OneSpan Inc.

Q1 2023 Earnings Conference Call


spk01: Good afternoon. Thank you for attending the first quarter 2023 One-Span Earning Conference call. My name is Alyssa and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star 1 on your telephone keypad. I would now like to pass the conference over to your host, Joe Maxa, Vice President of Investor Relations. Joe, you may proceed.
spk04: Thank you, Operator. Hello, everyone, and thank you for joining the OneSpan First Quarter 2023 Earnings Conference Call. This call is being webcast and can be accessed on the Investor Relations section of OneSpan's website at Joining me on the call today is Matt Moynihan, our Chief Executive Officer, and Jorge Martel, our Chief Financial Officer. This afternoon, after market close, OneSpan issued a press release announcing results for our first 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 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 May 4th, 2023, and 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.
spk03: Thank you, Joe. Hello, everyone, and thank you for joining us on the call today. I'm pleased by the 10% revenue growth we reported in the first quarter of our three-year transformation plan. ARR grew 10% and adjusted EBITDA was negative 1.6 million, consistent with our plan to front-load investments in 2023, to drive ARR growth in the second half of the year and through 2024. Topline growth was primarily driven by our security segment, as several customers increased their number of licenses and extended their contract lengths, resulting in strong subscription renewals. We also saw growth, to a lesser extent, in new customer logos. Our marquee security client base continues to leverage our enterprise class security solutions to mitigate fraud and hacking attacks, protect their infrastructure, safeguard their reputation, and optimize costs by consolidating vendors to achieve the best return on their investment during this uncertain macroeconomic time. We experienced 25% growth in digital agreements SaaS revenue driven by customer expansion. Consistent with our decision to sunset our on-premises signature offering last year and move to a cloud-first model, we experienced a decline in total digital agreements revenue in the quarter as a result of certain on-premise deals that had upfront revenue recognition in the first quarter of 2022, not repeating in this quarter this year. This model change is consistent with our plan to increase R&D efficiencies and grow revenue more predictably over time. As we initially communicated in May of last year, investing in digital agreements is a key component of our growth plan. I'm happy to share that we reached our goal of doubling our quota-carrying sales force ahead of our 2023 year-end target. I am pleased by the level of experience, talent, and professionalism of the people we've been able to hire, all of whom are universally excited about our market positioning and growth strategy. I also feel good about the progress we've made to enable our Salesforce and onboard new talent to execute our unified go-to-market strategy. It is important to note that we are still in the initial phase of our three-year plan. We continue to work hard to align our increased sales capacity with a maturing demand generation engine. to execute against our new logo strategy in the second half of the year. Equally important to our new logo strategy is driving upsell and cross-sell opportunities within our existing customer base. To this end, we are committed to getting new products into the hands of our sales team to help deliver against our goals. In Q1, we launched the first version of One Spend Notary to test the market. And later this quarter, we'll be launching One Spend Notary more broadly to sell into additional states where we've been certified. We also plan to launch DigiPath CX, our cloud-connected device, later this quarter, initially targeting certain use cases in the banking and healthcare sectors. And we are also working to bring secure key vaulting for documents and artifacts to markets this year based on blockchain technology, which was acquired in the first quarter of this year with proven DB acquisition. Lastly, we are pleased with the positive customer feedback we have received regarding our new pricing model, which allows us to offer advanced technology and services at the most favorable price per value in the market. We believe this pricing model will be a key differentiator in generating new logo opportunities over the balance of the year. Next, I'd like to highlight a few customer wins during the quarter. A long-term on-premise e-signature customer in North America significantly expanded its business with us by signing an upper six-figure annual SAS contract. This customer evaluated competing solutions and found One Span Sign to be the most secure and flexible option for its needs. The largest private bank in India, the current corporate banking customer, purchased authentication and mobile security solutions for their retail banking unit in the mid six-figure ACV range. It was a competitive win against multiple firms and highlighted the flexibility of our mobile security solution. This bank has potential to become a much larger customer in the coming years. And an auto finance customer in Europe expanded their six-figure ACV contract and migrated to our identity verification and one-span sign solution. from the legacy deal flow platform sunsetted last year. In a competitive bidding situation, the customer valued our expertise in helping them execute their complex workflows in our out-of-the-box identity verification service. Now turning to the macroeconomic environment, we are seeing longer sales cycles and more scrutiny over investments by our clients in certain regions, similar to prior quarters. Specifically, we are seeing more caution around budget spend, which may put pressure on our expansion and new logo activities, particularly in the digital agreement market. That said, we're also seeing an increase in our sales pipeline, and we are monitoring on a regular basis our lead generation activities, conversion rates, and Salesforce productivity. We are still early in our 2023 investment cycle and continue to make adjustments as necessary to drive sales performance while also meeting our 2023 profitability targets. Regarding our exposure to recent bank failures, I want to point out that we have minimal exposure to the banks impacted thus far, and we will continue to closely monitor developments across the entire banker sector over months to come. Now I'd like to provide a few comments on generative AI in deepfake technology. I'm sure you've all seen or heard about several recent deepfakes. For example, Pope Francis wearing a white puffer jacket, a German newspaper using AI to generate an interview with former Formula One driver Michael Schumacher, and various other documents or content being created by AI algorithms. The technology has progressed to a point despite its early days, where you literally cannot tell whether what you are seeing or reading is real or fake. If I'm in a virtual meeting with someone I haven't met before, how do I know it is them? If I'm signing a digital document, can I trust its authenticity? This is where we come in. The industry is coming in our direction. Our five pillar solution strategy was designed to enable us to secure an entire digital transaction lifecycle by seamlessly weaving together identity verification, authentication, high assurance virtual collaboration, e-signature, and secure transaction e-vaulting for our customers. I believe in this world of generative AI and deep fakes, solutions like ours will increasingly be needed to deliver secure virtual user interactions, digital transaction integrity, and secure and trusted digital documents, such as videos and other artifacts embedded in blockchain technology. With that, I'll turn the call over to Jorge to review our financials. Jorge?
spk05: Thank you, Matt, and good afternoon, everybody. I am pleased that we reported another good quarter. ARR grew 10% year-over-year to $141 million. ARR specific to subscription contracts grew 19% to $109 million and accounted for approximately 77% of total ARR. Net retention rate, or NRR, was 108%. ARR and NRR were impacted by longer sales cycles, timing related to contract renewals, a few lost contracts last year, and our decision to sunset certain portfolio offerings. First quarter revenue increased 10% to $57.6 million. Subscription revenue grew 29% to $30 million and accounted for more than 50% of total revenue. Strong growth in security software and SaaS e-signature more than offset a decline in term e-signature, which we began sunsetting last year. First quarter growth margin was 68% compared to 70% in the prior year quarter and was impacted by an increase in third-party costs and lower DigiPath margins. Operating loss was 8.1 million compared to 9.2 million in the first quarter of last year. Higher gross profit dollars were largely offset by an increase in operating expenses resulting from increased investments in sales hires, T&E, contract workers, and third-party marketing fees, among other costs. These costs were partially offset by an increase in R&D software capitalization costs and a reduction in non-recurring expenses related to our restructuring plan as compared to the same period last year. Regarding our cost reduction plan, total annualized savings from Phase 2 were $10.7 million as of March 31, 2023. As a reminder, Phase 2 began May of last year and will continue through 2025. The total annualized savings expected to be in the range of $20 to $25 million. Most of these savings are expected to be reinvested as part of our three-year growth plan. Gap net loss per share was 21 cents in the first quarter of 2023, compared to net income per share of 13 cents in the first quarter of last year. Non-gap loss per share, which includes long-term incentive compensation, amortization, non-recurring items, including the impairment of intangible assets, restructuring charges, and the impact of tax adjustments was $0.09 in the first quarter. This compares to non-GAAP loss per share of $0.01 in Q1 of last year. First quarter adjusted EBITDA and adjusted EBITDA margin was negative 1.6 million and negative 3% as compared to positive 0.2 million and positive 0.5% in the same period of last year. The year-over-year change is primarily related to the investments we made in the quarter, particularly in our sales and marketing functions, including the increased hiring of quarter-bearing sellers. I'll now discuss our first quarter digital agreement segment results. ARR grew 14% year-over-year to $48 million, led by subscription ARR growth of 17% to $43 million. As Matt noted earlier, a strategic decision to sunset our on-premise e-signature product and move to a cloud-first model impacted our segment revenue in the quarter. Digital agreements revenue decreased 13% to $11.6 million. This decrease was associated with the upfront recognition of two multi-year e-signature term contracts totaling more than $3 million in the first quarter of 2022 that didn't repeat this year. We are no longer sending new term e-signature contracts. We believe this will enable us to be more efficient with our R&D resources and result in more predictable and stable revenue growth in the coming years. It will take a few quarters for this to work through the system. We expect the related revenue variability to be smaller going forward and to be behind us beginning of next year. SAS subscription revenue grew 25% year-over-year and accounted for nearly 100% of subscription revenue in the quarter. We are investing for growth in this part of our portfolio as a key tenet of our strategic growth plan. First quarter growth margin was 73% compared to 77% in the prior year quarter. The declining growth margin percentage was largely a result of lower-term revenues. Operating loss was $6 million as compared to operating income of $1.1 million last year. The change in profitability is primarily attributed to the reduction in high-margin on-premise description revenue I just discussed, reallocation of expenses from our security solutions operating segment, the increased investment in quarter-bearing salespeople, and increases in sales and marketing CNA. These factors were partially offset by an increase in software capitalization costs. The investments and changes we made this quarter are consistent with our transformation plan to drive top-line growth. We anticipate operating leverage improvements as we make progress in the coming quarters. Turning to our security solution segment results, ARR grew 7% year-over-year in the first quarter to $93 million. Subscription ARR grew 20% to $66 million and was partially offset by a declining perpetual maintenance ARR. which we expect this trend to continue. Revenue increased 18% to $46.1 million. Subscription revenue grew 69% to $19.6 million, primarily driven by strong-term renewals from existing clients for authentication, transaction signing, and app shielding solutions. The growth in subscription revenue in this segment was partially offset by expected declines in perpetual maintenance and support professional services and other DigiPath token revenue and legacy software products that we sunset in 2022. We believe the electronic component shortages that impacted our DigiPath token shipments last year are largely behind us and expect to return to normalized delivery levels beginning later this quarter or early next quarter. We have increased inventory levels and partnered with our customers to optimize delivery schedules. This should enable us to ship the majority of DigiPAS units that were delayed to this year by the end of the third quarter. Q1 growth margin was 67%, consistent with the same period last year. Product mix favor and subscription revenue was offset by an increase in third-party costs and lower than average DigiPAS margins, which were impacted by electronic component prices, increased freight costs, and product mix. We expect DigiPath's margins to return to normalized levels for the balance of the year. Operating income was $15.6 million and operating margin was 34% compared to $7.8 million and 20% in last year's first quarter. The increase in profitability is primarily attributed to higher revenue and lower operating expenses, including the reallocation of certain expenses to digital agreements, and lower amortization as a result of the prior year deal flow intangible asset impairment. Turning to our balance sheet, we ended the first quarter of 2023 with $107 million in cash, cash equivalents, and short-term investments, compared to $99 million at the end of 2022. We generated $13 million of cash flows from operations during the quarter, primarily related to improvements in networking capital, and we have no long-term debt. Geographically, our revenue mixed by region in the first quarter of 2023 was 48% for EMEA, 36% from the Americas, and 16% from Asia Pacific. This compares to 47%, 33%, and 20% for the same regions in the first quarter of last year, respectively. Now turning to our outlook. As mentioned last quarter, we plan for our sales and marketing investments to be more highly weighted in the first half of the year to drive ARR growth as the year progresses, which we expect will result in increased revenue growth and profitability in the second half of 2023 as compared to the first half of the year. We are making progress in our transformation and affirm our full year 2023 guidance as follows. Revenue to be in the range of $232 to $242 million. ARR to be in the range of $157 to $164 million. And adjusted EBITDA to be in the range of $3 to $6 million. And with that, I'll turn the call back to Matt for some closing remarks.
spk03: Thank you, Jorge. New enterprise logo acquisition and expanding within our installed base by cross-selling our entire solution portfolio remain our top priorities for 2023. I'm very proud of our team. We've made a lot of progress in the transformation plan over the last several months, including bringing new products to market, doubling the size of our sales force, and continuing to implement the marketing infrastructure required to execute our unified go-to-market strategy. We believe this will result in more predictable revenue growth and synergies over time. I'm confident we are moving from a product company to a problem solving company to become more strategic to our customers. And I believe we are well positioned for future success, driven by our talented employees, world-class products, and newly implemented operational rigor. Jorge and I will now be happy to take your questions.
spk01: We will now begin the question and answer session. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question comes from the line of Rudy Kessinger with D.A. Davidson. Your line is now open.
spk06: Hey, guys. Hey, guys. Thank you for taking my questions. Jorge, on the security solution subscription, you mentioned there was some large renewal businesses in there. Can you quantify how much of large renewals, licensed renewals were in there in Q1 in that figure, the $19.6 million figure?
spk05: Yeah, thanks for the question, Rudy. So that, yeah, so we saw just to maybe take us to that. So we saw a good demand for authentication, mobile security, app shielding solutions in the quarter, basically across the board. The, the increase in the quarter, the strength of the quarter was right to three things. One is the earlier renewals that we saw in Q4, we started, I think, Q1. Second component was renewals with accounts on these products, as I mentioned. And then multi-year renewals, you know, two-year renewals into 2020, in Q1 2023. And so you get the benefit of that acceleration. So from a quantification perspective, I think most of the increase that you see, you know, is related to these three things. The multi-year renewals, probably about 30% to 40% of that increased number. Now, one thing to consider, though, is that When you look at seasonality in terms of our renewal seasonality, Q1 tends to be the highest, highly weighted on that renewal. So just keep that in the back of your head.
spk06: Okay. Got it. Fair enough. On the Salesforce side, certainly couldn't see it hit the doubling of the quota carriers well ahead of schedule. Matt, where's productivity at today? versus where fully ramped is? How far do you have to go to get sales productivity up to where your guys' targets are?
spk03: You know, I think right now we're consistent with the plan. You know, we've had January 1st was the first year of the three-year plan. We've accelerated the hiring of our sales force. We brought it in by about six months. Our talent acquisition team did a great job front-loading that. And now we have to really digest that, Rudy. So I would say we're hard at work. enabling the sales team, making sure that they're certified, and with sales cycles somewhere between five to nine months, depending on the region based on the current macroeconomic, you should see that kick in according to plan in Q3 and Q4. But we're monitoring it very closely, and that's probably our top priority is getting our sellers that we've now got on board enabled and productive.
spk06: Okay, and then last one for me, I'm not going to exposure to any of these certain banks who have failed. But is there, you know, maybe two questions. One, just what percent of your total revenue comes from financial services? I imagine it's probably the bulk of it. But secondly, what percentage of your revenue comes from, you know, regional banks, credit unions, smaller type of banks who in general are being pressured right now?
spk03: I'll speak to the materiality of it. Our exposure to the banks is, as far as company-wide, BFSI, Banking Financial Services, is over 50% of our revenue. Our exposure within that sector to the regional banks is really immaterial. I would say across the board, we have less than 2% of ARR exposure to the company from banks that have been impacted. And, uh, that's just exposure, not a realized, uh, not realized impact. So we're monitoring it closely, but I would say right now, we're fortunate to have, uh, immaterial impact from that. And on the flip side of this, uh, we have seen a flight of, uh, capital to larger international banks. And so we do see an opportunity to benefit from that as some of our larger banking customers actually see increased volumes. So it's a little bit of a put and take right now, but, uh,
spk01: uh i would say overall it's an immaterial impact of the business certainly in q1 and i would say going forward as well that is very helpful color thank you i'll jump back in the queue thank you rudy thank you our next question comes from the line of nick mariachi with craig hallam you may proceed
spk02: Hi, this is Nick on for Chad Bennett. Thanks for taking our questions. Matt, kind of the flip side of last question. Hi, can you talk about your customer base outside of banking and financial services, maybe the other types of verticals and customer sizes you have exposure to and also if the product mix looks any different outside of FinServ and banking and just how that kind of diversification has evolved since you joined the company?
spk03: Yeah, no, I appreciate that. So, you know, if there's one vertical and you want to be strong, then, you know, BFSI is the one, okay? And that, you know, the legacy of ASCO and now OneSpin really made their reputation partnering with, you know, these mission-critical banks and certainly proved that our products belong in those types of high-value, mission-critical environments. The company really historically had not made much attempt to break into other verticals, but we certainly see opportunity there. You know, pharmaceuticals is one that we're doing well in. And any organization that has, I would say, high assurance applications, we believe, you know, certainly our reputation, but also our products would support that environment. And that's really on the security side of things. On the digital agreement side of things, you know, the e-signature capability lives everywhere, right? So this is really around, you know, it's one of my top priorities here. Obviously, both in acquiring new logos and non-BFSI customers, but also cross-selling products. e-signature into our BFSI infrastructure, which we've been effective, but I think we have a lot of upside to go and do more in that. Essentially acquiring a BFSI customer in our install base is somewhat equivalent of a new logo acquisition, although obviously converting an existing customer is far easier, more cost-effective than a pure new logo, but that's where the enablement comes in for our sales force is really aligning the new sellers or existing sellers in a singular account control model to go after both new logos in our installed base in a more aggressive fashion than we have in the past. So I would say we've made some improvements, certainly in targeting non-BFSI customers, but much more we can do, and that's a core focus of mine going forward.
spk02: Got it. And then maybe you could expand on the opportunity for your new notary offering, just how that fits into the digital agreements portfolio and how you're thinking about that cross-sell motion, and then also anything – You can comment there on early indications from customer interest and if that can be a landing product for new logos.
spk03: Yeah, no, sure. I'm very excited by this. Just to recap the bidding here, at the end of Q1, we launched our initial foray into one-span notary and had limited coverage for states. As many will know, you have to go state by state by state to get certification based on individual state regulations. We are launching a more generally available version this quarter. We'll have coverage for approximately 30 out of the 50 states, and we'll continue to improve that over time. I'm very excited by this for two reasons. One is almost every single company out there has a notary in some shape or form. And then two, in particular in BFSI, given the nature of the applications, loans, regulated documentations, I would even say there's an overweighted concentration of notaries in the upper half of the pyramid. and the enterprise BFSI segment where we live. So early days, obviously, for the product in market, we do believe we have a significant opportunity in this multibillion-dollar TAM. I think it's also important to note that many of the notaries are doing notarization on high-value documentation, and we do plan on integrating our DigiPath CX product, a cloud-based product, authentication capability to authenticate yourself into a virtual notary session to bring additional layers of security to that notary environment, particularly when remote notary is being done on unknown users. So I think it's a perfect example. It's really leveraging our virtual room infrastructure that we talked about in the past, and it's a perfect example of bringing together the security and the digital agreement workflows to
spk01: into a virtual environment so very bullish on it but still early days for sure great thanks for taking the questions sure thank you nick thank you there are currently no questions in the queue so as a reminder it is star one on your telephone keypad to ask a question again that is star one on your telephone keypad
spk00: There are no additional questions waiting at this time.
spk01: So I would like to pass the conference over to Matt Moynihan for closing remarks.
spk03: Great, thank you very much. Thank you everyone for joining our call today. I appreciate you taking time out of your day to speak with us. Look forward to sharing our progress with you next quarter and in the quarters to come. Thank you for your time and look forward to our follow-on conversations.
spk00: That concludes today's call. Thank you for your participation.

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