Q3 2020 OneSpan Inc Earnings Call
Good day and welcome to the one span third quarter 2020 earnings conference call. All participants will be in a listen only mode should you need assistance. Please signal conference specialist by pressing the star key followed by zero. After todays presentation, there will be an opportunity to ask questions to ask a question. You May Press Star then one on your Touchtone phone to withdraw.
Your question. Please press Star then two please note that this event is being recorded I would now like to turn the conference over to Joe Maxa. Please go ahead Sir.
Thank you operator, Hello, everyone and thank you for joining the one spend third quarter 2020, <unk> earnings conference call.
My name is Joe Maxa, and I am the Vice President of Investor Relations. This call is being webcast and can be accessed on the Investor Relations section of one one spends website at investors Dot one span dotcom.
Joining me on the call today is our CEO, Scott Clements, our CFO Mark White.
This afternoon after market close once been issued a press release announcing the results for our third quarter 2020 to access a copy of the press release and other industry <unk> 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 outlook for full year 2020. Our forward looking statements. We have tried to identify these statements by using words, such as believes 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 <unk> 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 their 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 November 2nd 2020.
Any forward looking statements and related assumptions are made as of this date access.
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.
[noise], Joe Thanks, very much good afternoon, everyone and thanks for joining us here today.
Our results for the quarter reflect a near <unk> near term impact or the pandemic is our banking customers temporarily shifted their attention and their expenditures away from some security and authentication projects.
Despite this shift we continued to make progress in the execution of our strategy to transition to a recurring software and services dominant revenue model.
We remain optimistic about the future and we continue to believe that the core drivers of demand for our solutions remain intact.
Let me start by providing some insight into what we saw in the third quarter.
We entered the quarter with elevated uncertainty about our near term business outlook as our global financial services customers reacted to the increased severity of the pandemic bite.
By adding $70 billion to their loan loss reserve levels.
In addition to this financial pressure banks reallocated IP resources to support.
Work from home implementation.
Other critical digitization projects and business continuity needs.
This resulted in delays and uncertain typing timing for many other types of projects, including security and authentication improvements.
These factors impacted one Stan and other providers of software technology to banks.
Most banks also closed or restricted branch operations around the world limiting new account openings and reducing customer churn.
Both of which are key drivers of demand for our hardware and mobile security software offerings.
Branches remain the most used to channel for opening accounts around the world.
And are often a distribution point for authentication tokens.
The biggest impact of the pandemic on our business has been a sharp drop in demand for hardware authentication products.
This is a significant change compared with the third quarter of 2019, which are record hardware token revenue driven.
Driven by the implementation of payment services directive to a strong customer authentication regulation in Europe.
This onetime surgeon demand in Q3 19 makes for a difficult comparison.
The impact of the pandemic has made this comparison even more challenging.
A typical example is a major south American customer the temporary closed temporarily close most of its branches, resulting in a dramatic drop in new account opening m., reducing by two thirds of the number of authentication tokens it will purchase and 2020.
It's also important to note that in most cases, the sales and authentication endpoint also carries a user license for server or cloud based authentication software.
So on a respected financial services advisory firm publish its COVID-19 banking insight study confirming that the two most immediate priorities for financial institutions. During the thick of the pandemic had been to support customers in financial distress and to enable remote work for their employees.
The study also found that most banks do plan to increase their IP budgets in 2021.
With customer Onboarding, and mobile and online banking expected to see the largest increases which we believe will benefit one span.
We've already seen these trends in our one spend sign you signature business and the growth of our opportunity pipeline for mobile security and identity verification.
[noise], while uncertainties remain our customers have moved past their immediate financial.
And business continuity responses to the pandemic. They are looking ahead to 2021 and were getting better visibility into their security and Digitization investment plans.
As a result, we are today, providing updated guidance for 20 2020, and some comments around our expectations for 2021.
Now I'd like to look ahead and tell you why I'm optimistic about the outlook for one Stan.
As I've already noted customers are reengaging and there are several other positive developments first.
First our sales opportunity pipeline is rapidly growing second we're seeing sequential improvements in top line metrics and third our strategies are working I'll touch on each of these for a moment.
So first our software and services sales opportunity pipeline grow in excess of 40% year over year with strength in E signature identity verification and mobile security.
And our authentication token sales pipeline is presently at its highest level since Q4 of 2019.
Second bookings in all major product categories increased sequentially during the third quarter subscriptions increased 14% quarter over quarter and more than 100% year over year driven.
Driven by an urgent demand for process Digitization solutions, such as E signature and digital identity verification.
Other categories improved more modestly.
Third our strategies Trent to transform the business to focus on strong recurring revenue streams and high margin solutions and services continues to progress.
Software and services will likely exceed 60% of total revenues this year and forward.
Recurring revenue accounted for 74% of total software and services revenue in the quarter.
And annual recurring revenue a R.R. grew at 27% year on year.
And also our dollar based net expansion rate on recurring contracts was a solid 120%.
Year to date, our bookings on recurring revenue contracts are up 50%.
We're also working to it.
Expand our growth opportunities by improving and extending our solution portfolio developing a partner ecosystem to access new customers and increasing our focus on vertical markets beyond financial services.
We had several significant wins during the quarter that illustrate these trends.
We continue to see progress in the government space with a large six figure win at the U.S. Department of Agriculture.
As they continue to digitize their services for pharma assistance programs.
We also booked a seven figure opportunity and the digital health care space working with the top three U.S. telecommunications provider.
One span also closed an opportunity in Latin America, where the customer acquired multiple cloud based solutions simultaneously, including identity verification.
For digital customer Onboarding.
You signature for new contract signing.
And cloud authentication for prepaid card transactions.
Meanwhile, our partner ecosystem continues to expand.
We announced the technology and go to market partnership with Forge rock with whom we are already pursuing several sales opportunities.
We've also added supper banking and one log in as partners.
And continue expanding our global network of I'd verification and trusted service partners for our E signature identity verification and new account opening services.
Lastly, before I turn the call over to Mark.
I want to note that we continue to see evidence that financial institutions are accelerating their move to the cloud.
The pandemic has made clear the value of the scalability agility and resilience of cloud infrastructure.
And services as we envisioned and our trusted identity strategy back in 2018.
During the third quarter, we completed the deployment of our largest cloud project to date at U.S. based financial institution.
While there are still regulatory and other challenges banks adoption of cloud based services is gaining momentum to one stands benefit.
Aftermarket update you on our financials I'll come back to provide some additional comments on long with an update on our outlook before opening the call to questions.
Mark.
Thank you Scott.
As Scott mentioned.
We entered the third quarter of 2020 with uncertainty around the near term business outlook for our customers.
Well you know as we experienced reduced demand for our hardware and term license products.
However, there are some bright spots I do want to share.
Once again had a strong quarter of annual recurring revenue growth.
We define our AR as the annualized value of all active recurring product contracts greater than or equal to one year in length.
As compared to the end of Q3, 2019, Aon ARPU, 27% to $96 million.
Recurring revenue declined 5% year over year to $22 million due to diminished Q3 revenue from term licenses.
However, when looking at our total software and services revenue recurring revenue accounted for 74% of the total up from 62% last year.
We remain on track to exceed our initial goal for recurring revenue to be 75% of total software and services revenue by 2022.
We may reach that goal this year.
Our dollar based net expansion rate, which we define as the year over year growth in a are from existing customers was 120% in the third quarter.
We believe that these operational metrics like E.R.R. and D. NCR.
And our non-GAAP financial results provide additional insight into our transition to becoming a majority recurring revenue company.
Total revenue for the third quarter of 2020 declined 35% to $51 million.
The license revenue decreased 51% to $30 million, well services and other revenue increased 15% to $21 million.
Let me talk a little bit about our three recurring revenue components, that's subscriptions term licenses and maintenance in a bit more detail here.
Subscription revenue grew 34% to $7 million. This included strong growth in E signature improved growth and identity verification and a modest contribution from cloud authentication.
Term based software license revenue declined 68% to $2 million on pandemic driven delays in security related projects as Scott mentioned.
Maintenance revenue grew 17% year over year to $12 million.
Total software and services revenue declined 21% to $30 million and hardware revenue declined 48% to $22 million.
Again, the steep decline in year over year total revenue reflects Lars reflects large orders a year ago, driven by the PST to regulation deadline.
No well Q3 revenue declined from Q2.
Bookings in all major product categories grew in Q3 from Q2, Oh, no subscription bookings grew 14% and total software and services bookings grew 3%.
Gross margin in the third quarter of 2020 was 70% compared to 67% in the prior quarter and the third quarter of 2019.
The increase in gross margin is primarily attributed to our product mix tilting towards software.
Opex in the third quarter 2020.
Was $38 million flat with the prior quarter and 7% higher than the third quarter of 2019.
Adjusted EBITDA or adjusted earnings before interest taxes, depreciation amortization long term incentive compensation and non recurring items was $3 million is.
This compares to $3 million last quarter and $19 million in the third quarter of 2019.
Adjusted EBITDA margin was 5% in the third quarter versus 24% in the same quarter last year.
GAAP loss per share was four cents in the third quarter of 2020 compared to GAAP earnings per share of 30 cents.
In the third quarter 2019.
Non-GAAP earnings per share, which excludes long term incentive compensation amortization nonrecurring items and the impact of tax adjustments was three cents in the third quarter of 2020 compared to 36 cents in the third quarter of last year.
Well then ended the third quarter with $113 million in cash cash equivalents and short term investments compared to $110 million at the end of last year.
Cash generated from operations during the quarter was $3 million.
Geographically our revenue mix for the third quarter included 52% from EMEA and.
24% from the Americas, and 24% both Asia Pac region.
This compares to 61%, 20% and 90% in the same regions in Q3 2019, respectively.
Scott I'll turn the meeting back over to you.
Hi, Thanks, very much mark.
As I noted earlier, we have improving visibility to customer demand compared to the end of the second quarter. So we'd like to give you some updated views on 2020 2021.
In the fourth quarter, we expect sequential and year over year growth in recurring revenue to be are partially offset by a sharp decline in hardware authentication.
As Mark described.
And a continued shift away from perpetual license revenue.
We expect a are to be at or near our 25% to 30% goal for 2020.
More specifically for the full year 2020, we expect software and services revenue of 126 to 128 million hardware revenues of 77 to 79 million and total revenue of $203 million to $207 million.
Looking into 2021.
Our software and services sales opportunity pipeline is strong indicating that our product strategy is working and that our core value propositions. Its security productivity positive digital user experience and regulatory compliance are intact banks.
Banks are overall financially strong and while exact timing is difficult to assess we believe that delayed projects will proceed and 2021 and that the demand for endpoint products, especially mobile security will improve as banks refocus on consumer account growth.
This will be to some degree influenced by the course of the pandemic, but like other businesses banks are learning how to operate in this environment.
In 2021, we also expect the revenue headwind from the transition to recurring revenue to diminish with continued strong air our growth consistent with our long term target.
Of about 25% to 30%.
We now expect at least 85% of software and services revenue will be recurring by the end of 2022.
Compared to the prior outlook of 75%.
We also expect that hardware revenues will stabilize in 2021, though it's not yet clear whether we'll see some further decline or growth in that area.
The revenue mix shift to software and services will be accretive to gross margins.
We're still evaluating our operating expense investment for next year, given the uncertain path of the pandemic the quarterly piano spread is difficult to call at this point, but certainly we would expect progressive improvements in growth across the year.
I also want to note that we are assessing the benefits of realigning our authentication token hardware product line, we've been assigned an executive to lead this effort. While also streamlining the operation to match revenue expectations and reviewing its organizational structure.
We will update you on this as our plans develop.
In the meantime, we're focused on four.
Areas to strengthen our company for the future.
Number one we continue to use our digital infrastructure to engage with our customers to address their immediate and evolving needs.
We will increase our focus on E signature identity verification and agreement automation solutions, which are in high demand and continue to build our overall sales pipeline.
We continue to invest in our solution portfolio, increasing our capacity for innovation and differentiation in security broad.
Fraud management customer Onboarding and process Digitization number.
Number three we will expand our partner ecosystem, focusing on accessing complimentary technologies and expanding market access.
And number four well can we hope will develop targeted adjacent markets to increase our opportunity set and lessen our concentration in financial services.
Finally, I do want to remind you that we have prepared a third quarter update presentation that is available on our investor website right now.
So with that Mark and I'd be happy to take your questions operator.
Thank you we will now begin the question and answer session.
Ask a question you May press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset before pressing the keys.
So let's get to your question. Please press Star then two at this time, we'll pause momentarily to assemble our roster.
And our first question will come from Gray Powell with BTI Ji. Please go ahead.
Okay, great. Thanks for thanks for taking the questions here, maybe just a couple.
So high level and I think it could I think you did a good job adjusting to EPS, but just how do you feel about the visibility you have on that business today versus three to six months ago.
Yes, hi, great Scott.
I would say, it's it's much better than it was at the beginning of the third quarter.
And I say that in the sense that.
When at that point in time, you'll recall, we withdrew our guidance and the reason that we did that was because our cost we were having trouble.
Working with our customers understanding what their plans are going to be they couldn't tell us what in many cases their plans are going to be for projects that we that we knew about and been working with them. Some new projects. They really had a lot of uncertainty about when or what the timing would be on when those projects would go forward there were.
Organizations, we're just very focused in these other areas of business continuity and work from home and so on that I mentioned to you.
Before.
If I go back to certainly the beginning of the year I would say no visibility right now not yet as good as it was in a normal circumstance or at the beginning of the year, but certainly I think significantly improved.
From what we thought three months ago. So we have.
I think spent a great deal of time and effort.
Really.
Engaging with our customers very deeply spending the time with all of our sales organization around the world to do our very best to understand.
You know what is what's likely for certainly for the fourth quarter and to some degree for next year. So I think visibility in short a significantly improved from the end of Q2.
In some areas of the world, not yet where where we would like it to be normally.
Got it got it okay. That's very helpful and then on the hardware business.
So I mean, obviously I understand the headwinds there I think I'm just correct me if I'm wrong, but I think you said the pipeline on the hardware business is the best it's been since Q4 19 is that correct and then how should we think about the potential for that to recover as the economy gets better at some point if that's something that we'll just naturally happen or will you try to push more of.
That business into software form factors.
Yeah. So yeah, I think that when we look at the sales pipeline.
The you know we kind of we looked at of course every month and every quarter that.
That pipeline really bottomed out and kind of in the early part of last year.
A lot of orders coming in at that point in time, we're sort of whittling down the forward opportunity pipeline.
And the the value to pipelines, we see it today is is slightly above where it was oh really all of this year and even through the fourth quarter last year. So I think that I read that as I think some stabilization of demand for going forward.
The.
It does take it will take to some degree a new account opening trends to improve for banks to be bringing in new customers into their branches and so on and that will start to pull through.
Hardware as well as increased demand for mobile security as we go forward we're already seeing.
Some significant improvements in the opportunity pipeline or a mobile security. So I think you know we continue to be focused on driving our growth and a in software and services and the endpoint space for mobile security.
And Nevertheless, if you look at the data.
About 80, 82% or so roughly of our customers today are you still use our hardware token devices. So that's.
That's a that's a meaningful part of our business. It is important to a lot of our customers, we understand and really have understood I think for quite some time now that that's not going to be the growth engine of the company going forward and that will really come from mobile security and from the other solutions that we have to offer.
I have been answered your question Greg.
Yes, perfect. Thank you very much.
Right.
Our next question will come from Andrew King what color Your Securities. Please go ahead.
Hey, there thanks for taking my question so.
And it sounds like the hardware.
Or.
Cost.
Good good their sales.
Given the unpredictability in the volatility of it what do you consider breaking out the hardware and software gross margin and operating margin to give a little bit more visibility into really what you the real strength of the business behind the software.
[noise], Yeah, I'll make a couple of comments there Andrew.
Good evening by the way and Mark you May have some additional things you want to add here. So.
Look I think that as a you know as I always say that we as a management team and as a board our.
Look at our portfolio of solutions are constantly I try.
Trying to really assess.
What are the right, what's the right way for us to maximize value in terms of the assets, we own and the and the assets that we don't.
I think its.
Not not appropriate for me to talk really about you know private M&A activity or things like that if and until they become they'd become public.
I would just I guess reiterate what I said in a.
And the.
And the conference a script that.
We are we put somebody an.
And it's very experienced executive in charge of that business. He is taking a look at the the operation itself how to streamline the operation.
How to focus.
That on a the right product set and and how to a size. It really I think for the level of business that we see going forward.
Thanks, regardless of what we ultimately do these are all positive steps.
As we as we think about how to how to construct that business going forward.
Like I don't know if you have anything you want to add to that.
Sure I mean.
I think as Scott mentioned, we are seeing your thoughts.
We are excited to focus more on looking at that business and one of the challenges. We have is the is the shared back office functions, we have that support all our business lines.
I think that's one of the things I'm going to take a look at to see what.
Oh, it is necessary to support hardware and support software services and that's that's kind of the path that we're headed down at imports.
So we did not have in the future for it.
Got it. Thank you and then just.
I'd go to market strategy.
Outside of the banking vertical.
Adjusted that strategy to adapt the coded world and how you see that going or.
Yeah, I wouldn't I wouldn't say, we've really had to adjust that much for cove. It at this point these are.
Things that were in the early phases of a really trying to explore a couple of markets like healthcare like government, one or two others that were worth.
We're thinking about.
Really trying to you know we look at these verticals in the sense of.
Where or what are the use cases that are very similar to what we are doing banking financial services or the technology and the products can deliver value to that customer set outside of banking and financial services without us having to go create a whole another set of products.
To do that so when we look at when we look at these spaces and government not only U.S. government, but governments really around the world. There is a a real increase focused on digital identity.
Digital citizen services.
And things like this and those are you know those Ken in their own way be very high value transactions, maybe not in the same monetary sense as a bank, but certainly in many other ways.
So that's an area for example, where we can take much of our core technology and really I think apply it to those to it to a vertical market like government and I think the same holds true at health care, particularly as it applies to.
Digital health care, Tele health or things like that I think we were in the very early phases of that its certainly gotten a boost or because of the pandemic. So I think in that sense I guess, the pandemic is having an impact that that's really driving a interest in demand and so as you know it's almost always the case when sex.
There's like this started digitizing go mobile and all that they get they do it in a big hurry and often times their security is not as good as it should be in the early days. So I think we are these are two areas. We think there's a tremendous amount of opportunity. We don't have to really change our products or our business model all that much due to address.
Those markets and they are ones that are quite large and and growing in terms of their demand.
Great. Thank you.
Sure.
Our next question will come from RJ soda with.
Dodi. Please go ahead.
Hi, Good evening, everyone and thank you for taking my question I just wanted to follow up on this PSEG long after that Jason Marcus.
Additional investments you're going to need to do in terms of the sales team to do that or how do you see that playing out.
Yeah, Hi, I know yeah. That's a good question I think.
We're trying to well first of all and I think in the government market. We already do have some sales coverage and I think in certainly in North America and in a few other parts of the world the government sectors not completely new to us by any means but.
But we think there is really an expanding opportunity. There. So I think you know, we'll take that are a bit by bit.
And in terms of scaling out any resources I think when we look at the health care space.
That that's one where we would really be using a per you know probably a partner strategy a go to market approach that would really identify.
Technology companies and players that exist in our operating in that market already and the reason for that is because it's a very.
Fragmented market and I did it.
You know it take a lot of efforts are really build a direct sales model into.
Into that into that space. So we're very early on this one but I think you know our present approach and I think the likely approach going forward will really be white of finding the right channel partners to where we can add a security and digitization tools and things like that to maybe the larger value proposition that.
That that company may already have into the digital health and the telehealth space.
Okay. Thank you and that sort of segue into my my next question about your partnership ecosystem how.
Oh stop working for you to build that out given that sort of remote working and a pandemic has that affected that.
It's in that that really no I don't think it has it really hasn't I think that.
We've added a number of new partners in the in the quarter as I mentioned there'll be more to come.
And there are sort of a lot of different flavors of partners that were engaging west. So that really has not been a problem to any great degree that I I've heard from the team and I think the I think the area, where the the pandemic and remote work and all that probably has the biggest effect as you know trying to land new customers and new accounts.
I think in most cases, we've got pretty long standing relationships with our existing customers and we can do a lot to manage or manage that our relationship to those customers through our digital network.
It's a little tougher when you're trying to access a new customer and build a new relationship. That's not a you know a very big part of our business today, we want it to be a bigger part of our business going forward. So it's a it's something that you know certainly not helpful right now, but not a not a not us.
Significant problem for us I don't think at the moment.
Okay. Thank you that's all for me.
All right. Thank you.
This concludes our question and answer session I would like to turn the conference back over to Scott Clements for any closing remarks. Please go ahead Sir.
Yes. Thanks every much operator, and thanks, everybody for joining the call today I think that pandemic has certainly created some challenges for our customers and in turn US here in the third quarter, but we we do see this opportunity pipeline really really continuing to grow I think we're making great.
Progress on our transition to recurring revenue a in thinking about these adjacent spaces. So I as I look ahead I think there is tremendous opportunity for our company and we're going to continue to do our best to execute against that and not only deliver on the opportunities we have today, but to find new ones that will expand our.
Our opportunity set and I think we're as we go forward end up with a company that has a very high recurring revenue that stable and growing and that's our goal and I think we're making great progress toward that despite the current create a challenge. So thanks, everybody appreciate it and look forward to talking to many of you in the days ahead.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Hi, [noise].
[noise].