OneSpan Inc. (OSPN) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the OneSpan Fourth Quarter and Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] As a reminder, today's program maybe recorded. I would now like to introduce your host for today's program, Joe Maxa, Director of Investor Relations. Please go ahead, sir.

Thank you, Jonathan. Hello, everyone, and thank you for joining the OneSpan fourth quarter and full year 2019 earnings conference call. My name is Joe Maxa, and I am the Director of Investor Relations. This call is being webcast and can be accessed on the Investor Relations section of OneSpan's website at investors.onespan.com. With me on the call today is Scott Clements, OneSpan's Chief Executive Officer and Mark Hoyt, our Chief Financial Officer. This afternoon after market close, OneSpan issued a press release announcing results for our fourth quarter and full year 2019. 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 2020, are forward-looking statements. We have tried to identify these statements by using words such as believes, anticipates, plans, expects, projects and other 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. 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. In addition, please note that the date of this conference call is March 3, 2020. 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.

Thanks very much, Joe and good afternoon everyone. We had a very good fourth quarter and an outstanding 2019. We achieved record revenue for the year reflecting the growth investments we've made in our company over the last few years in a favorable market environment for our products and solutions. Our software license revenue reached record levels powered by growth in mobile security and overall our software offerings are generating significant market demand was strong bookings growth in 2019 and an expanded pipeline of trusted identity solution opportunities. Now, let me provide you a few fourth quarter and full year 2019 highlights. Revenue in the fourth quarter of 2019 increased 10% over a strong fourth quarter of 2018, the $71 million driven by increased demand for mobile security and e-signature solutions offset by the expected decline in hardware revenue. In the quarter, our key drivers of software revenue, mobile security and e-signature, each grew an excess of 50%. Software and services orders overall grew by more than 50%. For the full year, we exceeded the high-end of our previously increased revenue and adjusted EBITDA guidance. Revenue grew to 20% to a record $255 million and of course this translated into higher than forecasts of profitability and cash flow. I'd like to touch on two important developments in our product strategy. As projected, we completed during the fourth quarter the launch of important new features for OneSpan Sign. These include a new modern user experience that incorporates OneSpan's common UX design language, improved enterprise administration features and capabilities designed to address the needs of customers in Europe and Asia. These enhancements strengthen the competitive position and the growth outlook for OneSpan Sign in 2020 as we've communicated to you previously. We also recently announced our OneSpan Cloud authentication offering which we referred to as OCA. OCA, along with our mobile security, allows banks to operate a simple and effective large scale cloud-based authentication system. OCA provides an entry point into our cloud offerings for new customers who can then add other TID solutions as their needs expand. OCA is the final major piece of our overall trusted identity solution portfolio and our product focus in 2020 is now to optimize and enhance the already launched TID portfolio solutions based on customer feedback and our vision for the future. I'll now turn the call over to Mark to provide further financial information about the quarter and the full year, and then I'll come back for additional comments and 2020 guidance before opening the call to questions. Mark?

Thank you, Scott. Full year revenue for the fourth quarter of 2019 grew 10% to $71 million. Product and license revenue grew 7% to $51 million and services and other revenue grew 16% to $20 million. For the full year of 2019, as Scott mentioned, revenue increased 20% of $255 million and exceeded the high-end of our $248 million to $250 million updated guidance range given in October. We benefited from strong double-digit growth in software licenses, subscriptions, and as we previously shared, strong hardware revenue related to a September deadline for PSD2 compliance. In the fourth quarter, software license revenue grew 73% to a record $19 million. For the year software licenses grew 21% to a record $57 million. Subscription revenue grew 37% to $6 million in Q4 and for the year it grew, 44% to $22 million. Total software revenue including licenses and subscriptions, grew 63% to a record, $25 million in the fourth quarter and grew 26% to another record, $79 million for the year. Maintenance, support and other revenue increased to 11% for the year. Hardware revenue declined 13% to $32 million in the fourth quarter in line with our expectation. Hardware revenue increased 20% to $127 million for the full year. Gross margin for the fourth quarter of 2019 was 70% compared to 67% in the prior quarter and 65% for the fourth quarter of 2018. The increase in gross margin is primarily attributed to product mix with software and service contributing 55% of revenue in Q4 2019 versus 47% in the prior quarter and 44% in the fourth quarter of 2018. Operating expenses for the fourth quarter of 2019 were $44 million an increase of 15% from 38 million reported in Q4 last year. Operating expenses for the full year increased 7% to $157 million. Adjusted EBITDA or adjusted earnings before interest taxes, depreciation, amortization, long-term incentive compensation and non-recurring items was $30 million, $4 million dollars higher than in the fourth quarter of 2018. Adjusted EBITDA margin was 19% compared to 14% in the fourth quarter of last year. For the year, adjusted EBITDA totaled $33 million exceeding our updated guidance range of $26 million to $28 million. GAAP earnings per share was $0.13 in the fourth quarter of 2019 compared to $0.10 for the fourth quarter of 2018. Non-GAAP earnings per share, which excludes long-term incentive compensation, amortization, non-recurring items and the impact of tax adjustments was $0.24 in the fourth quarter of 2019 compared to $0.17 in the fourth quarter of last year. Moving over to the balance sheet, we ended the fourth quarter with $110 million in cash, cash equivalents and short-term investments compared to $99 million at the end of last year. Cash generated from operations for the year totaled $18 million. Geographically, our revenue mix for the fourth quarter included 55% from EMEA, 26% from the Americas and 19% from the Asia Pac region. This compares to 59%, 23% and 18% in the same regions in Q4 2018 respectively. I'm turning the meeting back to you, Scott.

Thanks very much, Mark. It's a great time for OneSpan as we enter the next phase of our transformation in 2023 through 2022. With our standard portfolio of trusted identity solutions and the strong growth momentum and our software and services offerings during the second half of 2019, this is the ideal time to accelerate our transition to recurring revenue business model. Our goal is for the majority of our revenue to have recurring nature by the end of 2022. While some customers are not yet ready to move to cloud services in the banking sector, for mission critical and regulated use cases virtually all our planning to make that shift over the next few years. Throughout 2019, we prepared for this transition with the development of new cloud first TID solutions, the necessary implementation of modern financial systems capable of efficiently managing recurring revenue contracts and by designing a fundamental shift in our sales compensation model to encourage sales of term and subscription contracts. Now in 2020, we have realigned our sales structure and are significantly expanding our sales force with software experienced people who will sell only software and services. This is expected to accelerate the company's software revenue growth, improve the predictability of revenues over time, increase profitability and elevate the value of our company. Now I will discuss our outlook for 2020. As I'm sure you've seen with other companies that have moved to recurring revenue business models, the transition to recurring revenue at the expense of perpetual licenses will impact our full year 2020 financial results. The increased focus on recurring revenue contracts will result in a revenue growth headwind of approximately 3 to 5 percentage points. In 2020, we expect the following to occur. Number one, software and services revenue growth will more than offset the declines in hardware revenue. Hardware revenue will likely approximate 2018 levels after the PSD2 driven demand in 2019. Software and services will contribute a majority of our total revenue 55% to 60% in 2020. And we expect that trend to continue through 2022 and after. Recurring revenue composed of subscription, term license and software maintenance will grow in the strong double digits approximately consistent with the long-term outlook that we gave in December of last year. Adjusted EBITDA will also be impacted by the transition to recurring revenue and increased investment in R&D and sales and marketing to capture global growth. This will be partially offset by increasing gross margin as the business mix shifts to a higher proportion of revenue from software solutions and less from hardware products. Finally, number four, strong growth in recurring revenue bookings in 2020 are expected. We plan to provide relevant bookings growth visibility beginning with our first quarter earnings release and as we noted at our Investor Day in December, we will provide additional detail for our software and services revenue streams as we report 2020 results. For the full year, our financial guidance is revenue in the range of $255 million to $265 million and adjusted EBITDA in the range of $24 million to $28 million. For modeling purposes, we expect Q1 revenue as a percent of full year 2020 revenue, could be similar to last year's first quarter revenue as a percent of full year 2019 revenue. Now let me comment on the Coronavirus and its potential impact on our company. As most of you know, our hardware production is in China. Well, there remains uncertainty about the global spread and impact of the virus. Our contracted factories have largely returned to production after the extended Chinese New Year holidays. We currently expect a limited first quarter impact to hardware revenues and we'll continue to monitor the outlook for future quarters. We have not presently seen any affect on our software sales. We will continue to assess the potential for a broader impact in demand if it appears the Coronavirus will cause a more substantial deterioration in the global economic outlook. In the meantime, we're actively engaging with our global employees to ensure both their safety and to limit any possible disruption to the company's operations. Finally, I'd also like to refer you to the other press release of today concerning the expansion of our Board of Directors. Today we announced the addition of two new directors, Ms. Naureen Hassan and Ms. Marianne Johnson, who bring decades of banking, financial and cloud technology experience at leading companies. Naureen Hassan was the Chief Digital Officer at Morgan Stanley Wealth Management with responsibility for Morgan Stanley wealth management's digital transformation strategy focused on modernizing how the firm interacts with clients. In this role, she led product development teams and building digital marketing capabilities, consumer facing technologies and artificial intelligence enabled platforms. Ms. Johnson is an Executive Vice President and Chief Product Officer driving innovation and technology advancements at privately held Cox Automotive, one of the largest automotive service companies in the world providing cloud based technology solutions for the automotive, wholesale and retail marketplace. She also has substantial background and experience in financial services and payments industries. These appointees bring depth in the design, development and delivery of secured digital services at scale. Over the past year, the OneSpan Board has added four new directors with experience and skills that directly align with the needs of our evolving business. So thank you for listening and with that Mark and I will be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Dan Ives from Wedbush Securities. Your question please.

Just sort of walk through the transition and just maybe talk through, I mean just talk about what you think is the biggest challenge as you get through this transition. Also maybe just talk about some customers. I mean, obviously feedback seems pretty positive need to what you're seeing also the ability to cross sell the broader platform. Thanks.

If I think about the challenges that we have in 2020, I think there are a couple of things. I think -- we are executing this transition to recurring revenue or accelerating the transition recurring revenue that have already been happening. I think as you can see from our 2019 results that we shared with you today that transition is already underway and we expect that to continue in 2019 or in 2020. I think the challenge is really in managing the customer relationship here. We are focused on shifting you know, as much of our customer base to a recurring revenue model as we can. Nevertheless, we know that this is not a simple matter for financial institutions, particularly large financial institutions. They have a range of regulatory security policy issues that have to be addressed in order for them to make the shift from on-premise and perpetual license products and solutions to cloud-based recurring revenue offerings. And it's not like a corporate enterprise who can simply make that decision and go, banks have a more sophisticated or complex, I should say operating environment with our regulations on, they have to deal with. Nevertheless, the outlook and the trend is very clear. The economics are a powerful driver of this shift, both in terms of the fact in the sense that banks want to start consuming solutions as they use them and as they need them just like almost every other sector of business in any economy. And they certainly are seeing a cost pressure and also competitive pressure from digital-only banks that are becoming more and more prevalent really in every region of the world and have a fundamentally lower cost structure. So these are the things that, I think are kind of be irresistible force over the next few years that is going to really drive banks to move towards recurring revenue models that's why we recognized this two, three years ago when we really started down this path that it would -- there was going to be a convergence that was going to happen three years ago and now a lot of banks are moving this direction, but now many, many are. And that includes in every region in the world in which we operate, which is pretty much all of them. We are seeing this trend play out. So we have to find the right balance between encouraging that transition, but also realizing that we aren't -- we don't want to leave our customers behind. And where, if a customer really is just not ready, we will try to deliver an on-premise solution to their needs. So I think just gating that, bringing on the new sales talent that we planned for in 2020, making them productive, getting them productive, helping them to contribute to the growth in 2020 and forward. These are the things that I think are going to require the right level of effort. And but I kind of touched on this in the script and I want to reemphasize that we have prepared for this. We have been preparing for this for really the last two years in terms of not only our products, but also our operating infrastructure, our IT systems, our business model, our sales compensation, all of these things, we have been aligning and preparing for this. So I'm confident that we are going to make good progress and be successful at this. We understand the impact this will have we believe and we hope we'll have the value of our company. And we are very focused on taking the steps to ensure that this company is recognized for the value that it's delivering to customers and the value that it's delivering to investors.

Thank you. Our next question comes from the line of Catharine Trebnick from Dougherty. Your question please.

So can you split out a couple of things for me if I can better understand the dynamics. The hardware versus software expert expectations for 2020 just kind of 55, 60, can you restate that? Thanks.

And I'll correct that Mark and certainly you have to bolster that whatever. The transition or the shift of the company's revenue away from hardware and towards software and services is going to accelerate in 2020 and that's for really two reasons, of course. One is, that we believe hardware revenues are -- will decline in 2020. And on the other hand, we will see a very strong growth in software and services during that time period, particularly in their recurring revenue software category. So that's what drives to a ratio of 55% to 60% of the company's revenue will be -- we expect in software and services in 2020. We also noted in the description earlier that we expect hardware to decline to something in the neighborhood of what revenues were in 2018 after we got the burst in demand from PSD2 in 2019. And our goal and our plan is to more than offset that with growth in software and services. Although I want to just also note, including the headwind that we will have related to the transition towards more recurring revenue and away from perpetual license revenue. We think that's about a 3% to 5% headwind on the top-line in 2020. And that, that variation around that really ties back to what I said an answer to Dan's question, which is not every customer is ready to make that move toward cloud and recurring. So there's going to be -- there's a little uncertainty about which customers and how many will move how fast and all of that. So we think that's a reasonable range of what's going to happen. And that the financials that we have guided to are a reasonable set of financials that understand the -- what will happen with hardware. The headwind we have on transitioning to more recurring revenue and then the really strong growth in the solid growth that we will see in our software offerings particularly in light in term license -- sorry in subscription.

Yes. So just in general, if I look back at your Analyst Day and the numbers I did on my base case, so what you're really saying is, the hardware is probably going to fall a little bit harder than you expected in 2020. So, when we modeled maybe so -- and we can do the details offline. I just want to make sure I understand that. And then, on your reoccurring, you expect that to pick up a little bit faster. You had said at the Analyst Day, think about 25% to 30% CAGR from 19% to 22%. Is that safe to say that that recurring revenue is still going to have that good clip even with the headwind or not?

Yes. The headwind on total software really relates to a less perpetual…

Okay. The mobile security, the software licensing piece of it?

Well, I will just jump in. So when we talk about headwind, it's really on the total software revenue. When we make that shift from perpetual to term, you have some short-term pain for long-term gain and you have less short-term revenue from perpetual than you would under terms. So that's what we mean by headwind Catharine.

Okay. No, that helps. And then just any insight into the new solutions and how much you expect them to contribute this year. And which one did you feel are most -- are going to do the best for you this year? And then I promise I won't ask any more questions.

I just wanted to touch on a couple of the other things you mentioned. We do -- I think in terms of the compound average guidance we gave in New York for 2020 through 2022 that is still our outlook for the business. And I think hopefully you will see that certainly in the recurring revenue category this year, we do expect that to be add-in or near the range in which we communicated in New York. And I think as far as hardware is concerned I think to the degree that it may be -- is coming down a little bit more than I don't know that it's more than our expectations, but maybe more than the expectations of some really relates to the fact that it did so much better in 2019 than we originally expected for sure. And that strength continued through most of the year. So I think I just wanted to sort of note those two items. What was your final question?

Products.

Which products do you think are the new ones that are you think are going to be your really the ones that you think will do the best for you this year?

I would touch on probably three areas that I think are going to be strong based on the work that we've done in 2019. I do think that OneSpan Sign is going to have a very good 2020. We already saw that start to happen in the fourth quarter of 2019 had a very good fourth quarter. As I noted and I mentioned before, we made significant investments in that product line and the organization that supports that product line. So I think we feel very good about that. Mobile security will continue to be, I think a very successful and strong product for us. And then, I think when we turn to toward the trusted identity solutions, there are probably a couple that are most maybe will have the biggest impact. I think one of those is intelligent adaptive authentication that represents the largest portion of the opportunity pipeline for the TID solutions. The other one that I think is going to be really interesting is the secure agreement automation offering. We just released the new modernized version of that in the latter part of 2019. We've already rolled that new version out with a major customer in Europe and I think that's going to be one that we're going to continue to -- all of these really, we're going to continue to build develop them in 2020, but those are the ones that I'm probably the most excited about.

Our next question comes from the line of Matthew Galinko from National Securities. Your question please.

So you mentioned, adding some sales reps. I'm curious with regards to the dedicated software folks that you're looking to hire. Do you have many on-boarding today or is that sort of aspirational over the course of 2020, and can you kind of just give a little bit more color on the linearity of those? And what kind of competition you see for adding those sorts of salespeople? And maybe just adding a little bit in terms of when you say the R&D spend increasing throughout the year. Thanks.

Sure. So, first of all, I think in terms of adding the new salespeople we have been working at since the fourth quarter really. Our goal is to get as many of those qualified people onboard as quickly as we can to the point that you made Matt, that's not always easy. It is a full employment economy and we do have the need for people who have a very good set of qualifications and the right attitude and the right mindset for succeeding in our business. We think we have an attractive value proposition to those sellers. In fact, we've had just in the last couple of months, we've had at least a couple of sales people who left us a year or so ago come back as they see in the story develop in the solution portfolio build they'd come back. We just came off our annual global sales meeting in Lisbon last week. We had 200 of our people there in Lisbon for looking at all of the things related to our business in 2020. And I have to say that the level of engagement and excitement was really outstanding. So that confirms for me that the story and the message that we have as a value proposition to attracting talented salespeople is pretty good. And we now have a track record, I would say, over the last two, three years of achieving our objectives from a sales and a growth point of view. So I think there's increasing evidence for our internal salespeople and those that we want to join the company that they can be successful and they can make money being part of OneSpan. So I think that's the way that I would respond to what you said. Let me add also that we have made already over the last few years significant changes and upgrades to the sales organization and we've turned over something in the neighborhood of 40% to 50% of the sales organization in 2018 and 2019 bringing in people who have enterprise software experience and security experience in many cases. So this is a continuation of a process that has been underway. A significant number of the already existing sales people are becoming software only salespeople. And then, the rest for the most part are what we would call a hybrid sales person who has -- maybe they have accounts where there's a substantial amount of hardware authenticator business, but they also have a set of goals and objectives in their quota that are specifically related to our software and services offering. So nobody on the sales team gets a pass on selling software. But we are over time shifting the character and the capabilities of the sales force to really be very directly focused on driving these solutions, which are really the future of the company. All the things you asked about, but if I didn't please...

It was a pretty full question and I appreciate the color. I guess the follow-up to that would just be -- you also mentioned investment in the R&D line. So, just curious when we should expect that to hit over the course of the year?

You want to take that Mark? I think it's pretty even actually…

We saw a lot of growth in the R&D line in 2019. That will be a tempered back in 2020, but still will be growing as we continue to invest in R&D, but it's not at the same rate as 2019.

Yes. We've got an overall sort of OpEx growth around 10% in a year-over-year. If we sort of break that down that's again with G&A being -- not a precise answer, but mostly flat with R&D up in kind of high-single low digits I believe. And then and sales and marketing will grow actually the fastest. So if you went back and looked at 2019, we saw R&D growing faster than sales and marketing, in fact sales and marketing overall was only up a little bit in 2019, but as we have now made the investment to bring these new solutions into the marketplace and we're beginning to execute this transition to more recurring revenue. The time was right now for us to step back on the pedal with respect to both our sales capacity and also our marketing effort. In terms of lead generation and sales enablement, brand development around the OneSpan brand. So, we do think very clearly about the right timing for these investments. We don't want to invest at the wrong time in one area or another that ends up kind of push on a rope. So I think we've tried to be very thoughtful and constraining sales marketing last year while we built a portfolio and now that we are further along and that really making some incremental investment in sales and marketing, while we continue to improve the product. The software business that part never ends. So that's the idea.

Thank you. Our next question comes from the line of Anja Soderstrom from Sidoti & Company. Your question please.

Hi guys. Thank you for taking my question. And congratulations on a great quarter and to the great year. Can you hear me?

Sure. We can.

Okay, great. Thanks. I just wanted to follow up on this transition this year to the software and SaaS service from. You talked about the financial institution warming up to maybe going away from the on-prem. So sort of where are you in that discussion? Is it a matter of them wanting to go on board with it, but it's hard for them, because of the regulatory and the policies or are they still warming up to the idea or sort of where are you in those discussions?

I think it's all over the map really when we look at -- it's not exactly like you might think it would look like, and I'll explain that in a moment. But we have some particularly some of the digital banks and some of the banks in North America who are really moving full speed ahead in that direction in a number of cases. A lot of times that's because I think that the institutions in North America have already had a little bit more experience with operating critical services and infrastructure in the cloud than maybe they've had in some of the other parts of the world. And e-signature for example, it's been pretty common for that to be a cloud offering or a cloud service that banks consume in North America quite some time -- it's much less common when we go to some of the other parts of the world. So it's very institution specific. When I got asked this question, maybe 1.5 years ago, I would've said, it's going to be North America first, then it will be Europe, and then somewhere down the road it will be Asia. What in fact is happening is that I think Asia and Europe are more moving together and in some cases there are Japanese institutions and in other parts of Asia who are now moving -- really moving forward quite briskly towards using a cloud based services for security and authentication and some of the things that we are offering. So I think in Europe the regulatory environment is more significant I would say. And there are -- European banking authority has published certain guidelines around the banks that want to move their infrastructure to the cloud. And so I think particularly the large banks in Europe are probably the most cautious in this regard. And probably, after them comes the Asian institutions and then the U.S. or North America institutions are pretty good. Latin America has actually moved pretty fast too. We are seeing a lot of opportunities in Latin America. So I know that wasn't super numerical or anything, but it's -- that's why we're kind of giving a range on the headwind for this year because it is a little uncertain in which customers will move and how fast and all of that. But, as I mentioned earlier, the fundamental economics and the requirements around cost, agility and competitiveness really make it inevitable that this is going to happen [indiscernible].

Okay. Thank you for that additional color. And so it's a matter of you having existing customers' cessation and that's where the most of the focus are rather than adding new customers, if that's…

I would say it a little differently. And I did mention this, I think in New York at the Investor Day, that I do think that our existing customers will be the largest set of customers for us on the new solutions. We're very global. We have a penetration across lots and lots of 2000 institutions around the world actually. So, there's no doubt that existing customer set will be a rich source of opportunity for us. But we've also said that ultimately we cannot be successful if we aren't driving growth in new logos and new customers including the new digital banks -- digital only banks and so on. And we have won a number of those in 2019 and we also are working closely with more than one several of the digital banking platform companies to take our services through their platforms into our customer base. So when we look at new logos, I think I probably need to check this number, but I believe the correct statistic is that our -- the number of new logo customers we had in 2019 was 50% more than we had in 2018. And so it's not as larger proportion of our revenue yet is. I think it can be, and I'd like it to be, but we are very clearly seeing a trend as we brought the portfolio of offerings of getting more new logos, more new customers across a more diverse set of banks than we have historically.

Thank you. [Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Scott Clements, CEO for any further remarks.

I don't think I have any further remarks. Other than maybe I just reiterate, I think we're at a very, very interesting time for this company. And I'm really looking forward to how we proceed in 2020. We have laid the foundations, I think for substantial growth and substantial growth in recurring revenue in 2020 and forward. And it was by accident that we got here. It's been a broad effort by the leadership team, the executive team here and our employees. And we're really excited about now seeing the fruits of that in 2020 and forward. So thanks very much for joining us today and we look forward to talking to many of you over the next few days.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.