OneSpan Inc. (OSPN) Q3 2019 Earnings Call Transcript

OneSpan Inc. (OSPN 13.15%)
Q3 2019 Earnings Call
Oct 29, 2019, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the OneSpan third-quarter 2019 earnings conference call. [Operator instructions] Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Joe Maxa, director of investor relations. Please go ahead, sir.

Joe Maxa -- Director of Investor Relations

Thank you, Sydney. Hello, everyone, and thank you for joining the OneSpan third-quarter 2019 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 results for our third quarter 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 2019, are forward-looking. [Audio gap] 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 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. In addition, please note that the date of this conference call is October 29, 2019. Any forward-looking statements and related assumptions are made as of this date. Except as expressly required by the federal securities laws, we undertake no obligation to update these statements as a result of new information or future events or for any other reason.

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

Scott Clements -- Chief Executive Officer

Thanks, Joe. Good afternoon, everyone, and thank you for joining us today. We just completed a really great quarter for OneSpan, generating record revenue and profits. Revenue increased 52% year over year to $80 million, and adjusted EBITDA was $19 million or 24% of revenue.

Overall software revenues grew at 77% driven by strength in mobile security and solid double-digit growth in e-signature. Hardware had another strong quarter, growing 55% with solid contribution from our advanced Cronto technology. We continue to gain traction with Trusted Identity solutions. We're on track to achieve our primary TID goals for 2019, which were to complete initial customer deployments, establish reference customers and develop a strong opportunity pipeline for 2020.

The number of qualified opportunities in the pipeline expanded at approximately 40% annualized rate during the third quarter. We expect material revenue contributions from Trusted Identity in 2020 as our global financial services customer base adopts these new offerings. These opportunities are in every region of the world and range from small institutions to Tier 1 banks. For example, our top five European bank and long-standing customer started with our hardware authenticators years ago then they added our mobile security solutions and have now deployed our TID Risk Analytics to identify and stop fraud in real time.

The interoperability of our Risk Analytics and mobile security technologies, the ability to collect data across channels and the real-time contextual and behavioral analysis were significant differentiators versus our competitors. Turning to OneSpan Sign, our electronic signature solution. The United States Postal Service recently decided to expand their use of our solution to address the cause of repeated delivery attempts while improving the customer experience. This USPS program will enable its customers to use their mobile phone to sign for packages without being physically present for the delivery.

Overall, we're seeing improved growth opportunities in e-signature as we introduce new features in 2019. In Q2, we launched a qualified electronic signature capability to support regulatory requirements in Europe and Asia. And in the fourth quarter, we're releasing an enhanced user experience and improved enterprise management features that will benefit customers worldwide. Finally, we're hard at work expanding our partner ecosystem to enable our Trusted Identity solutions and to expand market access.

We added three more technology partners to support our e-signature and secure agreement automation offerings, and we reached an agreement with Cisco Systems to resell our hardware authenticators in the enterprise market. I'll now turn the call over to Mark to provide financial details about the quarter, and then I'll come back to provide a few additional comments about 2019 and update guidance before opening the call to questions. Mark?

Mark Hoyt -- Chief Financial Officer

Thanks, Scott. Total revenue for the third quarter of 2019 grew 52% year over year to $80 million. Product license revenue grew 66% to $61 million, and services and other revenue grew 19% to $19 million. Revenue components for the quarter were as follows: software license grew 95% to a record $19.2 million; subscription revenue grew 33% to $5.5 million; total software revenue, including licenses and subscriptions, grew 77% to $24.7 million; hardware revenue grew 55% to $42 million; maintenance support and other revenue increased 8% to $11 million; and professional services revenue increased 47% to $2.3 million.

Gross margin in the third quarter of 2019 was 67%, compared to 68% in the prior quarter and 66% in the third quarter of 2018. Operating expenses for the third quarter of 2019 were $36 million, a decrease of 5% from $38 million reported in Q3 last year. We expect operating expenses in the fourth quarter to increase year over year in the mid-single digits. Adjusted EBITDA or adjusted earnings before interest, taxes, depreciation and amortization, long-term incentive compensation and nonrecurring items, was $19 million or $18 million higher than in the third quarter of 2018.

Adjusted EBITDA margin was 24%, compared to 2% in the third quarter last year. GAAP earnings per share was $0.30 in the third quarter of 2019, compared to a loss per share of $0.02 in the third quarter of 2018. Non-GAAP earnings per share, which excludes long-term incentive compensation, amortization, nonrecurring items and the impact of tax adjustments was $0.36 in the third quarter of 2019, compared to $0.04 in the third quarter of last year. OneSpan generated $9 million in cash from operations in the third quarter, and we expect to generate additional cash in Q4.

Timing of orders affected our accounts receivable balances, which we expect to decrease in the fourth quarter. Geographically, our revenue mix for the third quarter included 61% from EMEA, 20% in the Americas and 19% from the Asia Pacific region. This compares to 48%, 21% and 31% in the same regions last Q3, respectively. I'll turn the meeting back to you, Scott.

Scott Clements -- Chief Executive Officer

Thanks, Mark. Consistent with the outlook we communicated on last quarter's conference call, software revenue growth accelerated in the third quarter to a record level as we approached and passed the PSD2 compliance deadline. We expect continued strong double-digit softer growth in the fourth quarter with a sequential and year-over-year increase in overall gross margins as hardware revenues soften as expected. We expect double-digit adjusted EBITDA margins for the Q4.

For the full-year 2019, we are increasing revenue and adjusted EBITDA guidance as follows: revenue is expected to be in the range of $248 million to $250 million versus our previous guidance of $229 million to $237 million, adjusted EBITDA is expected to be in the range of $26 million to $28 million versus our previous guidance of $22 million to $27 million. The growth drivers of our company remain solid and clearly defined. Banks are increasing emphasis on the mobile channel and are beginning to transition more of their operations to the cloud to reduce costs, improve user experiences and increase agility as the competitive environment intensifies. Meanwhile, these mobile application threats are rapidly evolving due to increasingly sophisticated mobile malware and synthetic identity attacks powered by stolen personal information.

As a result, we anticipate continued solid demand for our expanding portfolio of advanced security technologies that have proven effective in preventing fraud attacks. We are seeing solid global growth in the pipeline of opportunities for our e-signature and our trusted identity solutions. I do want to take just one moment here to thank our OneSpan colleagues around the world who have been working very, very hard this year and I think really have seen the result of their work here in the third quarter, and we expect that to continue. So many thanks to all of you who are listening in today.

Before opening the call to questions, I do want to make sure that everyone received an invitation to our Investor and Analyst Day, which is scheduled for December 4th in New York City. If you have not received it, please reach out to Joe Maxa here, and he'll get you the invitation. So with that, Mark and I will be happy to take your questions. Operator?

Questions & Answers:

Operator

[Operator instructions] And our first question comes from Dan Ives with Wedbush Securities. Please proceed with our question.

Strecker Backe -- Wedbush Securities -- Analyst

Hi. This is Strecker on for Dan. And great quarter, guys. But our first question is hardware, again, really strong.

And I was wondering if that's coming more from PSD2 deadline, or if you're seeing some of those hardware devices from 2013 that need the battery life of only five- to six-year renewals or if that's being driven by both. That's our first question. Thanks.

Scott Clements -- Chief Executive Officer

Sure. So I think I would say that at this stage, the majority of that sort of above trend line performance is still really being driven by PSD2. I -- we do believe that over the next two or three years, we will start to see some refresh from those orders in the early part of the last decade -- this decade. I guess, we're still in the same decade.

So -- but I think at this point, it really is being driven by PSD2. One of the interesting things that happened during the third quarter is that the PSD2 deadline was actually officially extended to the end of 2020, December 31, 2020, I believe. So I don't know -- we don't know at this point whether that will have a significant impact. I suspect that we'll have some positive impact, but certainly not like we have seen this year with the PSD2 impact.

So I think that's really what's happening at present.

Strecker Backe -- Wedbush Securities -- Analyst

Great. And then just on the software license side, I mean, another great quarter there. Is there anything you guys would like to call out or any additional color you can give us?

Scott Clements -- Chief Executive Officer

I think we talked -- we did talk in the first -- the second quarter when we were seeing the real order activity. There are very, very strong order activity around hardware, but was taking some of the focus away from the mobile security business in the short term. We believed, at that time, that, that would begin to shift to back during the second half of 2020 -- sorry, 2019, and I think that's exactly what's happening. There is the real need and real demand in the marketplace for these total security offerings that we have.

Let's give you a few data points. We know that over the last three years, mobile transaction volumes have grown by about 600%. So the usage and the volume of transactions that are happening in the mobile space is growing very, very fast. That makes it an attractive channel for hacking and for fraud, as you can imagine.

And so at the same time, over the last year, we've seen global malware attacks, mobile account takeovers like SIM swaps and fake mobile application attacks all more than double during that period. And more than 25% of all those malware attacks hit banks and other financial services organizations. So I think we have an environment that is really -- creates a lot of demand for our mobile security offerings. And I think these trends that I've just talked about are probably going to continue.

So over the coming years, we would expect this to continue to be a very good business for us.

Strecker Backe -- Wedbush Securities -- Analyst

Thank you, Scott.

Operator

Thank you. And our next question comes from Matthew Galinko with National Securities. Please proceed with our question.

Matthew Galinko -- National Securities -- Analyst

Congrats on the solid quarter. Maybe my first question, maybe this will sort of suffice, but you mentioned the combination of data from, I think, mobile app security, feeding the risk engine as being a useful combination for the -- when you highlighted this quarter on Trusted Identity. So I guess, one, how do you expect that reference account to support the pipeline build? Will that help or is that sort of irrelevant? Is that moving with or without? And second, I'm curious how significant a cross-sell opportunity there is into the installed base of existing mobile app security customers. Thank you.

Scott Clements -- Chief Executive Officer

Sure, Matt. And I think -- let me just -- I'll maybe answer that a little bit in reverse order. I think that, as you know, and as we've talked about many times, we have Trusted Identity as a platform strategy. It's really about not isolated products or isolated solutions.

It's really about bringing these technologies and the capabilities together on top of a platform. And these things, when brought together, are greater than the sum of the parts. So we have a very large installed base of mobile devices out in the world that continues to grow, as you can see in this quarter. And that will, over time, provide a rich source of data that can help us both reduce fraud as well as simplify the identity verification needs versus the way it's been done in the past, improving the user experience.

So this is very intentional that these different elements of our portfolio do work together and make each other stronger. And so with respect to the first question, it's very important to us in 2020, the future that we build a strong base of reference customers in the early period of our -- the deployment of our Trusted Identity strategy. So I certainly would expect this customer that we referenced here as well as the other customers that we've already deployed, our Trusted Identity solutions to be important reference customers for us and really helpful in terms of our ability to build this business. And I think, over time, as that ecosystem of customers who are using our mobile security and our Trusted Identity solutions, as there are more and more of those, I think we will have opportunities to leverage all of that data in that information that comes from that whole universe of customers to make everybody safer and more secure.

So that's a key element of the strategy here is to really leverage that platform across the banking world to make -- to reduce fraud and improve people's user experience. [Inaudible] answer your question.

Matthew Galinko -- National Securities -- Analyst

Great. Thank you.

Operator

Thank you. And our next question comes from Anja Soderstrom with Sidoti. Please proceed with our question.

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

Congratulations on a great quarter. And I'm just curious about the Cisco agreement that you mentioned in terms of the hardware. So does that mean hardware might be staying elevated then or how is that going to affect the hardware orders, do you think?

Scott Clements -- Chief Executive Officer

I don't think that the long-term trend that we have talked about for the last couple of years is really going to change here. We do believe that over time, the hardware business is going to decline at a -- at some rate, which we believe will be a reasonably modest trend line. But some quarters falling faster, some quarters kind of falling as fast. And that of course, we've got some quarters now this year where it's grown quite nicely.

But the long-term trend of the secular shift away from hardware authenticators to mobile authentication and other ways of authenticated users, I think that trend is going to continue. I guess, we would like to, in the meantime, do take appropriate steps to broaden the customer base for our hardware authentication business. We are -- we make a lot of these things. And we have a lot of volume, we have a lot of cost advantage.

And then so there are opportunities for us to go more broadly, I think, into the market and sustain this hardware business as best we can and as long as we can. It's a profitable business for us. It's a good business. These devices remain extremely secure and safe and reliable.

So I think this is a business that we want to cost effectively maximize using additional markets and by going through OEM relationships and channel partners and things like that. And so then I think it will help to modulate or limit, perhaps, the pace of decline but I don't think it changes the fundamental figure for the next few years.

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

OK. Thank you. That was nice color. And then also the software was really a nice bump for this quarter.

How sustainable is that pace? What sort of affected this quarter, do you think? You said people probably held up in the first half because they were more focused on the hardware orders than your regulation there. But anything we should think about there in terms of the cadence and the kind of same level of --

Scott Clements -- Chief Executive Officer

Sure. Yes, of course. Look, I think there certainly was some contribution in the quarter to some pent-up demand from the first half of the year but I think when we put this in -- first of all, when we look at our order patterns in the fourth quarter, we expect to have another strong quarter for mobile security in Q4. And I think the other thing to recognize is that outside of these -- kind of the first quarter of this year in particular, this growth rate for mobile security over the past two, three years has been strong pretty consistently.

Been growing at very strong double digits over that time period with the exception of the softness that we've talked about in the early part of this year. And so I think that this business will continue to have significant opportunity. I described a little earlier the very, very active threat environment. Mobile is becoming such an important channel for financial services and customers or consumers are increasingly preferring that as a channel.

And then guess what, that means that it attracts the attention of hackers and those who would like to commit fraud and steal money. So those are fundamental drivers that I think will support this business for the foreseeable future, and we're optimistic about that.

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

OK. Thank you. And then so in terms of the partnerships you announced, the Avaloq last quarter, and I think you mentioned now that you had a couple of more. How much are you hoping with that go-to-market strategy? And when -- how fast do you think that should show sort of sales in the top line?

Scott Clements -- Chief Executive Officer

Yes. I think that what we're pointing to here, in general, is a larger strategy about strategic partnerships and relationships really across our entire value chain. So we are adding partners that are technology partners, those who, when combined with our e-signature offering or TID platform, increasing value of that platform and deliver increased value to our customers. We also are expanding our distribution channels through OEM and distribution agreements like Avaloq, like Cisco and some others.

And I guess -- and so we are doing everything we can to open up the business model so that we can benefit from other things that are happening in the security space. And it will, over time, I think, is -- and this will become a meaningful contributor to our revenues. I would say many of these relationships are starting out in a very positive manner, including Avaloq. We have won several more projects in the third quarter related to the Avaloq relationship, and we're in discussions with them right now to expand the geographic coverage of that relationship.

So it is -- these are relationships that are contributing to our business today, and I think they will contribute even more as we go forward, not only within the existing relationships, but in -- with these additional relationships that we're going to continue to add. And we have a very active program in finding the right partners that will help us accelerate, amplify the business opportunity that we think exists in identity security and the financial services industry.

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

OK. And then lastly, the timing of the Analyst Day. Is there anything we should weed into that or come out with a great quarter and having an Analyst Day in December and --

Scott Clements -- Chief Executive Officer

Thanksgiving and Christmas. So you have the opportunity to do some of your Christmas shopping in New York City.

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

All right. [Inaudible] I'm looking forward to it. Thank you so much for your time. [Inaudible] later.

OK. Bye.

Operator

[Operator instructions] And our next question comes from Andrew King with Dougherty & Company. Please proceed with our question.

Andrew King -- Dougherty & Company LLC -- Analyst

Hey, guys. Thanks for taking my questions. Congratulations on a really good quarter. First of all, I just want to touch more on the partner network.

What percent of revenues are you seeing come with some touch from the partner network currently? And how do you see that being changed by this Cisco partnership?

Scott Clements -- Chief Executive Officer

We -- the -- many of these partnerships or distribution partnerships are not all new. We have had a number of these for quite some time. I think I haven't looked at that number recently, Mark. I don't know if you have any insight.

I recall that about 20% of our revenue comes through distribution channels historically, just to give you a rough idea. And so of the -- I think the agreements that we're building out now, the additional partners and that we're collecting, these certainly, over the next year, I would hope, would add a few points to that, just to give you an order of magnitude. These things are -- these things albeit incremental to our -- so the organic growth rate of our traditional business model and hopefully contribute a few points to that growth rate. That's kind of the way I think about it.

Andrew King -- Dougherty & Company LLC -- Analyst

Great. And then -- so obviously, you saw a pretty rapid growth this quarter. How much of that was driven by PSD2? And within that, how much of that was really won over because of Avaloq? Do you see any of that really continuing forward? Obviously, it would be at a slower rate but with PSD2 being extended.

Scott Clements -- Chief Executive Officer

So I think the PSD2 driver is -- this year is predominantly a hardware driver. And so I would look at the -- some of that growth that it was in the mid-50s, I believe, hardware growth for the quarter, after a very strong quarter in Q2 as well. And I would say a lot of that trend line growth or above trend line growth is being driven by PSD2. We still believe, again, that the trend line over a multiyear period is going to be a decline in the hardware business.

I think -- I have to say I've been a little bit wrong on that for the last couple of years. We were flat with hardware last year, and we're obviously seeing some pretty solid growth this year. But I think the underlying drivers of that outlook remain intact. And so I mean -- so I would expect as we go into 2020 that there will be a decline in hardware revenues next year.

We don't know exactly what that will look like yet. We're working, obviously, on our plans for next year. And we're going through our bottoms-up assessment of the pipeline and the opportunities -- the macro factors that affect our business. We also expect that software and our services businesses will continue to grow at a very rapid rate.

And so I think we're very optimistic about next year, although we do believe that the hardware revenues are going to decline to some degree next year. And we'll have more details for you, of course, on that in the not-too-distant future. The -- I think relationships like Avaloq, it's a little hard to parse their contribution, how much of that was PSD2-driven versus more fundamental demand for security. Either way, I would say it's not the overriding factor that's moving these numbers.

Andrew King -- Dougherty & Company LLC -- Analyst

Great. Thank you. Well, congratulations on the quarter, guys, and thanks for taking my questions.

Scott Clements -- Chief Executive Officer

Please. Thanks, Andrew.

Operator

Thank you. And I'm not showing any further questions at this time. I'd like to turn it over to Scott Clements, CEO, for any closing remarks.

Scott Clements -- Chief Executive Officer

Thanks very much, operator. Thanks for listening in to our call today. I know there are a lot of other earnings calls that are going on this week. I don't think you'll see many with better numbers than these for the quarter.

So thank you for listening in, and look forward to talking with many of you individually over the next day. Thank you.

Operator

[Operator signoff]

Duration: 33 minutes

Call participants:

Joe Maxa -- Director of Investor Relations

Scott Clements -- Chief Executive Officer

Mark Hoyt -- Chief Financial Officer

Strecker Backe -- Wedbush Securities -- Analyst

Matthew Galinko -- National Securities -- Analyst

Anja Soderstrom -- Sidoti and Company LLC -- Analyst

Andrew King -- Dougherty & Company LLC -- Analyst

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