OneSpan Inc.

Good day and welcome to the OneSpan third quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's 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 OneSpan third quarter 2020 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 OneSpan's website at investors.onespan.com. Joining me on the call today is our CEO, Scott Clements, and our CFO, Mark White. This afternoon, after market close, One Stand issued a press release announcing results for our third quarter 2020. 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 outlook for four-year 2020, are 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 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-gap basis and have been adjusted from a related gap financial measure. We have provided an explanation and reconciliations of these non-gap financial measures to the most directly comparable gap 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. 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.

Joe, thanks very much. Good afternoon, everyone, and thanks for joining us here today. Our results for the quarter reflect the near-term impact of the pandemic as our banking customers temporarily shifted their attention and their expenditures away from some security and authentication projects. Despite this shift, we continue 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 by adding $70 billion to their loan loss reserve levels. In addition to this financial pressure, banks reallocated IT resources to support work-from-home implementation, other critical digitization projects, and business continuity needs. This resulted in delays and uncertain timing for many other types of projects, including security and authentication improvements. These factors impacted OneSpan 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 channel for opening accounts around the world and are often the 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 saw record hardware token revenue driven by the implementation of Payment Services Directive 2, a strong customer authentication regulation in Europe. This one-time surge in demand in Q3 2019 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 that temporarily closed most of its branches, resulting in a dramatic drop in new account opening and reducing by two-thirds the number of authentication tokens it will purchase in 2020. It's also important to note that in most cases, the sale of an authentication endpoint also carries a user license for server or cloud-based authentication software. Sellant, a respected financial services advisory firm, published its COVID-19 Banking Insight Study, confirming that the two most immediate priorities for financial institutions during the thick of the pandemic have 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 IT budgets in 2021, with customer onboarding and mobile and online banking expected to see the largest increases, which we believe will benefit OneSpan. We've already seen these trends in our OneSpan signed e-signature business and in the growth of our opportunity pipeline for mobile security and identity verification. 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 we're gaining better visibility into their security and digitization investment plans. As a result, we are today providing updated guidance for 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 span as i've already noted customers are re-engaging and there are several other positive developments 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 grew 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 by an urgent demand for process digitization solutions such as e-signature and digital identity verification. Other categories improved more modestly. Third, our strategy 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, ARR, 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 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 farm assistance programs. We also booked a seven-figure opportunity in the digital healthcare space, working with a top three U.S. telecommunications provider. OneSpan also closed an opportunity in Latin America where the customer acquired multiple cloud-based solutions simultaneously, including identity verification for digital customer onboarding, e-signature for new contract signing, and cloud authentication for prepaid card transactions. Meanwhile, our partner ecosystem continues to expand. We announced a technology and go-to-market partnership with ForgeRock, with whom we are already pursuing several sales opportunities. And we've also added Soper Banking and OneLogin as partners and continue expanding our global network of ID verification and trusted service partners for 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 in our trusted identity strategy back in 2018 During the third quarter, we completed the deployment of our largest cloud project to date at a U.S.-based financial institution. While there are still regulatory and other challenges, banks' adoption of cloud-based services is gaining momentum to one span's benefit. After Mark updates you on our financials, I'll come back to provide some additional comments along with an update on our outlook before opening the call to questions.