Earnings Call Transcript - OSPN Q2 2025

Operator, Operator

Welcome to the Q2 2025 OneSpan Earnings Conference Call. Please note that this conference is being recorded. I will now turn the call over to Joe Maxa, Vice President of Investor Relations. Please proceed.

Joseph A. Maxa, Vice President of Investor Relations

Thank you, operator. Hello, everyone, and thank you for joining the OneSpan Second Quarter 2025 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 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 2025. 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 the full year 2025 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 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 all growth rates discussed on this call refer to a year-over-year basis, unless otherwise indicated. The date of this conference call is August 5, 2025. 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.

Victor T. Limongelli, CEO

Thank you, Joe. Hello, everyone, and thank you for joining us on the call today. Before turning to our results, as we are halfway through my second year at the company, I thought I'd take a moment to review our trajectory and the overall position of our business. Last year, as you know, we focused on restructuring OneSpan to enhance its profitability so that it remains viable as a business and continue to be a long-term reliable partner for our customers. With that accomplished, our focus in 2025 has been on building the foundation necessary for OneSpan to not only be profitable, but also to grow the business and strengthen our product offerings for our customers. Right before the year started, we hired a new CTO, Ashish Jain, to lead our R&D team. And part of our strategy is to augment our increased internal development efforts with targeted mergers and acquisitions so that we can move faster in delivering great products to our customers. You saw that in the second quarter, both with our acquisition of Nok Nok Labs and with the establishment of a new line of credit to facilitate that kind of targeted M&A. As we move through the second half of the year, we will continue to enhance our go-to-market capabilities so that we can deliver our great products to more customers. As we have said previously, our goal is to grow the business while delivering strong profitability and to do both of those things while also returning cash to shareholders. Halfway through my second year, I'm happy to say that our transformation of OneSpan is on track. Looking ahead, our goal is that by the beginning of next year, we will have made significant progress in evolving our go-to-market capabilities as well as our product suite under Ashish's leadership such that we are well positioned to accelerate top line growth in 2026 as we continue to drive to a Rule of 40 performance. Turning to our results. I'm pleased to report another strong quarter and a solid first half of 2025, reflecting our team's disciplined execution. This focus by our team is driving our strong performance and positions us well to deliver sustained long-term value for our shareholders. As I mentioned a moment ago, I'm also pleased and excited by our acquisition of Nok Nok Labs during the quarter, which brings to us FIDO2 passwordless authentication software, to add to our FIDO2 hardware security keys. We have long been an industry leader in multifactor authentication and transaction signing technologies with our solutions widely trusted by many of the world's largest financial institutions, for their strong security, flexibility, and innovation. The addition of Nok Nok's FIDO2 software, combined with our recently launched FIDO2 security keys hardware, enables the company to provide customers worldwide with the industry's most innovative, comprehensive, and future-ready authentication portfolio. Whether on-premises or in the cloud, OTP or FIDO, software or hardware, including DIGIPASS and FIDO2 protocols and Cronto solutions for transaction signing, OneSpan now offers customers maximum flexibility to meet their authentication needs. As you can see, Nok Nok was exactly the kind of targeted acquisition that enhances our product portfolio and delivers value to our customers. With respect to the second quarter, we were solidly profitable in the quarter with adjusted EBITDA of $18 million or 29.5% of revenue. Also, for the first half of the year, we achieved record adjusted EBITDA of $41 million, representing 33% of revenue, our highest first half performance to date. We ended the quarter with annual recurring revenue of $178 million, up 8% year-over-year, including $8 million from the Nok Nok acquisition. Excluding Nok Nok, ARR grew 3%, in line with the low to mid-single-digit growth rate that we expected and discussed last quarter. As a reminder, we had a few very large contracts in last year's second quarter, which made for a challenging year-over-year ARR comparison this quarter. By the end of 2025, we anticipate our ARR to grow at a mid-single-digit percentage rate from the June 30 ARR level. Subscription revenue grew 22% in the second quarter of 2025, led by 39% growth in security and 5% growth in digital agreements. Security growth was primarily driven by on-premises authentication and app shielding software. As expected, total revenue declined modestly in the quarter. Strong subscription revenue growth was primarily offset by the three trends we've discussed on prior calls. First, banks in EMEA and, to a lesser extent, in APAC, have been adopting mobile-first authentication strategies with respect to consumer banking. This has reduced the security hardware revenue over time. Second, our 2024 transition of certain legacy perpetual maintenance contracts to term-based subscriptions lowered maintenance revenue compared to the prior year. Third, revenue was impacted by $1.2 million from sunsetted products. However, this was partially offset by $300,000 of acquired revenue during the quarter. Looking at geographies. In July 2024, we started a dedicated sales effort in North America focused on our security business. I'm pleased to report that that team had a great first half, and we expect continued high performance in that region in the second half of the year. As you know, historically, North America has represented only 10% to 12% of our overall security revenue, so we see that as a growth opportunity heading into 2026. In the first half of 2025, we also saw strong bookings performance in our Latin American region. In terms of the overall outlook, Jorge will provide additional details on the second half in a few minutes. Both business units remain solidly profitable at the segment level, and we believe we are well positioned to achieve our stated goals of delivering growth and strong profitability across both segments. We also continue to generate significant cash from operations. In the first half of the year, we generated $36 million and ended the second quarter with $93 million in cash on hand. As we have discussed previously, our Board remains committed to a balanced capital allocation strategy, weighing shareholder returns, organic investments, and targeted M&A. In the first half of the year, we returned cash to shareholders through two quarterly dividend payments of $0.12 per share, which totaled close to $10 million of cash returned to shareholders. The Board has also approved another $0.12 per share dividend to be paid in the current quarter. In addition, we used cash to make the strategic acquisition of Nok Nok, consistent with our plan to pursue targeted, technology-driven acquisitions with proven market fit, enabling us to bring additional value-added products to our customers and prospects. We have a strong global customer base and a leading position in the authentication market. With AI increasingly being used to amplify the scale and sophistication of account takeover attacks, we remain focused on innovating to stay ahead of emerging threats and to enable customers to adopt a wide range of flexible, future-proof authentication solutions. As a result, we will continue to invest in internal R&D and explore targeted M&A opportunities to enhance our product portfolio. And we plan to help our clients succeed by continuing to provide them with seamless and secure user solutions to meet their authentication needs and address related security challenges. As we look to the future, we are committed to operational excellence and to driving efficient, sustainable revenue growth while maintaining strong profitability. With that, I'll turn the call over to Jorge.

Jorge A. Garcia Martell, CFO

Thank you, Victor, and good afternoon, everyone. I am pleased to report another strong quarter, and I'm excited about our acquisition of Nok Nok Labs, which enhances our authentication portfolio and allows us to bring a broader suite of authentication solutions to our customers. We acquired Nok Nok on June 4, as such, our second quarter results include Nok Nok's financials from the acquisition date or for about a month. ARR grew 8% to $178 million, including $8 million from the Nok Nok acquisition. Our Net Retention Rate, or NRR, was 101%. As previously discussed, we anticipated a tough year-over-year ARR and NRR comparison this quarter, primarily due to large expansion contracts that benefited last year's Q2. In addition, this quarter, there was contraction at a few customers that reduced our overall ARR. Second quarter revenue was $59.8 million, down 2% compared to last year's Q2, primarily due to the anticipated decline in security hardware as a result of the long-term trends of banks moving to a mobile-first authentication approach. Digital agreements revenue grew 1%, while Security Solutions revenue declined 3%, both in line with expectations. Second quarter gross margin was 73%, up from 66% in Q2 of last year. The improvement was driven by favorable product and customer mix, including increased software and reduced hardware revenues as well as the absence of approximately $1.5 million in asset write-off charges recorded in the second quarter of last year. GAAP operating income was $10.5 million compared to $7.6 million in Q2 last year. The increase reflects higher gross profit and lower restructuring costs, partially offset by increased operating expenses related to share-based compensation, commission expenses, legal and consulting costs associated with the Nok Nok acquisition, and incremental operating expenses from Nok Nok. GAAP net income per share was $0.21, up from $0.17 in the same period last year. As a reminder, we made changes to our non-GAAP net income and non-GAAP net income per share reporting framework last quarter to better reflect our profitability trajectory and to ensure consistency across interim periods in 2025 and in future years. Please refer to our Q2 earnings release and investor presentation for additional details. Non-GAAP earnings per share was $0.34 compared to $0.31 in Q2 of 2024. This metric excludes long-term incentive compensation and related payroll taxes amortization, restructuring charges, nonrecurring items, and the impact of tax adjustments. Adjusted EBITDA and adjusted EBITDA margin were $17.6 million and 29.5% compared to $16.2 million and 26.5% in the same period of last year. Turning to our Security Solutions business. ARR was $114.5 million, up 9% year-over-year. Excluding Nok Nok, ARR grew 2%. Security revenue declined 3% to $44.2 million. Strong subscription revenue growth of 39%, including an immaterial amount of revenue from Nok Nok, was offset by expected declines in hardware and maintenance revenues and headwinds from sunsetted products. The strong growth in subscription revenue was primarily driven by the timing of multiyear renewals and conversion to multiyear customer contracts in the quarter, expansion of licenses, and, to a lesser extent, new logos. This growth was partially offset by the sunsetting of our legacy deal flow solution. Gross margin for security was 74%, up from 67% in the second quarter of last year, reflecting favorable product and customer mix. Segment operating income was $19.8 million or 45% of revenue compared to $20.7 million or 46% of revenue in the prior year quarter. The slight decline was primarily due to higher commission expense and increased operating expenses related to the Nok Nok acquisition. Turning to our Digital Agreements business. ARR grew 4.5% to $63 million. Revenue grew 1% to $15.6 million. New SaaS contracts and expansion of renewal contracts were partially offset by reduced maintenance revenue from the sunsetting of our on-premise e-signature product. Headwinds related to sunsetted products impacted revenue growth by about 3 percentage points. Subscription revenue grew 5% to $15.6 million. As mentioned earlier, we faced a tough year-over-year comparison due to a few large contracts that benefited Q2 of last year. Maintenance and support revenue was negligible this quarter compared to $0.5 million in Q2 of last year. The year-over-year decline is attributed to the sunsetting of our on-premise e-signature solution. Gross margin for digital agreements was 71%, up from 53% in the prior year quarter. The increase was primarily due to the absence of $1.5 million in asset write-off charges recorded last year. Segment operating income was $2.9 million or 18% of revenue compared to a loss of $0.2 million or negative 1% in Q2 of last year. The improvement was driven by higher gross profit and lower operating expenses primarily due to lower headcount and variable expenses. Now turning to our balance sheet. We ended the quarter with $92.9 million in cash and cash equivalents, compared to $105.2 million at the end of Q1 and $83.2 million at the end of 2024. We generated $6.2 million in operating cash flow during the quarter, up from $2.3 million in the second quarter of last year. We used $4.6 million to pay our quarterly cash dividend and $12.1 million net of cash acquired as part of the consideration for the Nok Nok acquisition. We expect to pay an additional $1.9 million in Q3 and the remaining balance in late 2026. As you are already aware, during the quarter, we entered into a five-year syndicated revolving credit facility in the amount of $100 million, which may be used for general corporate purposes, including to support our strategic growth priorities, including targeted M&A. Except for a small letter of credit supporting an office lease, we currently have no borrowings under the credit agreement and have no long-term debt. Geographically, our revenue mix was 39% from EMEA, 40% from the Americas, and 21% from APAC. This compares to 41%, 35%, and 24%, respectively, in the second quarter of last year. Moving to our modeling notes and financial outlook. We're very pleased with our second quarter and first half performance and expect a return to positive revenue growth in the second half of the year. We expect double-digit subscription revenue growth for the full year 2025, along with a modest revenue contribution from the acquisition of Nok Nok. We expect to see continued hardware headwinds, primarily in Q3 with gradual improvement in Q4. Also in the second half of the year as compared to the first half, we expect reduced year-over-year maintenance revenue headwinds from the transition of perpetual contracts to term-based licenses and from the impact of sunsetted products. Regarding hardware, due to the increased visibility into orders and shipping schedules as compared to earlier in the year, including the delay to 2026 of the shipment of certain already booked hardware deals, we now expect total second half 2025 hardware revenue to be similar to the first half, with the majority of the second half revenue recognized in the fourth quarter. On a sequential basis, in the second half of 2025, we expect an increase in year-over-year ARR growth and an increase in NRR for both the third and fourth quarters. For the full year 2025, we are maintaining our revenue guidance in the range of $245 million to $251 million. We expect incremental revenue from the Nok Nok acquisition to be offset by a similar reduction in hardware revenue. We are increasing our ARR guidance to be in the range of $186 million to $192 million compared to our previous guidance range of $180 million to $186 million. The increase in guidance is attributed to our acquisition of Nok Nok, partially offset by a few reductions by the customers that I discussed earlier. And we are maintaining our adjusted EBITDA guidance in the range of $72 million to $76 million. We expect the acquisition of Nok Nok to be slightly accretive to adjusted EBITDA in the fourth quarter of 2025. That concludes my remarks. I will now turn the call over to Victor.

Victor T. Limongelli, CEO

Thanks, Jorge. To recap, we had another strong quarter, and I'm very proud of the OneSpan team's disciplined execution and commitment to operational excellence. I'm also excited about our strategic acquisition of Nok Nok, which expands our authentication offerings to include software-based FIDO2 capabilities and provides us with an additional proven value-added solution that we can bring to our customers and prospects. Looking ahead, we remain focused on delivering value for our customers and executing well as a business in the second half, which we believe will position OneSpan for profitable growth. To that end, we remain committed to maintaining our strong profitability as we drive towards our goal of achieving a Rule of 40 performance as a business. Jorge and I will now be happy to take your questions.

Operator, Operator

Our first question comes from Catharine Trebnick of Rosenblatt.

Catharine Anne Trebnick, Analyst

Yes. On this acquisition, that's interesting that you're headed in this direction. Can you give us some more detail on how competitive you feel you'll be with this by buying Nok Nok and adding this to your capabilities?

Jorge A. Garcia Martell, CFO

Thank you for the question, Catharine. This is an area we've been discussing regarding how we can enhance our solutions in the security software sector. This acquisition aligns well with our strategy as it's a tuck-in acquisition where we appreciate the technology and can integrate it with our existing FIDO technology. As you may recall, we introduced FIDO security keys last year, and when considering the future of security for seamless user authentication within FIDO2, it's a crucial element that our banking and financial services clients will embrace. We believe this acquisition will be very beneficial for us in the long term as we strive to provide maximum flexibility and become the leading authentication provider, particularly for banks and financial institutions. I'm happy to answer any further questions you may have about this.

Catharine Anne Trebnick, Analyst

Are you considering this as a way to attract new customers due to the new technology, as well as an opportunity to upsell your existing banking clients?

Jorge A. Garcia Martell, CFO

Yes, that's a great question, Catharine. When considering one of the most significant assets this company possesses, as Vic has previously indicated, it is our long-tenured customer base. We serve over 1,000 banks worldwide. The main aim of this acquisition was not to generate immediate revenue. Instead, it focused on the technologies and the cross-sell potential we can leverage with our existing customer base. We see this as an opportunity that will likely yield more results in 2026 than in 2025 as we align our teams. The product needs to be integrated onto the same server to provide a seamless experience for our customers, and the sales teams are also coordinating effectively. We are optimistic not only about the product but also about the experienced team we acquired, which has been a leader in the FIDO2 space. They hold a board position in the FIDO Alliance, which we now also participate in. Overall, we are confident about our position, with a strong emphasis on cross-selling into our established customer base. Vic, feel free to add any thoughts.

Operator, Operator

Our next question comes from Anja Soderstrom of Sidoti.

Anja Marie Theresa Soderstrom, Analyst

I have a question about the ARR guidance and the increase there about $6 million, but Nok Nok said added about $8 million for the second quarter. How should we think about that?

Jorge A. Garcia Martell, CFO

Yes, I can answer that. Thanks for the question, Anja. We mentioned that Nok Nok contributed about $8 million to the ARR pool. When we provided new guidance, we increased it by $6 million on both the low end and the high end. The remaining $2 million is mainly due to a couple of contractions we've discussed in previous calls, particularly involving a bank that was selling operations in the Middle East. This process accelerated more than we anticipated in the first half of the year. Additionally, we had another significant customer whose implementation of our solutions is progressing more slowly than expected due to internal delays. As a result, we made the conservative decision to move that amount out of the ARR for the rest of the year. That summarizes the factors contributing to the $6 million increase on both ends.

Anja Marie Theresa Soderstrom, Analyst

Okay. And then just in general, regarding the pipeline, how is that shaping up for you?

Jorge A. Garcia Martell, CFO

Sorry, say that one more time, Anja, you got off for me a little bit.

Anja Marie Theresa Soderstrom, Analyst

The pipeline, how is that shaping up for you just in general?

Victor T. Limongelli, CEO

We had an excellent first half of the year regarding bookings. In the second half, typically, our business sees larger activity, especially in the third and fourth quarters, which usually yield higher business closures. We are pleased with our overall progress in the go-to-market strategy. As mentioned earlier, we expect the hardware business to face some challenges in the latter half of the year, but we are enthusiastic about introducing new offerings to customers, particularly the Nok Nok Labs FIDO2 capability. Overall, the second half of the year seems promising for us.

Operator, Operator

Our next question comes from Trevor Rambo of BTIG.

Trevor John Rambo, Analyst

Trevor on for Gray Powell. So a lot was happening in the quarter from a macro perspective with the tariff announcement we had in April, then the 90-day pause, and then an extension of that pause. And you mentioned in the prepared remarks that a few customers contracted in the quarter. But maybe from a higher level, can you give some more color on what you saw in the quarter? And then given the uncertainty in the macro had an impact on general customer buying behavior? And then has any of that spilled over into the first month of Q3 so far?

Unidentified Company Representative, Company Representative

Thank you, Trevor. We had a strong first half in terms of bookings. While we report revenue, which isn't directly comparable to our bookings, I can say we had a solid first quarter. The tariff situation affected us minimally; as we mentioned last year, the initial proposed tariffs were significantly higher, but ultimately the impact was just a few hundred thousand dollars, which is quite minor. Additionally, the federal cuts, particularly the DOGE cuts, were a topic of discussion in the second quarter. Since only about 2% of our revenue comes from the federal government, that had a limited effect as well. Overall, our performance has been good. Geographically, we've noticed that Europe has underperformed slightly, while we've seen better results in North and South America. EMEA usually represents a strong market for us, and we hope to see improvement there. But overall, our results have been solid so far.

Trevor John Rambo, Analyst

Great. That's some great color. And then maybe for my second, you talked on the prepared remarks and a bit earlier about evolving the go-to-market program by the start of next year. Can you dive a bit deeper into what that's going to look like? And maybe you can provide some more color on the process and maybe what the outcome is?

Unidentified Company Representative, Company Representative

Yes, part of our strategy involves allocating additional resources to areas where we see positive results. We began our efforts in North America, where we had previously combined our sales teams. Over a year ago, we had a sales team that was tasked with selling both product lines, which target different buyers and have distinct competitive landscapes. Last July, we separated the North American sales team into a dedicated security team and a dedicated digital agreements team. We are continuing to invest in this strategy as we start to see returns, which includes expanding the size of the North American security sales team. We also added more resources following the Nok Nok acquisition. Additionally, we are refining our approach in the digital agreements area, focusing on improving our efforts in acquiring new logos. As we've mentioned before, that segment operates on a land-and-expand model, so our emphasis is on securing more initial agreements, knowing that expansion will follow.

Operator, Operator

Our next question comes from Rudy Kessinger of D.A. Davidson.

Rudy Grayson Kessinger, Analyst

Jorge, could you maybe expand or just quantify maybe the contraction with those two large customers? Because understanding you're saying second half bookings are stronger historically, but your first half net new ARR $2 million relative to past years. I know last year, Q2 is a tough compare even relative to several years prior to that, still down quite a bit. So could you quantify maybe what the impact there was from those two customers?

Jorge A. Garcia Martell, CFO

Yes, thanks for the question. It was about $3 million, Rudy, between those two customers of the year-over-year contraction.

Rudy Grayson Kessinger, Analyst

Okay. And with that one customer selling off assets in the release? Is there a risk that they sell off more assets in other geographies or any further contraction risk from that one?

Jorge A. Garcia Martell, CFO

So obviously, we don't have the stability of the quantification ruling, specifically for that particular client. I think my sense is that, as I mentioned, this accelerated in the first half. I think there's still going to be some of it, but it may be a little more muted, but we still have yet to see it.

Rudy Grayson Kessinger, Analyst

Okay. Got it. And then with Nok Nok, could you maybe just quantify or try to size up for us just the upsell, cross-sell opportunity that they bring? What percent of your installed base do you believe can really use this capability or that you could sell to over the next couple of years?

Unidentified Company Representative, Company Representative

Yes. So this is an interesting topic because I think it's fair to say that the FIDO authentication protocol is something that has grown over the past few years and will grow even more over the next 3 to 5 years. So part of this strategy is for us to be able to offer a complete solution to our customers. And we saw this, if you go back 10-plus years ago, when banks in EMEA and in APAC were doing largely their consumer authentication was largely through hardware. And over time, we've talked about this before, it shifted to mobile first, so we needed to have a mobile offering. And we did. So with respect to the FIDO Authentication Protocol, we wanted to make sure that we had an offering both in hardware, which we introduced those recently, and software. So it gives us the opportunity to grow with those banks, to grow with our customers into the FIDO ecosystem without losing them to competitors and offering them a solution where they don't have to rush all at once into FIDO like flipping a light switch; they can start using FIDO and they can still use our DIGIPASS approach. So I think ultimately, all of our customers, if you fast forward 5 to 10 years out, we'll be using FIDO. Exactly how fast that goes, hard to say right now, but passkeys are here, and we see banks rolling it out in some markets, and other markets will probably take a little bit longer.

Operator, Operator

This concludes the question-and-answer session. I would now like to turn it over to Joe Maxa for closing remarks.

Joseph A. Maxa, Vice President of Investor Relations

Thanks, everyone, and glad you could join us. Have a nice day.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.