Good day, and thank you for standing by. Welcome to the OneSpan Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Joe Maxa, VP of Investor Relations. Please go ahead

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan second quarter 2023 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 is Matt Moynahan, our Chief Executive Officer; and Jorge Martell, our Chief Financial Officer. This afternoon, after market close, OneSpan issued a press release announcing results for our second quarter 2023. 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 full year 2023 and our long-term financial targets are forward-looking statements. 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. Also note that 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 August 9, 2023. 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. I will now turn the call over to Matt.

Thank you, Joe. Good afternoon, everyone. Thank you for joining us. Today, I would like to begin by providing a progress update on our plan to transform OneSpan into an enterprise-class company, achieve the Rule of 40 and create meaningful value for our shareholders. We are now more than two quarters into the plan, and the operating visibility we have into the execution of our transformation has increased. Given this increased visibility, it is now apparent that it will take longer than originally projected for our sales productivity and marketing demand generation engines to mature, exacerbated in part by current market conditions and increased competitive pricing pressure. As mentioned during previous calls, sales productivity and marketing demand generation are the two most important drivers of top line growth in our three-year strategic plan. We believe our five-pillar solution strategy, designed to enable us to secure an entire digital transaction life cycle by weaving together identity verification, authentication, high assurance virtual collaboration, e-signature and secured transaction eVaulting is sound, and it continues to resonate with customers across the globe. And the need to securely digitize business processes is becoming a must in today’s world of generative AI and deepfakes. Given the visibility we have into our business, coupled with our business strategy and improved operational rigor throughout the Company, we’ve decided to make adjustments to our operating model, including the acceleration of cost reduction initiatives to significantly improve our profitability while maintaining our long-term growth potential. To that end, we are taking our operating segments to the next logical level to continue driving operational excellence by formally creating two distinct operating business units, digital agreements and security solutions, each with a general manager to execute their respective business strategies of driving digital agreements for growth and managing the security segment for…

Thank you, Matt, and good afternoon, everybody. Before reviewing our second quarter results, I want to provide details on the actions we are taking to rebalance our cost structure to drive more efficient top line growth. The actions we took in the second quarter of 2023 resulted in annualized cost savings of $7.9 million. As Matt mentioned, we are expanding and accelerating our cost savings initiatives. In addition to the Phase 2 $20 million to $25 million of annualized cost savings target, we are expecting an additional $30 million of cost savings. As a result, we now expect $50 million to $55 million in total annualized cost savings by the end of 2025. We expect to realize the majority of these additional savings which will be primarily headcount related by this time next year. The balance of the savings, a few million dollars related to vendor consolidation and optimization strategies is expected to be realized by the end of 2025. Now turning to our results. Second quarter ARR grew 8% year-over-year to $144 million. ARR specific to subscription contracts grew 16% to $112 million and accounted for approximately 78% of total ARR. Net retention rate, or NRR, was 106%. Similar to last quarter, ARR and NRR were impacted by the macroeconomic environment. We continue to see increased deal scrutiny and longer sales cycles, resulting in more moderate new business and expansion rates, primarily in our digital agreements operating segment and to a lesser extent, in security. These metrics also continue to be impacted, as noted on prior calls, from a few lost contracts last year and our decision to sunset certain portfolio offerings. Second quarter revenue increased 6% to $55.7 million. Subscription revenue grew 16% to $23 million, led by 20% growth in e-signature SaaS revenue and 13% growth in…

Thank you, Jorge. I’m confident the actions we are taking to right size our cost structure, return capital to our shareholders and focus on efficient growth are the right operational and strategic decisions for the Company and will help OneSpan unlock shareholder value. I will now provide our full 2023 guidance and initial 2024 targets. For the full year 2023, we expect the following: Revenue to be in the range of $226 million to $232 million as compared to our previous guidance of $232 million to $242 million; ARR to be in the range of $148 million to $152 million as compared to our previous guidance of $157 million to $164 million; and adjusted EBITDA to be in the range of $0 million to $3 million as compared to our previous range of $3 million to $6 million. For the full year 2024, we are targeting revenue growth in the low to mid-single digits range, and as I mentioned earlier, adjusted EBITDA margin to be in the range of 20% to 23%. Given the adjustments we made to our operating model, we are resetting our 2025 financial targets, and we’ll communicate them at a later date. With that, Jorge, and I would now be happy to take your questions.

[Operator Instructions] And our first question comes from Chad Bennett of Craig-Hallum. Please go ahead.

So, Matt, I thought when you came into the business and looked at kind of how you wanted to reorganize the business I guess, now, I don’t know, 1.5 years, 2 years ago, however long ago it was. We thought the two segments actually were pretty synergistic together. And we kind of reorganized the sales force and enabled them and trained them to sell all the products across both segments and kind of more of the suite approach and so forth. And we actually hired salespeople that were qualified to do that and accelerated our hiring this year of salespeople to do that. So, what has changed in three months?

So, the unified sales force is -- unifying the sales force is still intact. When I came in, there was three sales forces, one for security hardware, one for security software and one for digital agreements. And we unified those to account control perspective where individual seller, as you mentioned, can go in and sell all products. Individual sellers will continue to be able to sell all products. So nothing has changed there. What really has changed, as you know, when we came into the business, we simultaneously have been attacking the cost structure, but -- simultaneously attacking the cost structure, but in parallel been investing in building out the infrastructure for the future. Key to any growth story really as a productive sales force and the marketing capability to essentially generate demand for those sellers. And we’ve invested in both. Both are necessary and they both continue to be necessary. What really we have more visibility into is the sum total of the performance of the existing team, combined with the new sellers, who we do believe bring more directly applicable enterprise application experience and their ramp times. And so, what essentially I’ve taken a look at is the time to execute the transformation. We still believe in our long-term growth potential. But, when I think about time value of execution, the longer the execution, the more cost, as we go through this and our commitment to the Rule of 40, we also have to look at the efficient capital deployment based against that time frame. And that’s really what has changed. Now we have more visibility as we committed to in previous calls, to give you an update on the uptake of that additional sales capacity and the uptake of the marketing demand generation engine, which was essentially built from scratch in the manner needed to go attack the market. And so I would say, Craig -- the only real thing -- Chad, the only thing that has changed has been the time required to execute the transformation, everything else remains intact. And this cost rebalancing, if you will, is really just to make sure that we’re efficiently deploying capital against that time frame. Our strategy remains unchanged, as I mentioned in the call, and the long-term growth potential of digital agreements, I believe, still remains intact. Increased focus with the division structure, which we started with the segment approach, I believe will facilitate that uptick.

Okay. Then can you provide some color into where the cost cuts will land in the P&L, at least kind of rough ranges or rough numbers?

I’ll give you a high level, just high level and then Jorge can break it down for you a little bit more. So obviously, parallel to that -- I think we put out there $10 million to $12 million cost savings. We came in at the high end of that. That was the initial one. That I have put in place right upon my arrival. And we also extended that restructuring to other parts of the business, rationalizing portfolios, et cetera. That we’ve executed very, very well against, and that execution gives me good comfort that we’ll be able to execute this more profitable approach as we manage the business for the long term. The increased spend that happened in parallel was really driven by the increased investment in sales and marketing cost. Okay? And so [Technical Difficulty] we are implementing a performance-based culture. It’s critical to the future of our company and really any company. And so you will see a meaningful reduction in sales and marketing expenses commensurate with what would be efficient spending of capital for the growth rate that those two entities are providing. So, sales and marketing in parallel we’ve made, as we talked about in the call, some product-related decisions to refine our focus and allow us to punch with two close fists if you roll across -- across a very broad portfolio. One of those decisions was around Digipass CX, our cloud-based token, and we had a few other technical decisions internally with regard to certain platforms and projects that were going. So primary message is sales and marketing with the product -- being the next largest area. Jorge, do you want to give a breakdown, a little more detail level?

Yes. Hey Chad. How are you? Thanks for the question. Yes. So I think, Matt, you covered pretty well, but I’ll just add a couple of things. One is, I think the lion’s share of what -- the cost savings will come from is going to be in sales and marketing. Secondly, it would be R&D, but also G&A. So it’s really looking at all those three OpEx categories, Chad, and optimizing those. Going back to what Matt mentioned is every dollar spend in the Company has to have NRI tied to it and tied to products that are going to drive growth -- top line growth, and have the biggest bang for buck ultimately at the end of the day. But it’s all the three categories, S&M, R&D and G&A will be impacted with the majority in S&M.

And our next question comes from Gray Powell of BTIG. Please go ahead.

A few on my side. Maybe just to start on the top line. Can you help us think through how much of the ARR reduction was due to more company-specific issues and the ongoing transformation versus a weaker-than-expected macro environment and just more customers delaying decisions?

I can take this one, Matt. So, Gray, just to maybe take a step back. And so -- when you look at the ARR over the last couple of quarters, ending 8% growth this quarter, that deceleration, I would say, is primarily related to, again, the taking longer -- the sales and marketing taking longer, which obviously has impacted -- part of it is the macro as well, but it’s partly that. The other component that I will mention as well is the product sunsetting, right? That has an impact. That’s about 2% on that 8% that has had an impact on. The other component, we mentioned this in the last 2 or 3 calls as well, which is the couple of larger clients that contracted, primarily in Q3. So, you’ll see that for another quarter or so. And then to a lower extent, I would say, but also important to mention is due to the macro, some of the verticals, particularly in the DA business, in this case insurance and mortgage continue to see that sort of like lower levels compared to the last few quarters. And so that also, again, driven by the macro, but as well, particularly impacting those verticals. And then one of the things just to mention as well is, I mentioned about the macro deals currently increasing. We saw that more pronounced in Q2, particularly in DA. One of the deals that slipped that Matt mentioned, slipped from Q2 into Q3, that deal, a 2 million ACV deal, that would have added another 1.5 points to it. And so I think it’s a combination of both, Gray, but I think it’s sort of like equally macro, but also the sales and marketing engine taking lower than anticipated also is dampening that growth.

And so then just the next one, and I don’t want to get too into the weeds on the math. But if I look at like net new ARR or like ARR additions, so that declined 45% in Q2. The midpoint of guidance implies that you add $5.6 million of new ARR in the second half of 2023 versus $4.4 million last year. I understand that you have easier comps, so I guess that helps. But can you just sort of help us think about what’s driving that improvement and just sort of reaffirm your confidence level there in this new target?

Yes. Like I said, we have that -- obviously, the deal that I just mentioned to add the 2 million ACV that’s going to be part of that remainder to get to that of the number for the full year. And then the other components are going to be primarily the expansion of existing clients. There’s an element of new logos as well that we’ll have, but the lion’s share of that is going to be the expansion of existing clients, Chad.

Okay. Cool. And then, just if I can squeeze in one more. I know it’s a lot. Taking EBITDA margins from effectively breakeven or I guess, slightly better than breakeven this year, to 20% to 23%. It’s just like a really big jump. So, how much of that is related to natural leverage in the business versus the cost that you’re ringing out from this additional restructuring? And do you think you can hit that target even if revenue comes in below expectations again over the next, call it, 6 to 18 months?

Yes. I’ll take that one. So we have -- I think more of the things that improved dramatically on, since we’ve arrived -- since arrived and we had our team, which was really fully intact on January 1st is the operational rigor in the Company and the ability to tackle the cost structure in a way that was not previously able when I came in. So, I feel very good about that. We have already begun actions, and we do anticipate that the vast majority of actions will be completed by the end of this year with some happening in 2024. But we do have line of sight into that, and so my degree of confidence in hitting that range is strong. And we continue to monitor the macroeconomic environment, but we believe these estimates that we put out there are executable, for sure.

And our next question comes from Anja Soderstrom of Sidoti. Please go ahead.

Thank you for taking my questions. Most of them have been addressed already. But I’m just curious about the increased deal scrutiny you saw in the second quarter being more pronounced. Was that more towards the end of the quarter, or when did you start seeing that and how has that developed since that started?

I mean, we’ve had -- obviously, a lot of our growth in our e-signature business has been driven by installed base customers, right, expansion. We’ve shown that when we get the right customer, Anja, and the product delivers, which it does, obviously, good things happen, right? And so, we think there’s obviously contractual situations already in place. When it comes to a new contract, or a migration from on-premise to the cloud, like was the case mentioned in that $2 million deal that moved out of Q2 into Q3, that was specifically a result of the size of the deal, but also the number of signators that were required to actually execute that transaction and the number of eyeballs that were reviewing it given the macroeconomic environment. So, it’s still deal specific, less so on the installed base customers because we have -- in most of the cases, we have vehicles in place, already in place. Most of it is around the new logo business that we would see already migrations from on-premise to the cloud.

And our next question comes from Rudy Kessinger of D.A. Davidson & Company. Please go ahead.

Similar to maybe a couple of the questions that have already been asked. Matt, you’ve been here now for almost two years and we’re still kind of yet to see any improvement on the growth profile. I guess, I’m just curious, you started to hire these new reps, correct me if I’m wrong, but in May of 2022. And so, if you look at that first wave of reps that you hired and you look at their productivity today, what would you attribute to those reps not ramping to productivity as expected? Would you attribute it to the macro? Would you attribute it to sales enablement? Would you attribute it -- I heard you call it competitive pricing pressure? What would you attribute the inability to get some -- that first wave of reps fully ramped and productive to drive faster growth this year, not happening?

Yes. No. Sure, sure. So I came in November 29, so it’s been about 1.5 years. We put in plan into play in May and began really in the back half of last year, adding additional reps. So as I stood there, Rudy, in May in New York, we rolled out our three-year strategic plan, we had about 40 -- 43, 44 reps, and we committed to doubling the sales force by the end of this year. Okay. We did hit that target. And so really, what you’ve seen is a full year of performance in the Company across certainly the 45 that were here. Okay? When I came in, we were partly through the year, quarter, quarter and half through that. So I had the ability to go to that performance, and that’s sort of one cohort, if you will. And the second quarter, which came in staggered on the back half of last year into this year, has many, many dates that would mark their second three-quarter and four-quarter anniversary. So that’s still flowing through the system. But when you look at the sum total of the performance, of the reps. So I would say it’s multifold really. And it really just comes down to the fact that this company is maturing on multiple fronts, but primarily across the sales and marketing and demand generation. Okay? And so, I’d say it’s not one thing. The team has done a good job, but for sure, maturing every quarter since I’ve been here. But the ability to go get those reps ramp and get them the demand with a company whose brand is still being built is taking more time. And so, that’s why you’re seeing -- in some of the cases, some of the restructuring that will be done,…

Okay. And then as you -- given the outlook for ‘24 low to mid-single digits revenue growth, should we expect ARR growth to be roughly similar to that in ‘24 or higher or lower? And then, when you think about getting the Rule of 40, should we think of that as now likely being more a mix of 30-ish percent margins, 10% growth as opposed to, I think, previously the targets were kind 20-20?

Yes. So I’ll take the last one, Jorge will then go into the ARR. So listen, since we’ve come in here, the new administration, so to speak, we’re committed to getting to the Rule of 40. I think when you look at the plan, it got it close to 30 through a combination of top line growth and adjusted EBITDA. Obviously, it was almost a 50-50 split between those two targeting sort of 2020 Rule of 40 as we exited ‘25 into ‘26, okay? And so I think just going back to that time value of execution comment, realizing that that was going to take time to achieve our digital agreements three-year targets, which is really the growth engine in the business, right? We know that security has a different growth profile for it. We took action or taking action to make sure that we continue on that path to the Rule of 40 and have the majority of that equation, if you will, coming from profitability. Okay? As we get stronger, we’ll obviously appropriately align expenses to that growth profile. But as we stand right now and given the time we’ll take to get that engine going, I think it makes perfect sense for us to go recalibrate now the expenses and profit elements of that equation and target to get into that Rule of 40, hopefully more quickly, but also in a different way than we previously stated based on the new information we have.

And Rudy, going back to your first question. So, we will be publishing sort of like full 2024 metrics and KPIs later. But I think just to address your question, I think that’s the right expectation. But like I said, we’re still a little premature from publishing all the KPIs for 2020. We’ll do that in due course over the next couple of quarters.

Thank you. I would now like to turn the conference back to Matt Moynahan for closing remarks.

Thank you, everyone, for joining us today. I very much appreciate your time, and very much look forward to our one-on-one sessions over the course of the next couple of weeks and quarter, and I look forward to giving you future updates on the Company as we progress in our transformation. Thank you for your time today.

This concludes today’s conference call. Thank you for participating, and you may now disconnect.