Good afternoon, and welcome to the OneSpan Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Joe Maxa, VP of Investor Relations. Please go ahead, sir.

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan Fourth Quarter and Full Year 2020 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 close, OneSpan issued a press release announcing results for our fourth quarter and full year 2020. To access a copy of the press release and other investor information, including an updated presentation reflecting our fourth quarter and full year 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 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-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 conference call is February 23, 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, good afternoon everyone, yes, can you hear me?

We can hear you fine. Thanks.

Okay, great. Thank you. Thanks, Joe. Good afternoon, everybody. Thanks for joining us on the call here today. Improving demand for mobile security and continued strong growth in e-signature solutions resulted in record bookings of recurring revenue contracts and stronger than forecast revenue in the fourth quarter. The FY'20 guidance we provided last quarter reflected uncertainty, given a material slowdown in business in Q3 and early Q4 as our banking customers address urgent issues related to the pandemic. As the quarter progressed, we saw customer engagement return to more normal levels with improved sales closure rates and sales pipeline flow. Now I will turn to the outlook for 2021 and reasons why I expect it to be a year of further progress toward our goal of becoming a profitable and fast growing recurring revenue centric company. First, our 2020 year-over-year ARR growth of 29% demonstrates that our growth strategies are working, to give you additional insight into our ARR performance. ARR specific to subscription and term-based contracts grew in excess of 50%. Second, fourth quarter total bookings were strong on par with the PSD2 driven booking levels of Q3 and Q4 last year. Bookings on recurring revenue contracts increased more than 60% sequentially, and for the year, it grew by more than 40%. Third, our transition to recurring revenue streams and high margin solutions and services is progressing faster than planned. Software and services accounted for a record 69% of total revenues in the quarter and 62% for the year. Recurring revenue accounted for a record 83% of total software and services revenue in the quarter and 76% for the year. And fourth is the global globally economy recovers, we expect new account openings to trend toward more normal levels compared to last summer and early fall, as reminder because…

Thanks, Scott. As Scott mentioned, the fourth quarter of 2020 came in stronger than expected in Q3 driven by increased demand across our security and e-signature solution portfolio. And for the full year 2020, we exceeded the high end of our revenue guidance ranges that we provided in early November. Annual recurring revenue or ARR at the end of Q4 was $104 million, representing a growth rate of 29% in line with our 25% to 30% target growth rate for 2020. We defined ARR as the annualized value of all active recurring product contracts greater than or equal to one-year in length. Our dollar-based net expansion rate, which we define as the year-over-year growth in ARR from existing customers was 120% in the fourth quarter. Now turning to recurring revenue. For the fourth quarter, subscription revenue grew 39% to $9 million. This included strong growth of e-signature, modest growth in identity verification and then increased contribution from cloud authentication. Term-based software license revenue grew 27% to $8 million, driven by strong sequential increase in demand for mobile security solutions. And maintenance revenue grew 14% year-over-year to $14 million. We expect maintenance growth to moderate in 2021, as we continue transitioning our business model toward subscription and term-based licenses. In total, recurring revenue increased 24% to a record $30 million in the fourth quarter and 26% to $102 million for the full year 2020. Recurring revenue accounted for a record 83% of software and services revenue in Q4 and 76% for the full year 2020. This compares to 63% in Q4 2019 and 64% for the full year 2019 respectively. As you may recall, we recently increased our 2022 recurring revenue target from 75% to 85% of our software and services revenue. With the continued acceleration in our transition to recurring…

Thanks, Mark. Appreciate it. We made that faster than planned progress in our transition to recurring revenue in 2020. And we plan to continue this transition in 2021 with a goal of essentially completing that shift by the end of this year. Now let me focus on our 2021 growth investments, the decline in our hardware revenues and our recurring revenue transition reduced our overall profitability in 2020, and it will continue to do so this year. Nevertheless, our goal is to sustain high rates of subscription in term license growth greater than 40% in 2021, which is key to higher levels of profitability going forward. And as we exit the pandemic period, we believe it's an opportune time to invest for growth after declines in sales and marketing and R&D expenses in 2020 as compared to 2019, and given the strong growth we've seen in recurring revenue, we're increasing our investments in these areas to enable continued strong growth in 2022 and after. In sales and marketing, in preparation for 2021, we expanded our sales team in the second half of 2020 with the focus on new customer acquisition and we're pairing this with higher lead generation investment this year. In R&D, we'll be investing in the core TID platform to shorten customer time to value, increase solution flexibility, and simplify integration to third-party technologies. We also plan to enhance our mobile security solutions with improved usability and increased data collection capabilities to deliver next generation, authentication and fraud prevention capabilities. And finally, we'll be adding high value extensions to our rapidly growing e-signature product line that we expect to increase the average transaction value in that business. As that noted previously, the profit generating capacity of our business model is fundamentally strong as indicated by our solid gross…

[Operator Instructions] And the first question will come from Catharine Trebnick with Colliers. Please go ahead.

Hi, thanks for taking my questions, very impressive quarter. Can we talk a little bit about going forward? You had record bookings this quarter, but could you maybe parse a little bit more on the 22% to 26% ARR growth, I expect that maybe with the record bookings, it might be a little bit stronger.

Catharine, good afternoon, I'll take a crack at that. And Mark, you can you can add too. Catharine, I think it really comes down to a couple of things. There is still some uncertainty that remains about the pace of the recovery and the economic recovery global and the impact that that has on banks. I think we all feel optimistic that it's moving in the right direction. Certainly, seems to be good news, some more good news each day in that area. But how our ARR number turns out after the year will depend to some degree on how that proceeds and the pace with which that recovery happens. Also as you go into the back of the year, obviously, the compares get tougher. And so we want to be aware of that. So I don't think it's anything more than we are -- we want to be sure that we have a good handle on the progression of bank spending on security and technology as the overall economy recovers and as the pandemic impacts start to lessen.

All right. Thank you.

I'll just add on there, Catharine, this is Mark. Reminder that recurring revenue can be driven in lumpy, if we get both the year contracts to come in and we did get one of those that came in Q4, then that did rub up recurring revenue that we won't see necessarily drive on the ARR as much. But overall, as Scott said, we want to make sure that we can now hit these numbers.

All right thanks gentlemen.

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

Great. Thanks for taking the questions and congratulations on the good numbers. I guess, yes, so I guess maybe just sort of a follow-up question. So in recent conferences, you've been talking about how large banking customers pushed out deals in mid 2020, and now you're starting to see that trend reverse. So I guess just how quickly does that play out? And then do you see the recovery maybe shifting from the hardware side more into the software and the recurring side of the business? And then I guess it was like, the other part of the question would be -- I just want to make sure I understand your guidance. Did you say hardware is going to be down mid-single digits for the full year or would it trend to down mid-single digits at some point in the year? I just want make sure I understand that point correctly.

Sure. All right. There's a lot there. So I'll try to...

I get very excited.

Sorry, I missed one. Just ask it again. So I'll try to go in reverse order here. The guidance or the commentary that we gave on hardware was really for the full year, we expect the same sort of a single-digit decline in hardware in 2021. So that's a significantly better outcome, obviously, from a growth point of view than we -- our declined point of view than we saw in 2020. We have seen some improvement in the hardware space. I think the bookings were -- we had our strongest booking quarter of the year in the fourth quarter for hardware. And the opportunity pipeline is actually higher than it was at this time last year. So we'll see how that plays out over the coming days. We spent -- we put a great deal of effort into really doing a very detailed bottoms-up forecast on hardware. And we just want to set the reasonable level of expectation for that. And we'll do everything we can to do better than that number, but I think that's a reasonable expectation for right now. With respect to the casing of the recovery, I guess, in banking and financial services, generally, what our -- I think our sales team's perspective is, is that we'll see increasing or better environment as we go through the first half and then as we kind of get to the middle of the year, we would hopefully be in a position where we'd be seeing a full recovery to the more normal tenor of business and approach to business that we have seen in the past. I think that recovery will affect actually software and services will be the bigger beneficiary of that than hardware. So we do come into the year, I think with a substantially higher sales pipeline by 40% higher, exiting last year and coming into this year. And we have very high expectations for growth of term license and subscription revenue in 2020, which will be the main drivers of ARR growth, but we'll see how that improves as we go through Q1 and Q2 and into the middle of the year. But I think our view right now is by the time we get to the middle of the year, hopefully we'll be back to a substantially normal environment with respect to banks or acquisition of security technology.

Understood. Okay. Thank you very much.

Sure. Thanks, Gray.

[Operator Instructions] And the next question will come from Anja Soderstrom with Sidoti. Please go ahead.

Yes. Hi everyone. Thank you for taking the question and congratulations on good Yes, hi everyone. Thank you for taking my question and congratulations on the good numbers. So first of all, if you can just elaborate on the investment growth you need to do there, that's going to keep the gross margins flat, it's mainly, you said more investment in the sales [indiscernible] or is it also that you need to invest infrastructure more that you did in 2019, 2020?

Thanks for your question. Good afternoon. And so the incremental investment that we're making is really in two areas and it's a little bit different when in sales and marketing versus R&D those two areas. In sales and marketing, we come into the year essentially fully staffed for what we think we need in sales for 2021. That's good. I think when we came into 2020, we still had some holes in the sales team that we needed to fill as we went through the year, but we really took the effort to fill all of the positions that we think we needed in sales in the second half of 2020. So that we would enter 2021 fully staffed and ready for 2021. And so the biggest piece of the increase in selling expense, sales and marketing expense in 2021 is related to those people that we have already brought on in the second half of 2020, a full year of their costs. The second piece is that we want to make sure that as we put those people in the field where we're driving increased amount of lead activity to those sales through the sales organization, those people in the field. So we have been spending a great deal of effort, I think, to really build a very, very capable lead-generation process over the last couple of years. We did see some good results from that and in 2020, and that's what part of what helped to drive our recurring revenue growth in 2020. And so, as we gain confidence in that lead-generation activity, we want to put more against that in 2020 -- in 2021 to drive growth, not only in '21, but also in 2022 and forward. And then I think in R&D, these are really investments to just -- I would say in general, strengthen the software and services product lines. And I described those, some of those in May in a conference call, we have, I think, an opportunity and need to strengthen our mobile security offerings, to modernize elements of that, and to really make it a strong element of data collection that can drive our analytics capabilities, our fraud and other analytics capabilities in the future. And then of course, we had a tremendous in 2020 with e-signature. We expect to have another very good year with that product in 2021. And there's a real opportunity to extend that product into some areas of very high value around notarization and ID verification and things like that that can substantially raise the per transaction value of that product line. So these are investments that we think will accelerate our time to market, increase our differentiation and allow us to access new opportunities beyond those, which we have focused on in the past.

Okay, thank you. And then you alluded to that you were going to revisit your longer term guidance later this year. It would be safe to assume that the sales that would have recurring revenue should accelerate [indiscernible] in 2022, we will have a lot of this investments behind you. So we would also see that margin fashion in 2022. Is that we expect to think about it that way.

Yes. You're breaking up a little bit, Anja, I don't know if it's on my end or your end. But I think I got the general gist of the question. Yes, we believe that for several reasons that as we go into '22, '23 and forward that we have the opportunity to drive higher levels of profitability in the business, as we grow. We remain -- we continue to target 25% to 30% ARR growth over the period through 2022. I think we have a very good shot of achieving that or doing better than that. But as we sustain our margins, we see the benefits of the investments that we're making this year. We really put that recurring revenue headwind behind us. All of those things should help to improve the profitability of the business as we look ahead in '22 and 2023. So we take that very seriously. We made a very conscious choice in '21 to make some of these incremental investments because we liked the momentum in the business. And we think that these are investments that can really continue to build the story and the differentiation of what we offer to our current customers and hopefully to a lot more new customers as we go forward.

Okay. Thank you. And then just one last question in your investor deck, or the presentation for the fourth quarter on Slide 10, you are talking about adjacency expansion in [indiscernible]. Can you just expand on that a little bit? What you mean by that?

Sure. As you know, Anja, we have been a really primarily a company that has been focused on banking, financial services for most of our history. I think we're roughly 75% of our revenue comes from banking and financial services still today. We believe there are good growth opportunities that remain and exist in banking and financial services, but we also know that there's a lot of working on and progress being made in digitization of -- in the areas of digital, healthcare, tele-health and in government. And if you really look at the use cases there and the needs in those spaces, they look in many ways, very similar to what we do in banking and financial services. And so we believe we have the opportunity to target some of these adjacencies with our existing technology, without having to make major changes to that technology and really expand our total available market. And then hopefully, our growth rates as we go into '22, '23 and forward.

Okay. And now you also announced sort of repositioning some of your [indiscernible] to go after that, or is that something you would have to do down the road?

We do business in both of those areas already. And we're looking at the different ways to go to market there. So in the healthcare space, in the telehealth space, for example, we would probably do a lot of that through channel partners and OEM partnerships rather than trying to go direct -- a direct sales model into that market. And then I think in government, it will vary a little bit, but the goal that we have for 2021 is to really do some of the work and the validation of those opportunities and determine the approaches that we will use to drive penetration growth in those markets in '22 and forward. As I said, we do have a significant amount of government business already. I do expect that to grow in 2021. And we are working with some partners in the healthcare and the telehealth space already as well, and trying to learn more about that so that we can structure the right approach.

Okay. All right. Great. Thank you. That was helpful for me.

Sure. Thanks Anja.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Clements for any closing remarks.

Thanks very much operator. Again, I appreciate all of you joining the call today. We had -- I think a good finish of the year of 2020 after a tough spot in the middle of the year. We're really optimistic about the 2021 and the continued shift of our business to recurring revenue. And we've learned a lot and I think we'll be largely done with that transition by the end of 2021 and that should really help both our growth and our profitability as we complete that transition. Thanks again, everyone. Have a good day.

And thank you sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.