OneSpan Inc. Q1 FY2024 Earnings Call

Good day. Thank you for standing by. Welcome to OneSpan's First Quarter 2024 Earnings Conference Call. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Joe Maxa, Vice President, Investor Relations. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan First Quarter 2024 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 Victor Limongelli, our Interim Chief Executive Officer, and Jorge Martell, our Chief Financial Officer. This afternoon, after market close, OneSpan issued a press release announcing results for our first quarter 2024. 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 2024 and other 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 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 and in the investor presentation available on our website. In addition, please note that the date of this conference call is May 2, 2024. 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 Victor.

Thank you, Joe, and good afternoon, everyone. Thank you for joining us today. I want to start by congratulating the entire OneSpan team for delivering another solid quarter, which exceeded our internal revenue and adjusted EBITDA expectations. Revenue grew 13% year-over-year to $65 million, and adjusted EBITDA was $20 million, or 31% of revenue. ARR growth also exceeded our internal expectations, growing 9% year-over-year to $155 million, offsetting the headwinds we discussed on our last earnings call related to expired contracts of sunsetted products. Q1 was my first full quarter leading OneSpan, and I continue to be impressed with the team's work ethic and dedication to operational rigor. For example, one of the major factors in the Q1 outperformance was that our renewals team did a great job closing several delayed renewals earlier than expected, which increased Q1 revenue by a few million dollars. Our APAC team did excellent work delivering its strongest quarter in terms of year-over-year growth in more than three years. In addition to the impact from delayed renewals closing in Q1, our first quarter top line outperformance was largely driven by expansion contracts from existing security customers, who continue to value our industry-leading anti-fraud solutions designed to mitigate potential hacking attacks. Profitability outperformance was driven by strong revenue, favorable product mix, and increased operating leverage resulting from the right-sizing of our cost structure over the last several quarters. We generated $27 million in cash from operations and ended the quarter with $64 million in cash. Our two business units, Security Solutions and Digital Agreements, both had strong quarters with solid year-over-year revenue growth and significantly improved profitability. Revenue growth in Security was primarily driven by increases in software licenses, including approximately $3 million from the past-due renewals just discussed that we originally expected to close in Q2. We also saw several annual contracts renew with multi-year terms, resulting in about $2 million of additional revenue compared to our forecast. We had solid double-digit ACV growth in Security, driven in part by increased demand for our cloud-based authentication solution, OCA, including a new seven-figure ACV contract and the expansion of a two-year contract to the mid-seven figures with new ACV of nearly $1 million. DIGIPASS hardware revenue declined as expected. Last quarter, we discussed a few orders that had shipped in Q4 to the tune of approximately $2 million that were originally scheduled to ship in the first quarter of 2024. Revenue growth in Digital Agreements was primarily driven by the expansion of cloud subscriptions from existing customers. Our profitability and cash flow generation improved significantly in the first quarter compared to the prior-year period. For the balance of the year, seasonal software and hardware revenue patterns suggest more modest revenue growth and profit margins in Q2 and in the second half. We will continue to focus on operational excellence and on driving efficient revenue growth to help ensure we achieve our profitability and cash flow commitments. With that, I will turn the call over to Jorge.

Thank you, Victor, and good afternoon, everyone. I'll start by providing an update on our cost reduction activities. Cumulative annualized cost savings to date from our restructuring efforts reached $64.5 million, in line with the $64 million to $65 million target range we previously announced, although achieved earlier than our end of 2024 forecast. We now expect total cumulative annualized cost savings to approximate $75 million by the end of 2024. Turning to our first quarter results, I'll provide a brief overview and then discuss each business unit in more detail before providing an update to our 2024 outlook. ARR grew 9% year-over-year to $155 million, ARR specific to subscription contracts grew 17% to $128 million and accounted for approximately 83% of total ARR. Net retention rate, or NRR, was 107%. It was impacted by a few percentage points as expected due to the timing of contract expirations related to sunset products. First quarter 2024 revenue grew 13% to $64.8 million compared to the same period last year, driven by 9% growth in Security Solutions and 25% growth in Digital Agreements. Subscription revenue grew 34% to $40 million. Security subscriptions grew 34% and digital agreement subscriptions grew 33%. The strong growth in subscription revenue was partially offset by a decline in maintenance revenue, which is by design as we transition to SaaS and subscription licenses, and a decline in hardware. First quarter gross margin was 73% compared to 68% in the prior-year quarter, driven primarily by favorable product mix, including record subscription revenue and seasonally low hardware, partially offset by an increase in depreciation of capitalized software costs. First quarter GAAP operating income was $14.1 million compared to an operating loss of $8.1 million in the first quarter of last year. Increases in revenue and gross profit margin and a decrease in operating expenses, primarily from lower headcount-related costs, were partially offset by an increase in restructuring and other related charges. GAAP net income per share was $0.35 in the first quarter of 2024 compared to a GAAP net loss per share of $0.21 in the same period last year. Non-GAAP earnings per share, which excludes long-term incentive compensation, amortization, restructuring charges, other non-recurring items, and the impact of tax adjustments, was $0.43 in the first quarter of 2024. This compares to a non-GAAP loss per share of $0.09 in the first quarter of 2023. First quarter adjusted EBITDA and adjusted EBITDA margin was $19.8 million and 30.5%, compared to negative $1.6 million and negative 3% in the same period of last year, respectively. Turning to our Security Solutions business unit, ARR grew 7% year-over-year in the first quarter to $100 million. ARR growth was impacted by approximately 1.5 percentage points due to the transition of identity verification products to our Digital Agreements business unit at the beginning of the quarter. Subscription ARR grew 16% to $77 million and was partially offset by an expected decline in perpetual maintenance ARR. We are transitioning perpetual-based maintenance contracts to subscription over time. First quarter revenue increased 9% to $50.4 million. Subscription revenue increased 34% to $26.2 million, driven by strong renewals, primarily expansion of licenses from existing customers for on-premise, mobile security, and authentication solutions. The earlier-than-expected closing of past-due renewals and a larger-than-expected increase in multi-year term contracts, as discussed by Victor, resulted in approximately $5 million of revenue upside in the quarter. Maintenance and support revenue declined slightly year-over-year to $10.1 million, with growth from on-premise subscriptions offset by the expected decline from legacy perpetual contracts. DIGIPASS hardware token revenue decreased by $2.3 million or 15% compared to the same quarter last year. This was primarily a result of a few contracts totaling approximately $2 million that closed earlier than expected and shipped in Q4 of last year instead of the first quarter of this year. Q1 2024 gross profit margin was 74% compared to 67% in the first quarter of 2023. The increase in margin is primarily attributable to favorable product mix, including a strong increase in high-margin subscription revenue and a decrease in lower-margin hardware revenue. As a reminder, Security gross margin is typically highest in the first quarter of the year due to product mix favoring software and can fluctuate on a quarterly basis due to product and customer mix. Operating income was $25.9 million and operating margin was 51% compared to $15.6 million and 34% in last year's first quarter. Strong increases in revenue and gross profit margin, combined with reduced operating expenses primarily attributed to restructuring and other cost reduction activities, drove the improved performance. I'll now discuss the financial results for Digital Agreements. ARR grew 14% year-over-year to $55 million. ARR growth benefited by approximately 3 percentage points due to the relocation of identity verification products to Digital Agreements at the beginning of the quarter. Subscription ARR grew 18% year-over-year to $51 million. Maintenance ARR declined as expected due to the sunsetting of our on-premise products. First quarter revenue grew 25% to $14.4 million. Subscription revenue, consisting primarily of cloud solutions, grew 33% in Q1 2024 to $13.8 million and included an unexpected $0.5 million short-term on-premise contract renewal, which we do not expect to repeat in future quarters. SaaS revenue grew 29% to $13.3 million. Maintenance and support revenue was $0.5 million as compared to $1 million in Q1 of last year. The year-over-year decline is attributed to the sunsetting of our on-premise e-signature solution. First quarter gross profit margin was 69% as compared to 73% in the prior year quarter. The decline in gross margin is mainly related to two items that we discussed last quarter. First, we relocated certain costs, primarily related to customer support and professional services, from sales and marketing expense to cost of revenues. We did this to better reflect where employees are spending their time. Second, depreciation of capitalized software costs have increased now that certain R&D projects are in production. Operating loss was $0.3 million as compared to an operating loss of $6 million in Q1 last year. The improved performance was driven by an increase in revenue and a decrease in operating expenses, primarily attributed to the restructuring and other cost reduction activities, and were partially offset by an increase in cost of revenues. Turning to our balance sheet, we ended the first quarter of 2024 with $63.9 million in cash and cash equivalents compared to $42.5 million at the end of 2023. Due in part to the seasonality in our collections, with the first quarter being typically strong, we generated $27 million in cash from operations during the quarter. We used $3 million in capital expenditures, primarily capitalized software costs, and $3 million for restructuring payments. We have no long-term debt. Geographically, our revenue mix by region in the first quarter of 2024 was 49% from EMEA, 33% from the Americas, and 18% from Asia Pacific. This compares to 48%, 36%, and 18% from the same regions in the first quarter of last year, respectively. I'll now provide our financial outlook. For the full year 2024, although we are, of course, pleased with the Q1 outperformance, given the time-shifting nature of certain items in Q1 such as the $3 million of delayed renewals closing in Q1 rather than Q2, at this point, we are affirming our previously-issued revenue and ARR guidance. We are increasing our adjusted EBITDA guidance to reflect an increase in operating leverage for the year. More specifically, we expect revenue to be in the range of $238 million to $246 million, ARR to end the year in the range of $160 million to $168 million, and adjusted EBITDA to be in the range of $51 million to $55 million compared to our previous guidance range of $47 million to $52 million. With due consideration of seasonality of collections in our business, we expect to end the year with more than $70 million of cash, absent additional share repurchases. That concludes my remarks. Victor?

Thanks, Jorge. Just to recap, we had an excellent first quarter, and I'm very proud of the OneSpan team's performance. Beyond the first quarter, however, we know that we have more work to do in order to deliver an excellent year. We're going to continue to focus our efforts on delivering value to our customers and thereby creating value for our shareholders. Jorge and I will now be happy to take your questions.

And our first question comes from Trevor Rambo with BTIG.

This is Trevor on for Gray. Congrats on a great quarter all around. So, first one for me, now that we're about four months into the year, how do you guys feel about your visibility on your pipeline for both the next quarter and the second half of the year? And I was wondering if you could touch on any linearity that you saw throughout Q1 as well.

Well, thanks, Trevor. What was the last part of the question? Can you repeat that?

Yes. Just wondering if you could touch on any linearity you saw throughout Q1, or if there's any like one-time items you saw besides some of the things you mentioned on the call.

We highlighted a few items that were mostly one-time in nature. The main factor in Q1 was the delayed renewals that contributed significantly to the one-time performance during that quarter. Looking ahead, we have a solid understanding of Q2. Since we are currently on May 2, nearly halfway through the quarter, we are still observing strong performance across several regions. I specifically mentioned the APAC team in my remarks about Q1, and they are continuing to perform well in the second quarter. However, as we look further into the year, particularly Q4, things become less certain regarding our pipeline for that quarter. This uncertainty is part of why we chose to maintain the revenue guidance, as much of our revenue tends to come in later in the year, making it too early to have firm expectations about Q4 revenue. Jorge, do you have any additional insights to share on this?

Yes. No, I think the only thing I would add is it takes four quarters to make the year, Trevor. And so, we got a solid Q1. We're proud of what the team executed on. But yes, we have a number of key renewals with potential add-ons that we're looking at. But it's still a little bit too early. We want to see a little more movement. Once that transpires one way or the other, we'll be looking into either changing guidance, etc., but that's going to happen later in the year.

Trevor, let me just comment also. I know you asked specifically about pipeline and revenue, but I will say when it comes to the cost structure of the business, we have a pretty good sense of it for later in the year. That was partly the reason why we increased the adjusted EBITDA guidance for the year.

Yes. Awesome. That makes a lot of sense. And maybe just one more. I know you mentioned last quarter that you had strong visibility into your large customers and some visibility into the mid-market. I was wondering if you could touch on that aspect of the business and see how that compares to some of your commentary and what you saw last quarter.

Sure. I think we definitely saw some good large deals last quarter, and we continue to have some good opportunities in that area in the second quarter. So I think quite naturally, the larger the opportunity, the more attention and focus it gets, not just from the salesperson, but also all the way up the chain for the sales management up to and including Jorge and myself. Mid-market, we do have decent visibility there. Once you get to the smaller deals, probably a little bit less. So I don't think that Q2 is too different than Q1 in that regard.

Great. That's it for me. Congrats again on a great quarter, guys.

And our next question coming from the line of Chad Bennett with Craig-Hallum.

Great. So obviously, a few one-time items benefited the first quarter here. And I think the rest of the year is pretty straightforward from a guide standpoint. But I'm just curious, just in terms of Digital Agreements versus Security Solutions, just kind of the relative growth rate for the rest of the year of those two segments, and if you kind of have any different view on the growth rates of the two businesses for the remainder of the year?

Yes. Thanks, Chad. Part of the Q1 numbers is due to the shift of the IDV business. We moved it into the Digital Agreements segment. Jorge, can you comment on what percentage of that growth came from that shift?

Yes. From a revenue perspective, it was about $300,000. From an ARR perspective, it's $1.5 million. So not too much from that standpoint. One thing to add is that on the Digital Agreements side, you need to consider that it follows a land-and-expand approach. Typically, you land a customer with one or two use cases, and then it expands from there. Timing is crucial, especially for enterprises where the land-and-expand model applies at both the top and bottom of the pyramid. You can expect gradual increases, particularly in SaaS. Now that on-prem is largely behind us, we have some dynamics to consider, but overall, you should see continued growth in the SaaS segment, not exponentially, but gradually. While we are acquiring new customers, they aren't always generating millions of dollars right away. Some do, but it isn’t as common as we would like. The growth from expansions is where we see more activity on the security software side. There are new customers and logos, but the impact won’t be as significant given our scale. We serve 60% of the top 100 banks, indicating a more mature market. Additionally, on the hardware side, be aware of a secular decline in regions like APAC and EMEA, where there's a shift from hardware to software. We aim to capitalize on that shift as much as possible. I anticipate security growth will be in the low single digits, while the Digital Agreements side could see mid to high single digits. These are the expectations for now, but we want more clarity as we approach the second half of the year, although we don't provide guidance on a per quarter basis, so keep that in mind.

No, that's great insight. So maybe a follow-up regarding your progress on cost savings. It sounds like you are ahead of your plan, exceeding it by about $10 million from where you started. I know you have also increased your EBITDA incrementally. Are there other types of investments being made? I'm curious why that additional $10 million wouldn't simply contribute to that EBITDA guidance. Of course, we want to be conservative and aim for better results, but I'm interested in your thoughts on this.

Well, Jorge, I'll let you elaborate on this, but I want to mention that the $10 million is an annualized figure. Some of those cost savings will come later in the year as they have already been identified, but as we progress through the year. All of that will take effect in 2024.

Yes. And I would say, just from a product perspective, Chad, so obviously, we've been selective at what investments we deploy from an R&D perspective, things like that. We mentioned last quarter about FX BIO products, etc., more towards the 100% towards the workforce authentication market. It's still early. It's still premature, but it's just one example of investments that we're working on.

Got it. I appreciate it. Nice job on the quarter.

And our next question coming from the line of Anja Soderstrom with Sidoti.

Congrats on the good quarter here. Just to clarify, the gross margin this quarter was helped by the lower volume of hardware, right? So, that should be coming down as you see more higher hardware revenue in the coming quarters.

That's correct.

Okay. And then, in terms of the macro environment and your customers' willingness to take on more subscription costs and whatnot, are you seeing that changing at all, the sentiment among your customers?

I think we discussed this last quarter. The macro environment isn't the best, but it's not too bad from our viewpoint. We've seen positive results in some areas, though the European market has been slightly weaker compared to others. Overall, it's decent and manageable, I would say.

Okay. And is there any way you're sort of measuring the land-and-expand approach, how that is trending?

Well, we do report NRR. We report that quarterly. That would probably be the most pertinent data point.

Okay. And there's some sunsetting and stuff that's clouding that right now, right?

A little bit, yes. So, Jorge, I don't know if you want to comment on that. I think it was 107%, if I'm remembering correctly.

That's right. If you remember, last quarter, we had 110%. We mentioned that two to three percentage points of that was clouded with the conversion from on-prem in our e-signature solution to the cloud. Clients were in migration. They bought both solutions. Now that they completed those migrations in Q1, we guided towards a drop to about 3% lower. That’s exactly what happened. When you take those one-offs into account, you would expect about 107% to 106% going forward. But, as I always caution, we don't guide on a quarterly basis, so just keep that in mind.

And our next question coming from the line of Rudy Kessinger with D.A. Davidson.

Jorge, I want to delve deeper into some points. I'm not sure I caught everything. Regarding the strong performance in the quarter, I believe you mentioned a couple of million in benefits from renewals that carried over from last quarter. Can you clarify the benefit from multi-year terms? Were those renewals, or were they new deals?

Yes, it was a tough question. So, just to go back through this, there were $3 million of delayed renewals that closed earlier than we expected this quarter. That's $3 million in software terms, subscription revenue. There were also a couple million dollars, about $2 million of increased multi-year deals that closed this quarter that we were not forecasting. Again, that's part of the operational rigor the team is going through. They're incentivized to close multi-year deals. We benefited from that this quarter. We always have, in any given quarter, a number of conversions from perpetual to term as well. So, you're looking at about $5 million, a little more than that in terms of those three items. Again, I caution, the conversion is typically present in any quarter.

Okay. That's helpful. I heard you mention the strength in APAC, but since it represents less than 20% of the revenue, can you comment on the bookings performance in the U.S. and other global regions during the quarter compared to expectations?

Yes. Thanks for the question, Rudy. From a public statement standpoint, we're not giving detailed geographical performance. I called out APAC because the team performed very well there. I did mention that the macro-environment in Europe, I think, was a bit weaker, so you can probably read into that what you will. Overall, I think performance in North America feels decent. The macro-environment in North America feels pretty decent. We're continuing to work on execution, and we're looking to have every region and both business units performing well.

And I'm showing no further questions in the queue at this time. I will now turn the call back over to Joe Maxa for any closing remarks.

Thank you, everyone. We appreciate your time today and look forward to sharing our progress with you again next quarter. Thanks again, and have a nice day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and you may now disconnect.