Good day and thank you for standing by. Welcome to the Q3 2023 OneSpan Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Joe Maxa, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan third 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 third 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 longer 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 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 November 8, 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. We announced important changes to our operating model last quarter to help us drive more efficient revenue growth, increased profitability and enhanced shareholder value. I'm pleased to tell you we made good progress towards these objectives in the third quarter, including the execution of significant cost reduction activities and the appointments of general managers for our two operating business units. We are working hard toward our commitment of achieving the Rule of 40 and our driving toward our aspirational goal of attaining a level of 30% under the Rule of 40 framework by the time we exit 2024. Third quarter revenue grew 3% year-over-year to 59 million, ARR grew 10% to 150 million and adjusted EBITDA was 6.3 million or 11% of revenue. I am pleased by the 11% adjusted EBITDA margin we reported, driven primarily by our focus on operational rigor and our cost reduction initiatives. During the quarter, we reduced headcount by approximately 15%, resulting in an annualized cost savings of more than $20 million. This was in addition to the approximate 5% headcount reduction we completed in Q2. And we are planning further right-sizing before the end of this year. Jorge will provide more details on our annualized cost savings during his financial review, including our expectation to achieve approximately 58 million of cumulative savings by the end of 2023. Based on our Q3 results and our plan to execute on additional cost savings, I believe we have positioned OneSpan to achieve our full year 2024 targeted adjusted EBITDA margin of at least 20%. We are closely monitoring our go-to-market metrics, including sales productivity and marketing efficiency, along with our revenue growth. If necessary, we plan to further address our cost model to achieve our profitability…

Thank you, Matt, and good afternoon, everybody. Before reviewing our third quarter results, I want to provide an update on the actions we have taken to rebalance our cost structure to drive more efficient top line growth. For simplicity, we are providing combined total annualized cost savings for the cost reduction actions we announced last quarter and the phase two of our restructuring plan announced in May of 2022. As Matt mentioned, we reduced headcount by approximately 15% in the third quarter, and it was mostly related to the cost reduction actions we announced last quarter and resulted in annualized cost savings of approximately 21 million. Total annualized cost savings achieved in the third quarter, including headcount reductions, vendor consolidation and other optimization strategies, were approximately 24 million. Cumulative annualized cost savings as of the end of the third quarter were approximately 43 million. We expect to execute an approximately 50 million of additional cost savings in the current quarter, mostly labor related, bringing total annualized cost savings to approximately 58 million by the end of 2023. Over the course of the last few months, we have firmed up incremental vendor-related savings and other cost optimization strategies and now expect to achieve total annualized cost savings of 60 million to 65 million by the end of 2025, or approximately 10 million more than the 50 million to 55 million range with this cost last quarter, which included a level of conservatism. The 10 million increase is due to a stronger line of sight into our cost savings targets, which had already been incorporated into our 2024 adjusted EBITDA margin target range of 20% to 23%. Turning to our third quarter results. Third quarter ARR grew 10% year-over-year to 150 million. ARR specific to the subscription contracts grew 17% to 119…

Thank you, Jorge. I'm very proud of the work our team is doing to transform OneSpan into an enterprise class company with a performance-based culture. We are committed to creating and returning value to our shareholders by growing revenue efficiently and profitably. Jorge and I will now be happy to take your questions.

[Operator Instructions]. Our first question will be coming from Gray Powell of BTIG. Your line is open.

Great. Thanks for taking the question. I have a few at my end. But before I get into it, just congratulations on what looks like a fairly clean quarter. So just to start off, a number of other tech companies are talking about how they're seeing macro headwinds get worse in October. I was just wondering if you could talk about the linearity that you saw throughout Q3, and then just provide any color on what you've seen like the last 30 or 40 days and just your overall confidence level in terms of your visibility on demand.

Hi, Gray. How are you? This is Matt. I don't think there's any material change over the course of the year. We've seen this over the past two or three quarters and we continue to see, I would say, somewhat consistent macroeconomic challenges. Obviously, we mentioned some of the lengthening [ph] deal sales cycles, some deal prioritization NDA which is more typical than it would be in the cyber side of the house, which you can tie to online banking. The one area that we do believe is having a slight increase in effect is in the midmarket financial sector, particularly as it relates to the purchase of hardware tokens. We're hard at work launching a new channel program that should get us more visibility into that particular sector. But I would say that would be the only one that there's a question mark for me, has it worsened or not? And we'll have more visibility I'm sure next quarter, particularly after the release of this new program, a general program, which should give us more visibility with those partners who control most of that volume for us.

Okay, that's really helpful. And I think you may have kind of sort of answered this one on the prepared remarks, but I just want to make sure I have it correct.

Sure.

So net new ARR additions bounced back pretty nicely in Q3, you added just over 5 million of net new ARR. I know there were some deals slipped from Q2 to Q3 that probably helped that number. But the high end of guidance implies that you'll only add $2 million in Q4. So is there any reason to think that's not just a conservative number? I know you've talked about the sun-setting issues. So I just want to make sure that I'm sort of thinking about the ARR trend lines.

Yes, we have -- I think that's fair to say. We do have a couple of mitigating impacts here, as Jorge mentioned. We sort of have a double bump going on right now where we've been migrating on both the e-signature and the security side of the house, obviously, migrating from perpetual to subscriptions in the e-signature side of the house at SaaS. So we oftentimes during the migration from an on-premise to a cloud-based installation, you run both in parallel, so there's a tail where we're sort of getting the double benefit of both contracts in place at the same time. And so we do anticipate as customers roll off of on-prem and the maintenance associated with that to the cloud application that there's a little bit of a headwind or a dampening effect, I should say, associated with that. We also have a couple of planned downsizing. One of our banking customers is selling off some international assets, for example, which is really obviously uncontrollable. And then the big thing, Gray, is really just the importance of getting the new logo acquisition engine going. And so the biggest area for us, given our size, is the index that we have to drive ARR and NRR associated with new logo acquisition. And so again, we've seen some lengthening in sales cycles. So I think all those dampening effects suggests that we're being prudent and where we are right now, given that we are at the midpoint of the range. But I don't think your comment is unwarranted, if we continue to perform the way we think we will this quarter.

All right. Perfect. Then last one on my side, I know I've asked a couple here, just looking at Slide 19, that summary is really helpful on the cost reduction actions. Back of the envelope math, it looks like you're going to generate maybe and if I just kind of look at like full year '23 versus full year '24, it looks like you're going to get like an extra 40 million or so in cost savings. And that pretty much gets you to your EBITDA target. Is that directionally correct?

Hi, Gray. This is Jorge. How are you? I apologize because I'm a little under the weather. So I think just to maybe take a step back, so we're planning by the end of this year to be at 43 million. And that's the sum of 19 that we had entering Q3, and we executed on 24 million in Q3, that gets you to that 43 million. We plan to execute, as I mentioned, an incremental 15. That gets you to the 58 million that you see on that Slide 19 of the investor deck. And the range that we're looking at is 60 to 65. Now going back to sort of how we laid this out. So we had clear identification of the sources that this is going to come out. Some of the work that we've done over the past couple of months last quarter firmed up some of these specific numbers in terms of the makeup of the mix between headcount of vendors, et cetera. And so we guided to that number. So the 60 to 65 has already been included in the 20% to 23%.

Got it. Okay. I was trying to factor in like sort of the timing of when they layered in, but it might be easier for me just to take it after the call. I've been on here long enough.

We'd have to, Gray. This is some dynamics with the sources of spend, particularly as it relates to some of the savings associated with the vendor community that obviously has a little bit longer tail and a different layering in as far as when the impact takes place. We'll be happy to walk through it in detail with you after the call.

Cool. All right. Thanks a lot.

Thank you.

[Operator Instructions]. Our next question will come from Anja Soderstrom of Sidoti. Your line is open.

Hi. Thank you for taking my question and congrats on a good performance here I guess you're challenging backdrop. In terms of the scrutinizing of projects and longer sales cycle, do you see it has become worse or is it the same or is it improving?

No, I think it's largely the same this year. Certainly, it was worse than last year for us. And we started calling it out this year. But I don't think there's been any material change in that. Again, I think the challenge with the e-signature business as we've talked about, I would say it's important. Obviously, every business is going through some sort of digital transformation. And it's strategic in the long term. But in certain macroeconomic cycles, when an IT budget's being chopped from the top 10 to top 7 to top 5, there's just the question whether e-signature is the area they're going to invest their calories, particularly if there's an incumbent in place already. So I'd say it really is the macroeconomic challenges, Anja, where it meets, particular incumbent and the ability to unseat them in environment. And now we are seeing some benefits from our new pricing model, which hopefully plays a role and provides an incentive for some of these enterprises to see material savings by moving. But nonetheless, they do have to apply IT resources to make that migration happen. So we continue to see that happening. I would expect that through the first half of next year to some degree.

Okay. Thank you. And I think you said you kept about 50% of headcount in the quarter. Where did most of the cuts come from? And then how's your sales organization ramping up?

Sure. So I'll just walk through a high level math. And Jorge, please feel free to dive in. So on total expenses that came through, about half of them came from the digital agreements side of the house, 30% of them came from security and 20% from G&A. And we can let Jorge walk through some of the details on that. But let me just give you the high level narrative. On the digital agreement side of the house, obviously we committed since day one to profitable growth. Digital agreements was always going to be that primary growth engine, given the size of the e-signature market. And security, obviously, we're going to consistently run for cash flow. On the DA side of things in addition to the macroeconomic, it was clear for us that the operating leverage that we thought may be there from cross selling into our installed base, essentially turned into a completely new sale. Okay, given the distance between the buying centers and the influencers on the security side of the house versus selling through side of the house. And so we rebalanced our sales capacity, not just in the direct sellers but also with the sales development reps and the sales engineering community attached to those sellers to really make sure that we focus really on not so much the 1,000, which we spoke about before, which was 1,000 top install base customers, but really as we created this new digital agreements division on the top 500 installed base customers for digital agreements, which have really been driving our growth. So the increased focus on the installed base of the digital agreements community, coupled with our execution, I would say have a more focused go to market, which focused on Tier 1 common law countries really provided us the opportunity to reduce the size of the sales force and the marketing spend associated with those other countries where we weren't seeing material growth, and really having a more focused effort, making sure that North America and Canada, which are the Commonwealth countries where there’s exceptional product market fit, get the lion's share of our attention. And we'll continue to sell the product globally. But the way we're serving that market is slightly different. Then we'll continue to evolve as we get a more cost effective approach with the self-serve Try and Buy model coming in Q2 of next year. So I would just say it was rebalancing and be focusing on the DA business to ensure that we get that beachhead of growth in common law countries that allow us to do some of the sales capacity across the executive sales, engineering and STR communities inside of OneSpan.

And Anja, just to add into your first question. So in terms of the split, S&M or sales and marketing was about close to 40%, then R&D about 27%, and then GNA about 15%. And then there's vendors that go across these three sections. That's about 20% of the savings. And as Matt said, digital agreements, it's about 50% of the total savings combined.

Okay. Thank you. And also I think you alluded to it in your remarks, Jorge, but for the fourth quarter, you're implying with a full year guidance on the adjusted EBITDA that that will be lower. Is that because of the one-time items in the third quarter or --?

Yes. Thanks for the question, Anja. So I think there's two or three dynamics that I think it's important to explain. One is the visibility that we have into particularly the hardware margins, which is very depending on the customer mix, as I mentioned. So this quarter, we benefited from that, particularly because a larger portion of the orders went to APAC, which have a higher margin. In Q4, we have the stability. That mix is going to shift. And so that's going to have an unfavorable impact on the hardware margins. The second component is the increased amortization of cap software. As I mentioned, that is going to impact our DA. Also security, but to a larger extent is going to be DA. And so the mix of revenue does impact profitability. And so I think you're going to continue to see these restructuring taking hold, taking place and OpEx coming down, but these other dynamics on the profitability side will impact that number in Q4.

Okay. Thank you. And then one last on capital allocation and the Dutch auction tender offer. What made you decide for that? And what are some other options? And you acquired ProvenDB. Is that acquisition in the pipeline or how are you thinking about that?

So we do continue to look at tuck-in acquisitions for sure. We're hard at work at that and are committed to our overall strategy. We do believe it's prudent, particularly with this pivot to the new operating model, Anja, that we have the flexibility given that we have proven since day one our ability to control costs. And that's the one thing we've been very, very consistent in. We've simply changed the capital allocation model from investing more materially in sales and marketing to having that cash on the balance sheet in addition to the operating model pivot that we feel comfortable going and returning 20 million-ish, if you will, to this Dutch tender offer. That is not we're not continuously looking for tuck-in acquisitions. In fact, this environment is quite favorable for those. But obviously, you want that fit to be truly strategic, like the ProvenDB acquisition was and we're going to hold out until that becomes the case.

Okay. Thank you. That was all from me.

Thank you, Anja.

Thank you.

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

Thank you everyone for joining. I really appreciate your time today and attention. I look forward to sharing progress with you next quarter. And thank you all and have a nice day and a big thank you to the OneSpan team as well for all the hard work over the past quarter. Thank you everyone.

This concludes today's conference call. Thank you for participating. You may now disconnect.