OneSpan Inc. (OSPN) Q1 2021 Earnings Report, Transcript and Summary

Good day, and welcome to the OneSpan First Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Joe Maxa, Vice President of Investor Relations. Please go ahead, sir.

Thank you, operator. Hello, everyone and thank you for joining the OneSpan first quarter 2021 earnings conference call. This call is being webcast and can be accessed on the Investor Relations section of OneSpan's website at investors.onespan.com. Joining me on the call today are Scott Clements, OneSpan's Chief Executive Officer; and Mark Hoyt, our Chief Financial Officer. This afternoon, after market closed, OneSpan issued a press release announcing results for our first quarter 2021. To access a copy of the press release and other investor information, including a presentation reflecting our first quarter financial results, 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 outlook for full year 2021 are forward-looking statements. These statements use words such as believes, anticipates, plans, expects, projects and similar words, and these statements involve risks and uncertainties and are based on current assumptions. 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 annual report on Form 10-K filed with the U.S. Securities and Exchange Commission for a discussion of such risks and uncertainties. Please note that 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 for 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 call is May 4, 2021. Any forward-looking statements and related assumptions are made as of this date. Except as required by law, we undertake no obligation to update these statements as a result of new information or future events or for any other reason. With that, I will turn the call over to Scott.

Thanks very much, Joe, and good afternoon, everyone. Thanks for joining us on the call here today. During the first quarter of 2021, our annual recurring revenue, ARR, increased 29% year-over-year and ARR specific to subscription and term-based contracts grew in excess of 50%. In addition, a record 87% of our software and services bookings and revenues were recurring. We’ve made tremendous progress in our shift to recurring software revenue, and we expect to be materially complete with this transition by the end of 2021. Subscription revenue grew 47%, driven primarily by strong demand for e-signature solutions. Term license revenue declined from last Q1's pre-pandemic record quarter, but Q1 2021 was the third highest term license revenue quarter in our history and just shy of Q4 2020's total. Mark will provide more detail on these revenue items during his financial review in a few minutes. Profitability was impacted in the quarter by planned growth investment, several one-time expenses and higher vacation accruals, which we expect to return to normal levels in future quarters as employees return to more typical vacation patterns. Now I will turn to business highlights from the first quarter. During Q1, we won the largest multi-million dollar e-signature subscription contract in our history, displacing a major competitor and a leading provider of digital lending solutions. And just a few weeks ago, we launched the OneSpan Sign Virtual Room, which enables financial institutions and other organizations to safely and securely collaborate with their customers via video conference and live interactive co-browsing in order to review and e-sign high value agreements in retail banking, corporate banking and wealth management as well as insurance and automobile financing use cases, to name a few. Instead of customers getting to patch together multiple apps and tools, the virtual room is an out of the box solution that is unique to the market, combining video conferencing, e-signature, identity proofing, end-to-end audit trails and recording options. It can be completely white-labeled to put the spotlight on our customers' brand, which is particularly important for B2C, consumer-facing transactions. We have initial interest from many top North American banks that are already using our e-signature solution, and pricing for the virtual room service will be at a significant premium compared to pricing for only e-signature solutions. We are also integrating our newest identity verification capabilities into OneSpan Sign, which, combined with our virtual room technology, will deliver remote online notarization capabilities. We expect these expanded offerings to be available to customers starting in Q2 and Q3 of this year. In Gartner's September 2020 market guide covering issues such as identity verification and identity proofing services, they stated that "by 2023, 75% of organizations will be using a single vendor with strong identity orchestration capabilities and connections to many other third parties for identity proofing and affirmation, which is an increase from fewer than 15% today." We are preparing OneSpan to benefit from this trend in the coming years. Next I want to comment on a recent consumer study from Aite Group, which found that 47% of all U.S. citizens were victims of some type of identity theft in 2019 and 2020. There was also a substantial increase in new account opening fraud as criminal groups looked to launder funds stolen from emergency government, unemployment and stimulus programs. In 2021, the decline in opportunities for stimulus fraud is expected to drive hackers back to traditional banking fraud with a focus on account takeovers, and which we believe will increase demand for our anti-fraud solutions. We believe we're well-positioned to respond to these fraud attacks through our complementary portfolio of mobile, cloud and hardware solutions. Turning to hardware for a moment. As many of you are aware, we are realigning and streamlining operations to match lower revenue levels and maintain gross margins. Today, actually 19 of our top 20 customers use some combination of our hardware and software authentication solutions, all of which contribute to our profitable maintenance revenue and ongoing upsell and cross-selling opportunities. I also want to provide you with some color on the progress we are making in adjacent regulated verticals within the government and healthcare sectors that require a high level of security. Our entry into these verticals is still early, but we are gaining traction. Bookings were up more than 40% in the 12 months ended March 31, and our pipeline was up approximately 70% at the beginning of this quarter. Before I turn the call over to Mark to go through our financials, I would like to discuss a couple of recent announcements from OneSpan. First, during the quarter, Garry Capers was appointed to our Board of Directors. Garry joins four other current independent and highly qualified directors who have been added to the Board over the last 2 years. Garry has significant fintech and SaaS experience. He is Division President of Cloud Solutions at Deluxe Corporation, where he has full financial and operational responsibility for the company's SaaS and cloud solutions that are primarily targeted at end markets in the financial services industry. Second, as we announced on April 23, our CFO, Mark Hoyt, is leaving OneSpan to become the CFO at a private company. Mark has been an important contributor to OneSpan's transformation as we shifted to an emphasis on recurring software and services revenue, expanded our disclosure of relevant financial metrics and rebuilt our information systems architecture. On behalf of OneSpan, I'd like to congratulate Mark in his new role and wish him the greatest of success. We are fortunate to have a very strong finance and accounting team that will provide continuity during the interim period. We've already begun our search process for our next CFO and are seeking highly qualified candidates with deep cloud based software solutions experience to help continue the transformation of our company. Mark will now take you through our financials, and then I'll come back to provide additional comments along with an update on our outlook before opening the call to questions. Mark?

Thank you for the kind words, Scott. Before I get into the results, I want to acknowledge that it has been a privilege to serve as part of the OneSpan team, and I want to thank all of my colleagues for the support and collaboration over the years. We've made tremendous progress in transforming the company, and I’m confident that OneSpan is well-positioned to continue that progress. Turning to the quarterly results. Annual recurring revenue at the end of Q1 was $108 million, representing a growth rate of 29% in line with our 25% to 30% target growth rate for the quarter. Our dollar based net expansion rate, which we define as the year-over-year growth in ARR from existing customers, was 119% in the first quarter. Turning to recurring revenue. For the first quarter, subscription revenue grew 47% to $8 million. This included strong growth in e-signature and an increased contribution from cloud authentication. Term-based software license revenue declined 13% to $8 million compared to an unusually strong first quarter of 2020 that benefited from strong pre-pandemic demand and had an average contract duration approximately 60% longer than the average contract duration in the first quarter of 2021.This impacted our term license revenue in the quarter, which was still our third highest term-based software license revenue quarter ever. Maintenance revenue grew 14% year-over-year to $13 million. We expect maintenance growth to moderate over the balance of 2021 as we continue transitioning our business model toward subscription and term-based software licenses. In total, recurring revenue increased 12% to $29 million. Recurring revenue accounted for a record 87% of software and services revenue in Q1 compared to 71% in the first quarter of 2020, and ahead of our expectation to achieve 85% this year. In the first quarter, total software and services revenue declined 10% to $33 million, impacted by our shift to recurring revenue. Hardware revenue declined 10% to $18 million and total revenue declined 10% to $51 million. Gross margin in the first quarter of 2021 was 70% compared to 71% in the first quarter of 2020. The difference in gross margin is primarily attributed to product mix. Operating expenses for the first quarter of 2021 were higher-than-expected at $45 million. The total increase in operating expenses resulted from planned growth investment, several one-time expenses and significantly higher vacation accruals as employees delayed vacations due to the pandemic. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation, amortization, long-term incentive compensation and nonrecurring items was negative $5 million for the first quarter of 2021. This compares to $5 million positive in the first quarter of 2020. GAAP loss per share was $0.23 in the first quarter of 2021 compared to GAAP earnings per share of $0 in the first quarter of 2020. Non-GAAP earnings per share, which excludes long-term incentive compensation, amortization, nonrecurring items and the impact of tax adjustments was negative $0.16 in the first quarter of 2021 compared to $0.08 in the first quarter of last year. We ended the first quarter with $115 million in cash, cash equivalents and short-term investments, consistent with the end of 2020. Cash generated from operations during the quarter was $4 million. Geographically, our revenue mix for the first quarter included 53% from EMEA, 33% from the Americas and 14% from the Asia Pacific region. This compares to 60%, 22% and 19% in the same regions last Q1, respectively. I will now turn the meeting back to Scott.

Thanks, Mark. Before we open it up to questions, I'd like to provide a bit of perspective on the current market landscape. The global economy is improving, but it is still uneven. In North America, profitability at large banking institutions improved substantially, and new account opening trends are improving as we expected. In Europe, travel restrictions and physical lockdowns continue, but with expected improvements in vaccine distribution, we should start to see sequential improvement going forward. The Asia Pacific region also had a soft first quarter, but as in other regions, we expect improvement as the year progresses. The outlook for e-signature remains strong around the world with continued demand for digitization services in today's economic environment. At this time, we are reaffirming our FY '21 objectives and full-year guidance, consisting of the following: total revenue of $215 million to $225 million; recurring revenue to be in the range of $120 million to $125 million; ARR growth of 22% to 26%; and adjusted EBITDA to be approximately breakeven. In the second quarter of 2021, we expect ARR growth of 25% to 30%, and for recurring revenue to increase sequentially and year-over-year. While perpetual license and hardware revenues decline as we continue to shift to a recurring model. We expect profitability to improve in the second quarter on higher revenue with increasing contributions from software and services. The second half of 2021 revenue is expected to exceed the first-half revenue, led by continued growth in recurring software and services. And as previously indicated, we expect hardware revenues to decline in the mid single-digit range for the full year. We also continue to expect $15 million to $20 million of revenue headwind resulting from our transition to recurring revenue for the full year of 2021, and then we expect to see acceleration in software and services revenue growth in 2022 with increasing bottom-line profitability. Our core value propositions in security, productivity, positive digital user experience and regulatory compliance remain solid. Our transformation from a hardware-centric technology business to a modern cloud based software and solutions company is well under way and is driving positive results. Along with this transition, our Board has evolved with the addition of significant expertise and experience matched with the businesses' changing risks and opportunities. Our goal over the next 2 to 3 years is to drive increased revenue growth as the recurring revenue transition wraps up and we expand our solution portfolio, along with increased profitability and greater shareholder value creation. In the coming months, we will be identifying opportunities for structural cost reductions that we expect to improve profitability in the 2022 to 2023 time frame, and we plan to refresh our multiyear financial goals and update you further later this year. Before we open the call to questions, I just want to remind everyone that this call is to discuss our Q1 results and outlook. We won't be taking questions about our annual meeting election, but I encourage those of you who are interested to visit www.onespanvalue.com for our proxy materials. With that, Mark and I will be happy to take your questions. Operator?

Thank you. [Operator Instructions] And the first question will come from Andrew Nowinski with D.A. Davidson. Please go ahead.

Great. Thank you. I will start with a question on the e-signature business. So was there any more details you could provide on the record contract that you won in the quarter, maybe the size of the contract or the length of the contract?

Andy, yes, I think, Mark, that's a 3-year contract, correct?

This was the initial phase one, yes, that's correct. And it's -- the total value of the project is, I would call it, mid single-digit millions.

Great. thank you. Maybe shifting gears then, I know you said you had record demand for term-based licenses in Q1 of 2020, but it looks like the term-based revenue is still down a bit more than hardware this quarter. Were you surprised by the magnitude of the decline? And was there anything in term-based licenses that may have impacted that decline other than the tough comp?

No, I don't think so, Andy. Really when you go back and look at -- or personally, it was in the range of what we expected, I think, in the quarter. If you go back and look at Q1 of last year, we went from about $500,000 of term license revenue out in Q1 2019 to something -- I think it was about $9.5 million or so in the first quarter last year. So it was an order of magnitude increase in the first quarter last year that related to some specific large contracts, particularly around mobile security and things like that. So the -- and then, of course, the other compares sequentially and we had a real -- very, very strong fourth quarter of 2020 as we usually do have a back-end loaded results. So I think as Mark said in his comments, it was still the third highest quarter for us in terms of term license. So it's -- yes, I don't -- I think we are just bumping up against a couple of real tough compares, but it doesn't really change our outlook for the business or our expectations.

Okay. Great. And then maybe just last one for me real quick. Is it possible -- I know you reiterated your hardware guidance for the year of down mid single digits. But as the economy starts to reopen, do you think there could be some pent-up demand for hardware and maybe even a pending hardware refresh cycle that might provide a little bit of upside to that guidance?

Well, I think, first quarter, I think came in pretty good, I think relative to our expectations. We will see as we go through the year. We do know there are some -- a few larger opportunities that are out there. Whether they really come through the right kind of timing to impact revenues this year is TBD. I think these larger projects tend to have a pretty long cycle, right, of manufacturing and delivery and so on and so forth. So -- and when you go through that cycle, it's a few months, right, you get through that cycle. So if some of these things come in, or booked early enough in the year, we could see some better performance out of hardware. But I think it's kind of -- it's too early to call that, really. As you know, historically, this is a little bit of a volatile part of the portfolio or a solution category. And so we -- I think we feel good about the guidance we've given at this point. And -- but a lot of that tends to come late in a year or two with hardware. Usually, hardware is a later -- we have bigger quarters later in the year. So there's a lot yet to go, I guess, let me put it that way.

Okay. That makes sense. Thanks a lot guys and best of luck, Mark.

Thank you, Andy.

The next question will come from Gray Powell with BTIG. Please go ahead.

Okay. Great. Thanks for taking the questions. Yes, just a couple, if I can. So maybe a follow-up on Andy's question. So I mean, it definitely seems like sentiment in the banking sectors improved a lot this year. Do you see that impacting purchase decisions or sales cycles at your larger customers for any part of the product portfolio? And then just how should we think about that recovery playing out over the rest of the year?

Yes, I think we -- our expectation is that, sequentially, things are going to continue to get better through the year. And we have seen some of that in terms of the structure of our sales pipeline in terms of more of the sales pipeline is in the later stage gates of the pipeline than we saw early in the first quarter. So things are moving through the pipeline. We have seen, certainly, North America banks, their profitability has improved quite a lot. As you know, they've been reversing some of the reserves they've put up last year. And we have also seen some upticks in new account opening at some of the large banks that report those figures here for the first quarter. I think that on the other hand, the area that -- there's a couple of areas that remain concerning, and those are Europe. Certainly, we have a very uneven situation in Europe with some lockdowns coming back and continuing in spikes in infection rate. I do believe that they are starting to do better moving forward with vaccination over the coming few months, and that will, I believe, have a positive effect on that region and on our business as we, I think, are beginning to see here in the U.S. at this point. Japan is a hard one to call. There is a spike in infection rates going on in Japan right now. And then we also have the issues in Brazil, which are concerning. So all of those, I think, are the present period and we do expect generally to see progress in those areas over the coming months. So I think we said really since the fourth quarter last year that we expected sequentially better business conditions as we go across the year. I don't see any reason to change that expectation at this point in time.

Understood. Okay, that's really helpful color. And then maybe just kind of help us think about some duration and how that impacts term license? And I'm guessing that the answer is really, that we should just focus on the ARR metric. But how should we think about multiyear term license deals within the context of your 2021 guidance? And then would it be possible to say like sort of a -- I think you said that duration was down 60% in Q1. Is there a way to sort of just give like an apples-to-apples for like constant duration Q1 term versus last year?

Gray, the 60% down reflects the term license duration that we've seen for the last couple of quarters, which we've mentioned is approaching about 12 months. It's approaching about 1-year. So last year, Q1 was kind of an aberration because we had a couple large 3-year deals that brought that average up to about 1.6 years. So we saw that revert back to the median of about one this quarter, not unusual. And that's reflected, the 1-year average duration was reflected in our guidance and in our numbers for 2021. And it's along -- it's in the plan with what our sales team is offering to customers and what our customers are asking for as they approach more 1-year deals. Of course, if we have customers that request 3, 5-year deals, we feel we are happy to oblige. But we are seeing a lot of customer traffic headed towards 1-year deals that are pretty close to mirroring subscription-like terms.

I think in general that we have -- as a matter of course, really tried to move toward 1-year terms in general to really, I think, minimize revenue volatility from one period to the next. And so that's really been -- as we've gone through the transformation away from perpetual to recurring license models, we wanted to keep it somewhat simple, as simple as we could, and then also get that outcome of improving or reducing the historic revenue volatility that the company have seen. So that's really what the goal has been. I think as we look into 2022, we could potentially fine tune that to some degree. As Mark said, we're not -- we don't tell customers who want a multiyear contract to go away. We love them, and we will take it. But that has been really on purpose that we have moved toward a 1-year average duration. And we will see whether we continue on that course in the quarters ahead or we start to modulate that a little bit. But right now, we continue to believe that's the best course.

Got it. Okay. That’s really helpful. Thank you very much.

Thanks, Gray.

The next question will come from Anja Soderstrom with Sidoti. Please go ahead.

Hi. Thank you for taking my question. I just had a follow-up first on the e-signature contract you mentioned. You said the total value was in the mid single millions. But in context to sort of your average contract, are you going after these kind of deals? Or how did this come about?

Well, I think this was a customer that was actually a customer of a competitor who had a large deployment, I guess, of e-signature across different use cases in the company. And so when they decided to seek alternatives, we were, I think, well-positioned to take advantage of that and win that customer. So I think our average contract value in e-signature has come up quite a lot over the last year or so, and that was on purpose. We have focused our direct salespeople on pursuing larger contracts there. There have been, I think, a tendency in that we're going to, in that part of the organization to maybe chase too many small contracts. And so we really did refocus everybody on larger sized contracts. And I never talk top of my head, Mark, I don't know if you do know exactly what those numbers are. But this -- they're not in the million. The average is not in the million, let's put it that way.

Okay.

It's much smaller. But we do have -- it's not that we have not had other contracts over $1 million. We have. But this one is a little remarkable, I think, in terms of the size. And I think indicative of the progress that we are making in that business, both in terms of our product and also our go-to-market model.

Okay. That was good color. And then in terms of the other virtual meeting room that you launched, I would assume there's a good use case for that in your adjacent businesses. Well, are you going after that initially, or are you just pushing it to your existing customers in finance or?

I'm sorry, Anja, I didn't quite hear the other business, what you said. Could you just repeat that?

Just wondering how you're going to market with that. Are you trying to upsell existing customers? Or are you -- I would assume there's a broad use case for that product that you might be able to push in the adjacent, too.

No question there. There's a broad set of opportunities for that product. And we -- banking is definitely a high demand area for it. This is a solution that has been a specific request of many of our customers to really help them personalize their relationships with important customers, even in the digital space, so they can put a face to a transaction and really interact in a more intimate way, I think, with their customers in higher value type transactions. And I think you can -- when you sort of conceptualize the best value proposition, I think you can see that it should have application across many different use cases where there is discussion or negotiation or an agreement that's being put in place that is of value and requires strong identity verification component to it. So it's -- I think it's very much a horizontal solution. We will, I think, in the early period here, the -- most of the opportunities will be in banking, really just because of where we come from. But certainly, as you know, we think about government and we think about health care and some of the other spaces that we're interested in, certainly should be opportunity in those as well.

Okay. Thank you for the color. That was all from me.

Right. Thanks, Anja.

This concludes our question-and-answer session. I would like to turn the conference over to Scott Clements, President and CEO, for any closing remarks. Please go ahead, sir.

Thank you, operator, and thanks to all of you for joining the call today. We have -- we are very -- looking very much looking forward, I think, to the balance of this year and the continued progress. As you know, we are making significant incremental investments in our solutions and our go-to-market model this year so that we can continue the transition to recurring revenue and really materially complete that transition this year and start to see that be reflected in the overall growth rates of the company as we move into 2022. So thanks again for your attention, and hope you all have a good evening.

Good bye.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.