OneSpan Inc (OSPN) 2018 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the OneSpan Third Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Joe Maxa, Investor -- Director of Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan Third Quarter 2018 Earnings Conference Call. My name is Joe Maxa, and I am the Director of Investor Relations. This call is being broadcast over the Internet and can be accessed on the Investor Relations section of OneSpan's website at investors.onespan.com.

With me on the call today and speaking first will be Scott Clements, OneSpan's Chief Executive Officer. Also on the call is Mark Hoyt, our Chief Financial Officer. This afternoon, after market close, OneSpan issued a press release announcing our results for the third quarter of 2018. To access a copy of the press release and other investor information, please visit our website. Following our prepared comments today, we will open the call for questions.

Please note that statements made during this conference call that relate to future plans, events or performance, including the guidance for full year 2018, are forward-looking statements. We have tried to identify these statements by using the 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 a discussion of such risks and uncertainties in this regard.

Please note that certain financial measures that may be discussed on this call are expressed on a non-GAAP basis and have been adjusted from a related GAAP financial measure. We have provided an explanation and reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in the earnings press release that can be found on the Investor Relations section of our website.

In addition, please note that the date of this conference call is October 30, and any forward-looking statements and related assumptions are made as of this date. Except as expressly required by the federal securities laws, we undertake no obligation to update these statements as a result of new information or future events or for any other reason.

At this time, I will turn the call over to Scott.

Thanks, very much, Joe. Good afternoon, everyone, and thank you for joining us today.

Security for financial institutions and their customers is more important than ever, because hacking attacks are constantly evolving and losses to fraud continue to increase. At the same time, consumers are demanding a pleasant and low-friction user experience with security that is mostly transparent to the user. Delivering this has become a top priority in the financial services industry as institutions drive growth in the digital channel. Our cloud-based Trusted Identity solutions are designed to enable banks to provide a positive customer experience while detecting and mitigating fraud at every step of the customer journey and helping institutions comply with regulatory requirements.

We're making significant progress in executing our Trusted Identity Strategy. We have a number of pilots, proof-of-concepts and initial deployments worldwide, and a robust product release roadmap over the next several quarters.

Now I'll summarize third quarter results. Revenue growth in the third quarter was below trend line at 3% due to order timing, resulting in approximately $2 million of revenue shifting into early Q4. The timing of this revenue does not affect our full year 2018 outlook. We also saw an acceleration in the plan to transition from on-premises to cloud deployments in our e-signature product line, impacting e-signature license revenue. We believe this shift will continue to be a headwind to overall e-signature revenue growth in the near term, though it will begin to benefit e-signature subscription revenue growth in the coming quarters. Mark will provide additional details on our third quarter financial results during his review.

During the quarter, we went live with a number of initial Trusted Identity intelligent adaptive authentication and risk analytics deployments at financial institutions in Europe and the Americas. We received from a major Asian bank, the first order for our new FIDO-compliant software authentication solution that encompasses server side and mobile security suite components that support the increasingly popular fast identity online standards. And we saw continued broad adoption of our mobile security suite software.

Now turning to guidance for a moment. We expect to return to stronger revenue growth in Q4, and as such, we reaffirm our full year 2018 guidance. Revenue is expected to be in the range of $201 million to $211 million and adjusted EBITDA is expected to be in the range of $15 million to $19 million.

I'll now turn the call over to Mark Hoyt, our Chief Financial Officer, to provide more details about the quarter and about our outlook. Mark?

Thank you, Scott. Total revenue for the third quarter of 2018 grew 3% year-over-year to $52.5 million. Product and license revenue declined 4% to $36.9 million, and services and other revenue grew 23% to $15.6 million.

Subscription revenue grew 38% for the quarter and 43% for the first 9 months of the year. Software licenses revenue, which includes mobile security, server and e-signature licenses, declined 17% in the quarter.

Mobile security itself grew a robust 50%. But as Scott noted, due to the transition of our e-signature customer base from on-premise to cloud deployments, our e-signature software license revenue declined. Year-to-date, total software licenses grew 17%, including 60% growth in our mobile security software.

OneSpan's sign revenue growth, including subscription, licenses and services moderated to 10% year-to-date due to the transition from on-premise to cloud deployments. Maintenance, support and other revenue increased 18% to $9.9 million during the quarter. Hardware revenue grew 2% as expected year-over-year and 10% sequentially in the third quarter of 2018.

Gross margin for the third quarter of 2018 was 66% compared to 72% for the third quarter of 2017. This decline in gross margin percentage was due to lower software license revenue and the hardware mix. We anticipate the fourth quarter gross margin will be similar to Q3's, and that the gross margin for the full year 2018 will approximate 70%.

Operating expenses for the third quarter of 2018 were $37.7 million, an increase of 19% from $31.5 million reported in Q3 last year. The year-over-year change includes a full quarter of Dealflo's operating expenses, along with increased R&D and sales and marketing investments.

Our third quarter 2018 operating expenses benefited from a $900,000 accrual reversal based on a favorable result in a legal matter. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation, amortization, long-term incentive compensation and nonrecurring items was $1 million, a decrease from $8.8 million in the third quarter of 2017.

Adjusted EBITDA margin was 2% compared to 17% for the third quarter of 2017. GAAP loss per share was $0.02 in the third quarter of 2018 compared to earnings per share of $0.07 in the third quarter of 2017.

Non-GAAP diluted earnings per share, which excludes long-term incentive compensation and amortization, nonrecurring items and the impact of tax adjustments was $0.04 for the third quarter of 2018 compared to $0.14 in the third quarter of last year.

Geographically, our revenue mix for the third quarter included 48% from EMEA, 31% from Asia-Pacific and 21% from the Americas region. This compares to 45%, 27% and 28% in the same regions last Q3, respectively.

Moving on to the balance sheet. We ended the third quarter with $92 million in cash, cash equivalents and short-term investments as compared to $158 million at the end of 2017. The acquisition of Dealflo accounted for a majority of that difference.

I will now turn the meeting back to you, Scott.

Thanks a lot, Mark. As I mentioned earlier, we've got a robust product release schedule in the coming quarters. We anticipate launching our cloud-based Trusted Identity risk analysis solution in the fourth quarter and our Trusted Identity verification hub in the first quarter of 2019, which will support identity verification requirements for several of our new offerings.

The risk analysis solution enables financial institutions to detect and mitigate fraud in real time across multiple channels. And when combined with our intelligent adaptive authentication solution, that will improve the end user experience with no degradation in security.

Our identity verification hub solution combines technology we acquired through the acquisition of Dealflo with our Trusted Identity and e-signature capabilities, allowing financial institutions to modernize their account opening process while mitigating application fraud.

We see solid growth in our pipeline of opportunities, and we'll continue to invest in R&D while managing overall operating expenses. The significant investments we've made over the prior year will contribute to revenue growth in 2019, and we're confident that 2019 will be a year of progress, enhancing customer and shareholder value.

With that, Mark and I would be happy to take your questions.

(Operator Instructions) Your first question comes from Zack Turcotte with Dougherty.

Zack on for Catharine. First is a quick one on e-signature piece. So you mentioned e-signature license revenue going down due to transitioning those customers to the cloud. I don't know if you gave and I missed it. What is the overall growth for e-signature as compared to last year?

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

And the decline in license revenue is a large majority reasoning for the lower gross margins, correct? As well as on hardware?

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

Right. Okay. And then I've still one more on the geographic breakdown. The Americas portion of revenue was pretty significantly smaller in this quarter. Is that a trend of less spending in Americas or more traction in EMEA and APAC?

No. That license revenue we talked about in OneSpan sign is almost all North America revenue. So you would see that disproportionately impact North America in the short term.

(Operator Instructions) Your next question comes from Saliq Khan with Imperial Capital.

Two questions on my end -- a couple of quick questions on my end. The first one being is, when you talk about the e-signature transition from on-prem to the cloud, I recognize that long term, this is a positive thing. But could you give us a bit more granularity? What within the transition itself is causing the decrease in the revenues? Is it something where the customer is just not ready to be able to transition, so they are just catching the contract? Or is there something else within that, that we're not seeing just yet?

No, I think it's really in the year-on-year comparison. So last year, we had a significant amount of license revenue in that business. It was a significant contributor to overall license revenue. On a comparable basis, we see that license revenue coming in significantly lower this year. So this is really about new customers, new contracts who are getting more and more comfortable with going to the cloud. I think the news that's out this week about IBM and the Red Hat acquisition is kind of consistent with what we're seeing. And that is that even our large customers, even some of our financial institution customers who really wanted to buy on-premise in the past for a variety of reasons are really changing their mind and moving new business and new orders into the cloud. That's also really consistent with this -- with the TID strategy. When we started the TID strategy developing that about 1.5 years ago, even though a lot of our business was still on-prem at that time, we really determined that even our largest customers were going to be increasingly moving to the cloud. And so we began from the beginning building out TID to support first and foremost cloud implementations. So that's really what's going on. I think there has -- this has happened even a little faster than we thought it would. I think we knew what the trend was. But I think it's hit a little bit harder and a little bit faster than even we thought, which is in the short term creates some headwind for the e-signature revenue. But I think in the medium term, it will lead to better recurring revenue growth or higher recurring revenue growth. And it is a presumption about our TID strategy and makes us feel encouraged about, that we made the right choice, I think, strategically around the TID.

Got it. And Scott, as you kind of talk about the acquisitions that were announced this week, I would have thought that the transition to the cloud would have caused the revenue to increase, not decrease year-over-year. So what are we missing there? I'm just trying to get a bit more granularity on what exactly is happening? Is this a longer sales cycle or longer conversation with the consumer? What is it that is causing the year-over-year decrease? And I do recognize that you had a significant amount of license revenue within that business last year, but again with the ongoing demand that you're seeing, I would have envisioned revenues to increase.

Yes, so it is purely revenue accounting, right? When we do -- when we've done on-premise license project, we generally can recognize most or all of the revenue in the quarter in which we book that job, even if it's a multiyear commitment. When I say -- so let's just take an example, right? If we sold a $1 million license deal, we could probably book $1 million -- $1.2 million of revenue in the current quarter, including the first year of maintenance, okay? When we do a recurring revenue subscription for $1 million, we only book 1 -- say, it's a 3-year term, we only book 1/36 of that revenue in the first month in which we book that order. So you have a -- in short term, you have a very significant headwind that gets created when revenue shifts from license to recurring subscription revenue. I hope that -- did that make sense? Should I explain it further?

Yes, it definitely did. Yes, definitely. They just need to be a lot more comfortable because it sounds like it gives you much better visibility to the revenue generation profile and the cash flow profile of those customers and your overall business. So theoretically down the road, I would assume that the lumpiness that we have historically seen from VASCO and now OneSpan, that lumpiness within the top line would decrease over time as the cloud-based solutions continue.

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

Scott, just 1 or 2 other quick questions for you as well. Could you kind of highlight what the life cycle of the contract looks like? Is it a 3-year contract or 1-year contract? Or does it vary by the customer?

It certainly varies by the customer, but it's very, very typical that it would be -- that those recurring contracts -- cloud-based contracts are 3-year terms. That's the most typical. Occasionally, we will get into a 5-year term. Occasionally, we will get into a 1-year term. But in a large proportion -- large majority of the cases, I would say, those are 3-year terms.

Yes. And then lastly, on my end, is going to be -- regarding what the gross margin is going to look like theoretically. As you continue to increase the amount of revenue coming from the cloud and that transition continues to take hold, what is that ideal gross margin that you're targeting?

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

(Operator Instructions) I am showing no further questions at this time. I'd now like to turn the call back over to you, Scott Clements.

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

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