting back to you, Scott.

[Scott Clements:]

Thanks a lot Mark. As I mentioned earlier, we got a robust product release schedule on the coming quarters. We anticipate launching our cloud based trusted identity risk analysis solution in the fourth quarter and our Trusted Identity verification hub in the first quarter of 2019, which will support identity verification requirements for several of our new offerings. The risk analysis solution enables financial institutions to detect and mitigate fraud in real time across multiple channels and when combined with our intelligent adaptive authentication solution that will improve the end-user experience with no degradation security. Our identity verification hub solution combines technology we acquired through the acquisition of Dealflo with our Trusted Identity and e-signatures capabilities allowing financial institutions to modernize their account opening process while mitigating application fraud. We see solid growth in our pipeline of opportunities and will continue to invest in R&D while managing overall operating expenses. The significant investments we’ve made over the prior year will contribute to revenue growth in 2019 and we’re confident that 2019 will be a year of progress enhancing customer and shareholder value. With that Mark and I’d be happy to take your questions.

[Operator:]

[Operator Instructions] Your first question comes from Zack Turcotte with Dougherty. Your line is open.

[Zack Turcotte:]

Hi guys, Zack on for Catherine. First is a quick one on the e-signature piece, so you mentioned e-signature license revenue going down due to transitioning those customers to the cloud, I don’t know if you gave it I missed it what is the overall growth for e-signature as compared to last year?

[Scott Clements:]

We did not give that number specifically for the quarter. I don't think generally we have, but I would tell you this that the growth rate overall for subscription and e-signature for the full year is running or year-to-date and the full year is running strong double digit I think that’s a way in which we usually describe it. The license fees as Mark described has declined pretty significantly as part of that transition. We think that that will play out over the next few quarters in terms of increased growth in subscription, that’ll be -- that transition will happen gradually of course, as you would expect but I think we would continue -- we would expect to continue to see strong double digit growth and recurring revenue. We also are very focused on bringing some of our security capabilities and the Dealflo capabilities to support identity verification security around e-signature and we believe as we go into the latter part of 2019 in particular that's going to give us a very differentiated offering around e-signature which will then help us to really accelerate the growth; we would like to see and we think e-signature can grow better than how it's growing right now, there’s sort of strong double digit growth and we’re working hard to make that happen.

[Zack Turcotte:]

And the decline in license revenue is large majority reason for the lower gross margins, correct as well as some hardware?

[Scott Clements:]

Yes that's a big part of it, certainly yes, I think the lower software revenue contributes significantly to the margin deterioration in the short-term. I would note Zack that the margin variations that we’re seeing here are not that unusual for this company even if we just go back to the fourth quarter of 2017 we saw gross margins kind of similar to where we are reporting this quarter, so because of the variation in hardware, software mix, we do see that gross margin move up and down. And so I don't think anything really changed it hasn’t really changed our outlook for the business or our expectations around our guidance for the full year.

[Zack Turcotte:]

Right okay, still one more on the geographic breakdown. Americas portion, revenue was pretty significantly smaller this quarter, is that a trend of less spending in Americas or more traction in EMEA or APAC.

[Scott Clements:]

To license revenue we talked about and OneSpan sign is almost all North America revenue. So you would see that disproportionately impact North America in the short-term.

[Operator:]

[Operator Instructions] Your next question comes from Saliq Khan with Imperial Capital. Your line is now open.

[Saliq Khan:]

Two question from my end, the first one being is when you talk about the e-signature transition from on prem to the cloud I recognize a long-term this is a positive things but could you give us a bit more granularity, what was in the transition itself, it's causing the decrease in the revenue at something where the customers is just now ready to be able to transition, so they are discussing the contract or is that something else within it that we’re not seeing just yet.

[Scott Clements:]

I think it's really in the year-over-year comparison. So last year we had a significant amount of license revenue in that business. It was a significant contributor to overall license revenue on a comparable basis, we see that license revenue coming in significantly lower this year. So this is really about new customers, new contracts who are getting more and more comfortable going to the cloud. I think the news that's out this week about IBM and the Redhat acquisition is kind consistent with what we're saying that is even our large customers, even some of our financial institution customers who really wanted to buy on premise in the past for a variety of reasons are really changing their mind and moving new business and new orders into the cloud. That’s also really consistent with this with the TID strategy when we started the TID strategy, developing that about a year and half ago, even though a lot of our business was still on prem at the time we really determined that even our largest customers were going to be increasingly moving to the cloud. And so we began from the beginning building out TID to support first and foremost cloud implementations. So that's really that's really what's going on I think there has this happened a little faster than we thought it would. I think we knew what the trend but I think it's hit little bit harder and faster than even we thought, which is in the short-term creates some headwind for the e-signature revenue. But I think in the medium term will lead to better recurring revenue growth or higher recurring revenue growth and it is a presumption about our TID strategy and makes us feel encouraged about that we made the right choice, I think strategically around the TID.

[Saliq Khan:]

Scott, as you kind talk about the acquisition that were announced this week, I would have thought that the transition to the cloud would have caused the revenue to increase not decrease year-over-year so what are we missing there, I just want to get a bit more granularity on what exactly is happening, is this a longer sales cycle a longer conversation with the consumer what is that is causing the year-over-year decrease and I do recognize that significant amount of license revenue within that business last year, but again, with the ongoing demand that you’re seeing I would have envisioned revenue to increase.

[Scott Clements:]

Yes, so it’s purely revenue accounting right, when we do an on premise license project we generally can recognize most or all of the revenue in the quarter in which we booked that job even if it’s a multiyear commitment, when it’s a -- so let’s just take an example right if we sold a $1 million license deal, we could probably book a $1.2 million of revenue in the current quarter, including the first year of maintenance okay when we do a recurring revenue subscription for a $1 million we only book one, say it’s a three year term we only book 136 of that revenue in the first month in which we booked that order. So you have -- in a short-term you have a very significant headwind that gets created when revenue shifts from license to recurring subscription revenue, I hope that -- did that make sense, did I explain in correctly.

[Saliq Khan:]

Yes it definitely did, because we need to be a lot more careful because it sounds like it gives you much better visibility to the revenue generation profile and the cash flow profile of those customers and the overall business so, theoretically down the road I would assume that the lumpiness that we’ve historically seen from [indiscernible] now OneSpan that lumpiness at the top line would decrease over time as the cloud based solutions continues…

[Scott Clements:]

That’s exactly right, I think lumpiness even and we’ve seen in this quarter with that $2 million shift in revenue from the very end of the third quarter to the very beginning in the fourth quarter was the manifestation of that volatility. The plan that we have for reducing that volatility is to sell more subscription services and that’s what TID is all about. That is a cloud first subscription first business model and we gained traction with that, we will see a shift towards recurring revenue and less volatility in the revenue strength.

[Saliq Khan:]

Scott one or two questions for you as well, could you probably highlight what the life cycle of the contract looks like, is it a three year contract, a one year contract but does it vary by the customer?

[Scott Clements:]

It certainly varies by the customer but it is very-very typical that it would be that those recurring contracts, [indiscernible] contracts are three-year terms that’s the most typical. Occasionally we’ll get into a five-year term, occasionally we’ll get into a one year term but in a large proportion -- large majority of the cases I would say those are three-year terms.

[Saliq Khan:]

And then lastly on my end, regarding what the gross margin could look like theoretically as you continue to increase the amount of revenue coming from the cloud and that transition continues to take off what is that ideal gross margin that you’re targeting?

[Scott Clements:]

I don’t know what the ideal is but certainly higher, I think as we do more cloud business we’ll start to see those margins on average go up, we still as you can see from this quarter we still have a pretty reasonably vibrant I guess I would say hardware business and we do continue to believe the trend line on the hardware is kind of down mid single digits over time but as in this quarter we will have quarters where it's up, where we have some large contracts that come through. So and then that causes a short-term suppression in the margin rate but the trend very clearly will be higher. I think we look at other companies with a similar revenue mix or more of the SaaS revenue mix and I don't see any fundamental reason why we would be a lot different from them as our mix shifts and so I’m not sure I can give you an exact number, but I would say there's certainly comparable companies out there that have made this journey or are in the middle of this journey that could give some benchmark.

[Operator:]

[Operator Instructions] I’m showing no further questions at this time. I would now turn the call back over to you Scott Clements.

[Scott Clements:]

Thank you for your questions that we got there today, and thank you for joining us on the call today. We remain very excited about the future of OneSpan and we look forward for fourth quarter and for 2019. So look forward to talking again with each of you soon. Have a good day.

[Operator:]

Ladies and gentlemen this concludes today’s conference. Thank you for your participation. Have a wonderful day. You may now disconnect.