# OneSpan Inc. (OSPN) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from OneSpan Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1044777/000162828024009466/ospn-20231231.htm
Accession: 0001628280-24-009466
Filing date: 2024-03-06
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/OSPN/
All MD&A years: /company/OSPN/mda/
Previous year: /company/OSPN/mda/fy2022/ (FY 2022)
Next year: /company/OSPN/mda/fy2024/ (FY 2024)

Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations (in thousands, except head count, ratios, time periods and percentages)

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion may contain predictions, estimates and other forward-

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looking statements that involve a number of risks and uncertainties, including those discussed under Item 1A, Risk Factors and elsewhere in this Form 10-K. These risks could cause our actual results to differ materially from any future performance suggested below. Please see “Cautionary Note Regarding Forward Looking Statements” at the beginning of this Form 10-K.

For a comparison of our results of operations for the fiscal years ended December 31, 2022 and 2021, see “Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2022, filed on February 28, 2023.

Overview

OneSpan provides security, identity, electronic signature (“e-signature”) and digital workflow solutions that protect and facilitate digital transactions and agreements. Through our two business units, Security Solutions and Digital Agreements, we deliver products and services that automate and secure customer-facing and revenue-generating business processes for use cases ranging from simple transactions to workflows that are complex or require higher levels of security.

Our solutions help our customers ensure the integrity of the people and records associated with digital agreements, transactions, and interactions in industries including banking, financial services, healthcare, and professional services. We are trusted by global blue-chip enterprises, including more than 60% of the world’s largest 100 banks, and we process millions of digital agreements and billions of transactions in more than 100 countries annually.

We offer our products primarily through a subscription licensing model and provide multiple deployment options, including cloud-based and on-premises solutions. Our solutions are sold worldwide through our direct sales force, as well as through distributors, resellers, systems integrators, and original equipment manufacturers.

Business Transformation

We are currently in the midst of a business transformation. In December 2021, our Board approved a restructuring plan (the “restructuring plan”) designed to advance our operating model, streamline our business, improve efficiency, and enhance our capital resources. The first phase of this restructuring plan began and was substantially completed during the three months ended March 31, 2022. In May 2022, our Board approved additional actions related to the restructuring plan and we announced a three-year strategic transformation plan that began on January 1, 2023 (the "2022 strategic plan"). In conjunction with the 2022 strategic plan and to enable a more efficient capital deployment model, effective with the quarter ended June 30, 2022, we began reporting under the following two lines of business, which are our reportable operating segments: Digital Agreements and Security Solutions.

•Digital Agreements. Digital Agreements consists of solutions that enable our clients to secure and automate business processes associated with their digital agreement and customer transaction lifecycles that require consent, non-repudiation and compliance. These solutions, which are largely cloud-based, include OneSpan Sign e-signature, OneSpan Notary and OneSpan Trust Vault. This segment also includes costs attributable to our transaction cloud platform.

•Security Solutions. Security Solutions consists of our broad portfolio of software products, software development kits ("SDKs"), and Digipass authenticator devices that are used to build applications designed to defend against attacks on digital transactions across online environments, devices, and applications. The software products and SDKs included in the Security Solutions segment are largely on-premises software products and include identity verification, multi-factor authentication and transaction signing solutions, such as mobile application security, and mobile software tokens.

When we began the 2022 strategic plan, we expected that we would manage Digital Agreements for accelerated growth and market share gains and Security Solutions for cash flow given its more modest growth profile. During the three months ended March 31, 2023, we changed our methodology for allocating expenses between the segments to better reflect the shift in employee time, effort, and costs toward supporting the growth of our Digital Agreements segment instead of our Security Solutions segment.

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During the quarter ended June 30, 2023, we determined that we were unlikely to achieve the revenue growth levels set forth in our 2022 strategic plan within the contemplated three-year timeframe. A number of factors contributed to the challenges achieving the originally planned growth levels, particularly in Digital Agreements, on the timeframes set forth in the 2022 strategic plan, including: macroeconomic uncertainties in the banking and financial services segments, which have resulted in longer sales cycles and greater price sensitivity on the part of customers; increasing maturity and competitiveness in the market for e-signature solutions; limited awareness of our brand among buyers of e-signature tools; and higher pricing aggressiveness from competitors. These and other factors made it more difficult than we originally anticipated to build our Digital Agreements sales pipeline, generate demand for our Digital Agreements solutions through marketing efforts, and improve our sales force productivity levels.

In response to these challenges in growing our Digital Agreements revenue, we modified our strategy to focus more heavily on improving Adjusted EBITDA margin across the business. To this end, in August 2023, our Board approved the 2023 Actions described in Item 1, Business, to seek to drive higher levels of Adjusted EBITDA while maintaining our long-term growth potential. We intend to continue to pursue the overall strategy set forth in the 2022 strategic plan, including driving efficient growth in Digital Agreements and managing Security Solutions for modest growth and cash flow, while implementing adjustments to our operating model that are intended to achieve greater operational efficiency and strengthen our ability to create value for our shareholders.

Our updated strategy, the 2023 Actions and other cost reduction actions implemented under our restructuring plan originally adopted in December 2021 involve numerous risks and uncertainties. For additional details please see Item IA, Risk Factors.

Restructuring Plan

In December 2021, our Board approved a restructuring plan designed to advance our operating model, streamline our business, improve efficiency, and enhance our capital resources. The first phase of this restructuring plan began and was substantially completed during the three months ended March 31, 2022.

In May 2022, our Board approved additional actions related to the restructuring plan through the year ending December 31, 2025. The additional actions consisted primarily of headcount-related reductions designed to continue to advance the same objectives as the first phase of the plan.

On August 3, 2023, our Board of Directors approved the 2023 Actions. We have incurred and expect to continue to incur restructuring charges in connection with the 2023 Actions, and anticipate that these charges will consist primarily of charges related to employee transition and severance payments and employee benefits, with a significantly smaller amount of charges relating to vendor contract termination and rationalization actions. We currently expect that we will incur restructuring charges of approximately $11.0 million to $12.0 million in employee transition and severance payments related to the 2023 Actions and approximately $2.0 million to $3.0 million in vendor contract termination and rationalization charges. We incurred approximately $9.0 million of these expected restructuring charges in 2023.

We completed a substantial majority of the workforce reductions that are planned as part of the 2023 Actions by the end of 2023, and we expect that most of the remaining workforce reductions will occur over the course of 2024 as several Company projects are completed during the year. The vendor contract component of the 2023 Actions is planned for completion by the end of 2025.

As part of the restructuring plan (including the 2023 Actions), we reduced headcount by eliminating approximately 270 positions. We incurred severance and related benefits costs, recorded in “Restructuring and other related charges” in the consolidated statement of operations for the year ended December 31, 2023.

Tender Offer

In December 2023, we completed a modified "Dutch auction" tender offer (the "Tender Offer"). Pursuant to the Tender Offer, we repurchased a total of 2,380,834 shares of our common stock at a purchase price of $10.50 per share, for an aggregate cost of approximately $25.0 million, excluding fees and expenses related to the Tender Offer. The repurchase of common stock in the Tender Offer was made pursuant to the share repurchase program approved by our Board of Directors in May 2022. Please see Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, for more information on share repurchases.

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Recent Developments

On January 4, 2024, our Board of Directors appointed Victor Limongelli as Interim Chief Executive Officer, effective immediately. Mr. Limongelli is a seasoned software executive who most recently served as Chief Executive Officer at BQE Software, a private SaaS company providing billing, accounting, and similar functionality to professional services firms. Please see Item 1, Business, for more information about Mr. Limongelli.

Mr. Limongelli replaced Matthew Moynahan, whose employment as the Company’s President and Chief Executive Officer was terminated without cause on January 4, 2024 immediately prior to Mr. Limongelli’s appointment. Under his previously disclosed Amended and Restated Employment Agreement, dated February 27, 2023 (the "Employment Agreement"), subject to Mr. Moynahan’s timely execution and non-revocation of a separation and release agreement, which includes a release of claims against the Company and its affiliates, Mr. Moynahan is entitled to receive the payments and benefits associated with a termination without cause as set forth in the Employment Agreement. Therefore, $1.2 million of severance and other benefits were accrued for as of December 31, 2023 and included within "Other accrued expenses" on the consolidated balance sheet.

Components of Operating Results

Revenue

We generate revenue from the sale of our subscriptions, maintenance and support, professional services, and Digipass hardware products. We believe comparison of revenues between periods is heavily influenced by the timing of orders and shipments reflecting the transactional nature of significant parts of our business.

•Product and license revenue. Product and license revenue includes Digipass hardware products and software licenses, which are provided on a perpetual or term basis subscription model.

•Service and other revenue. Service and other revenue includes solutions that are provided on a cloud-based subscription model, maintenance and support, and professional services.

Cost of Goods Sold

Our total cost of goods sold consists of cost of product and license revenue and cost of service and other revenue. We expect our cost of goods sold to increase in absolute dollars as our business grows, although it may fluctuate as a percentage of total revenue from period to period.

•Cost of product and license revenue. Cost of product and license revenue primarily consists of direct product and license costs, including personnel costs, production costs, freight, and inventory write-off adjustments for discontinued products and services.

•Cost of service and other revenue. Cost of service and other revenue primarily consists of costs related to cloud subscription solutions, including personnel and equipment costs, depreciation, amortization, and personnel costs of employees providing professional services and maintenance and support.

Gross Profit

Gross profit is revenue net of the cost of goods sold. Gross profit as a percentage of total revenue, or gross margin, has been and will continue to be affected by a variety of factors, including our average selling price, manufacturing costs, the mix of products sold, and the mix of revenue among products, subscriptions and services. We expect our gross margins to fluctuate over time depending on these factors.

Operating Expenses

Our operating expenses are generally based on anticipated revenue levels and fixed over short periods of time. As a result, small variations in revenue may cause significant variations in the period-to-period comparisons of operating income or operating income as a percentage of revenue.

Generally, the most significant factor driving our operating expenses is headcount. Direct compensation and benefit plan expenses generally represent between 50% and 60% of our operating expenses. In addition, a number of other expense categories are directly related to headcount. We attempt to manage our headcount within the context of the economic environments in which we operate, restructuring activities, and the investments we believe we need to make for our infrastructure to support future growth and for our products to remain competitive.

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Historically, operating expenses have been impacted by changes in foreign exchange rates. We estimate the change in currency rates in 2023 compared to 2022 resulted in an increase in operating expenses of approximately $0.9 million in 2023.

The comparison of operating expenses can also be impacted significantly by costs related to our stock-based and long-term incentive plans. In 2023, 2022, and 2021, operating expenses included $14.6 million, $8.8 million, and $5.2 million, respectively, of expenses related to stock-based and long-term incentive plans. Stock-based compensation expense during 2023 included the impact of a significant number of new grants to executives hired in 2022 as well as an overall expansion of the equity incentive program in 2022 in order to promote the long-term retention of our employees. Long-term incentive plan compensation expense consists of stock-based incentives and an immaterial amount of cash-based incentives.

•Sales and marketing. Sales and marketing expenses consist primarily of personnel costs, commissions and bonuses, trade shows, marketing programs and other marketing activities, travel, outside consulting costs, and long-term incentive compensation. We expect sales and marketing expenses to decrease in absolute dollars as as result of the 2023 Actions. However, our sales and marketing expenses may fluctuate as a percentage of total revenue.

•Research and development. Research and development expenses consist primarily of personnel costs and long-term incentive compensation. We expect research and development costs to decrease in absolute dollars as a result of the 2023 Actions, and as we capitalize certain costs related to the expansion of our cloud product portfolio. However, our research and development expenses may fluctuate as a percentage of total revenue.

•General and administrative. General and administrative expenses consist primarily of personnel costs, legal, consulting and other professional fees, and long-term incentive compensation. We expect general and administrative expenses to decrease in absolute dollars as a result of the 2023 Actions, although our general and administrative expenses may fluctuate as a percentage of total revenue.

•Restructuring and other related charges. Restructuring and other related charges consists of employee costs which include severance and related benefits incurred from headcount reductions as part of our restructuring plan, including the 2023 Actions; real estate rationalization costs incurred to optimize our real estate footprint which include lease contract termination costs, fixed asset write-off charges, and lease right-of-use asset and lease liability write-off gains or losses; and vendor rationalization costs for contractually committed services that we are no longer utilizing. We plan to incrementally incur additional restructuring costs through December 31, 2025, when the restructuring plan terminates and the 2023 Actions are completed.

•Impairment of intangible assets. Impairment of intangible assets are incurred when we determine that the carrying value of an asset exceeds its fair value. We test annually, or when triggering events arise. During the year ended December 31, 2022, we performed an impairment review of the customer relationships intangible assets obtained in our 2018 acquisition of Dealflo Limited (“Dealflo”). The impairment review was triggered by our July 2022 notification to customers regarding our intent to gradually sunset our Dealflo solution in the months leading up to December 31, 2023. The results of the impairment review indicated that the carrying value of the Dealflo customer relationships exceeded the fair value, and we recorded a $3.8 million impairment charge on the entire remaining value of the asset during the year ended December 31, 2022. This was recorded in "restructuring and other related charges" on the consolidated statements of operations.

•Amortization of intangible assets. Acquired intangible assets are amortized over their respective amortization periods and are periodically evaluated for impairment.

Segment Results

Segment operating income (loss) consists of the revenue generated by a segment, less the direct costs of revenue, sales and marketing, research and development and amortization and impairment charges that are incurred directly by a segment. Unallocated corporate costs include general and administrative expense and other company-wide costs that are not attributable to a particular segment. Financial results by operating segment are included below under Results of Operations.

Interest Income (Expense), Net

Interest income (expense), net, consists of income earned on our cash equivalents and short-term investments. Our cash equivalents and short-term investments are invested in short-term instruments at current market rates.

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Other Income (Expense), Net

Other income (expense), net, primarily includes exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries’ functional currencies, subsidies received from foreign governments in support of our research and development in those countries and other miscellaneous non-operational expenses.

Income Taxes

Our effective tax rate reflects our global structure related to the ownership of our intellectual property (“IP”). The majority of our IP in our Security Solutions business is owned by two subsidiaries, one in the U.S. and one in Switzerland. The e-signature IP in our Digital Agreements business is owned by a subsidiary in Canada. These subsidiaries have entered into agreements with most of the other OneSpan entities under which those other entities provide services to the IP owners on either a percentage of revenue or on a cost plus basis, or both. In addition, many of our OneSpan entities operate as distributors for all of our OneSpan products. Under this structure, the earnings of our service provider subsidiaries are relatively constant. These service provider companies tend to be in jurisdictions with higher effective tax rates. Fluctuations in earnings flow to the IP owners.

As the majority of our revenues are generated outside of the U.S., our consolidated effective tax rate is strongly influenced by the effective tax rate of our foreign operations. Changes in the effective rate related to foreign operations reflect changes in the geographic mix of earnings and the tax rates in each of the countries in which it is earned. The statutory tax rate for the primary foreign tax jurisdictions ranges from 11% to 35%.

We recorded changes in valuation allowance of $8.5 million and $4.4 million, as of December 31, 2023 and 2022, respectively, against deferred tax assets that, based on management’s assessment are considered not to be more likely than not to be realized. The increase in the valuation allowance in 2023 reflects Net Operating Losses (“NOLs”), other deduction carryforwards, and credits for which the realization is not more likely than not. The change in valuation allowance also reflects other factors including, but not limited to, changes in management’s assessment of the ability to use existing deferred tax assets, including NOLs and other deduction carryforwards.

Management assesses the need for a valuation allowance on a regular basis, weighing all positive and negative evidence to determine whether a deferred tax asset will be fully or partially realized. In evaluating the realizability of deferred tax assets, significant pieces of negative evidence such as 3-year cumulative losses are considered. Management also reviewed reversal patterns of temporary differences to determine if the Company would have sufficient taxable income due to the reversal of temporary differences to support the realization of deferred tax assets. Management continues to maintain a valuation allowance against certain deferred tax assets in jurisdictions where assets are not more likely than not to be realized. For all other remaining deferred tax assets, management believes it is still more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.

Impact of Currency Fluctuations

In 2023 and 2022, we generated approximately 83% and 83% of our revenues and incurred approximately 58% and 66% of our operating expenses outside of the U.S., respectively. As a result, changes in currency exchange rates, especially the Euro exchange rate and the Canadian dollar exchange rate, can have a significant impact on our revenue and operating expenses.

While the majority of our revenue is generated outside of the U.S., a significant amount of our revenue earned during the year ended December 31, 2023 was denominated in U.S. dollars. In 2023, approximately 53% of our revenue was denominated in U.S. dollars, 43% was denominated in Euros and 4% was denominated in other currencies. In 2022, approximately 54% of our revenue was denominated in U.S. dollars, 42% was denominated in Euros and 4% was denominated in other currencies.

In general, to minimize the net impact of currency fluctuations on operating income, we attempt to denominate an amount of billings in a currency such that it would provide a natural hedge against the operating expenses being incurred in that currency. We expect that changes in currency rates may impact our future results if we are unable to match amounts of revenue with our operating expenses in the same currency. If the amount of our revenue in Europe denominated in Euros continues as it is now or declines, we may not be able to balance fully the exposures of currency exchange rates on revenue and operating expenses.

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The financial position and the results of operations of our foreign subsidiaries, with the exception of our subsidiaries in Switzerland, Singapore and Canada, are measured using the local currency as the functional currency. The functional currency for our subsidiaries in Switzerland, Singapore and Canada is the U.S. dollar. Accordingly, assets and liabilities are translated into U.S. dollars using current exchange rates as of the balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the year. Translation adjustments arising from differences in exchange rates generated comprehensive income of $3.7 million in 2023 and a comprehensive loss of $7.2 million in 2022. These amounts are included as a separate component of stockholders’ equity.

Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations in other income (expense). Foreign exchange transaction losses aggregated $1.1 million and $1.9 million for the years ended December 31, 2023 and 2022, respectively.

Results of Operations

In conjunction with the 2022 strategic plan, effective with the quarter ended June 30, 2022, we began reporting under the following two lines of business, which are our reportable operating segments: Digital Agreements and Security Solutions.

The following table sets forth, for the periods indicated, selected segment and consolidated operating results.

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022"],["Digital Agreements"],["Revenue","$","50,925","","","$","48,401"],["Gross profit","$","37,742","","","$","37,488"],["Gross margin","74","%","","77","%"],["Operating (loss) income","$","(18,525)","","","$","5,348"],["Security Solutions"],["Revenue","$","184,181","","","$","170,605"],["Gross profit","$","119,974","","","$","111,082"],["Gross margin","65","%","","65","%"],["Operating income","$","60,190","","","$","32,051"],["Total Company:"],["Revenue","$","235,106","","","$","219,006"],["Gross profit","$","157,715","","","$","148,570"],["Gross margin","67","%","","68","%"],["Statements of operations reconciliation:"],["Segment operating income","$","41,665","","","$","37,399"],["Corporate operating expenses not allocated at the segment level","70,536","","","64,514"],["Operating loss","$","(28,871)","","","$","(27,115)"],["Interest income, net","2,090","","","595"],["Other income (expense), net","(532)","","","14,827"],["Loss before income taxes","$","(27,313)","","","$","(11,693)"]]
[[/GREPCENT_TABLE]]

Revenue

Revenue by products and services allocated to the segments for the years ended December 31, 2023 and 2022 is as follows:

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[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2023","","2022"],["(In thousands)","Digital Agreements","","Security Solutions","","Digital Agreements","","Security Solutions"],["Subscription (1)","$","45,886","","","$","60,550","","","$","42,029","","","$","47,124"],["Maintenance and support","4,143","","","42,240","","","5,451","","","42,894"],["Professional services and other (2)","896","","","5,425","","","921","","","7,087"],["Hardware products","\u2014","","","75,966","","","\u2014","","","73,500"],["Total Revenue","$","50,925","","","$","184,181","","","$","48,401","","","$","170,605"]]
[[/GREPCENT_TABLE]]

(1) Subscription includes cloud and on-premises subscription revenue, previously referred to as "subscription" and "term-based software licenses", respectively.

(2) Professional services and other includes perpetual software licenses revenue, which was approximately 1% of total revenue for the year ended December 31, 2023 and approximately 2% of revenue for the year ended December 31, 2022.

For the year ended December 31, 2023, total revenue increased by $16.1 million, or 7%, compared to the year ended December 31, 2022. Changes in foreign exchange rates as compared to the same period in 2022 favorably impacted total revenue by approximately $2.3 million.

Additional information on our revenue by segment follows.

•Digital Agreements revenue increased $2.5 million, or approximately 5%, during the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase in Digital Agreements revenue was driven by higher cloud subscription revenue from existing customer expansion, including some of our clients purchasing and running our on-premise and SaaS products simultaneously during their product migrations, partially offset by contraction related to our strategy of sunsetting our on-premises e-signature product. Changes in foreign exchange rates as compared to the same period in 2022 favorably impacted Digital Agreements revenue by less than $0.1 million.

•Security Solutions revenue increased $13.6 million, or approximately 8%, during the year ended December 31, 2023 compared to the year ended December 31, 2022. This increase was driven primarily by higher on-premises term subscription revenue, driven by existing customer expansion, and increased hardware revenue as a result of product mix and a higher average selling price, partially offset by a decrease in professional services and other revenue, driven by lower perpetual license revenue. Changes in foreign exchange rates compared to the same period in 2022 favorably impacted Security Solutions revenue by $2.3 million.

Revenue by Geographic Regions: We classify our sales by customer location in three geographic regions: 1) EMEA, which includes Europe, Middle East and Africa; 2) the Americas, which includes sales in North, Central, and South America; and 3) Asia Pacific (APAC), which also includes Australia, New Zealand, and India. The breakdown of revenue in each of our major geographic areas was as follows:

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[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022","","$ Change","","% Change"],["Revenue"],["EMEA","$","111,568","","","$","100,298","","","$","11,270","","","11","%"],["Americas","80,057","","","77,740","","","2,317","","","3","%"],["APAC","43,481","","","40,968","","","2,513","","","6","%"],["Total revenue","$","235,106","","","$","219,006","","","$","16,100","","","7","%"],["% of Total Revenue"],["EMEA","47","%","","46","%"],["Americas","34","%","","35","%"],["APAC","19","%","","19","%"]]
[[/GREPCENT_TABLE]]

For the year ended December 31, 2023, revenue generated in EMEA was $11.3 million or 11% higher than the same period in 2022, driven largely by higher on-premises term subscription revenue and increased hardware revenue as a result of higher average selling prices.

For the year ended December 31, 2023, revenue generated in the Americas was $2.3 million or 3% higher than the same period in 2022, driven primarily by growth in Security Solutions, including hardware, mobile, and cloud authentication, as well as mobile application security products.

For the year ended December 31, 2023, revenue generated in the Asia Pacific region ("APAC") was $2.5 million or 6% higher than the same period in 2022, driven largely by higher on-premises term subscription revenue and an increase in hardware sales.

Cost of Goods Sold and Gross Margin

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022","","$ Change","","% Change"],["Cost of goods sold"],["Product and license","$","48,676","","","$","45,106","","","$","3,570","","","8","%"],["Services and other","28,715","","","25,330","","","3,385","","","13","%"],["Total cost of goods sold","$","77,391","","","$","70,436","","","$","6,955","","","10","%"],["Gross profit","$","157,715","","","$","148,570","","","$","9,145","","","6","%"],["Gross margin"],["Product and license","63","%","","63","%"],["Services and other","72","%","","74","%"],["Total gross margin","67","%","","68","%"]]
[[/GREPCENT_TABLE]]

The cost of product and license revenue increased $3.6 million or 8% for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase in cost of product and license was driven by product mix, including increased sales of lower margin hardware products, and higher third-party license costs, partially offset by lower freight and hardware components costs.

The cost of services and other revenue increased $3.4 million or 13% for the year ended December 31, 2023, compared to the year ended December 31, 2022. This increase was largely due to a one-time credit from a cloud service provider in the prior year period, along with higher cloud platform costs related to higher volume usage, higher depreciation of our capitalized software costs, and increased amortization associated with the ProvenDB acquisition.

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Gross profit increased $9.1 million, or 6% for the year ended December 31, 2023 compared to the year ended December 31, 2022. Total gross margin was 67% for the year ended December 31, 2023, compared to 68% for the year ended December 31, 2022. The increase in total gross profit was driven by the increased revenue and the higher costs of revenues discussed above.

The majority of our inventory purchases are denominated in U.S. dollars. Our sales are denominated in various currencies, including the Euro, although over 90% of our sales are either in U.S. dollars or Euros. The impact of changes in currency rates are estimated to have had a unfavorable impact on overall cost of goods sold of approximately $0.2 million for the year ended December 31, 2023. Had currency rates in 2023 been equal to rates in the comparable period of 2022, the gross profit margin would have been less than 1 percentage point higher for the year ended December 31, 2023.

Additional information on our gross profit by segment follows.

•Digital Agreements gross profit increased $0.3 million, or approximately 1%, for the year ended December 31, 2023 compared to the prior year. The increase in gross profit was driven by higher overall revenue, partially offset by increased costs of sales depreciation and amortization included in cost of goods sold. Digital Agreements gross margin for the years ended December 31, 2023 and 2022 was 74% and 77%, respectively. The decrease in gross margin is related to the increase in depreciation and amortization included in cost of goods sold in 2023 as compared to 2022.

•Security Solutions gross profit increased $8.9 million, or approximately 8%, for the year ended December 31, 2023 compared to the prior year. The increase in gross profit was primarily driven by higher overall revenue. Security Solutions gross margin was 65% for each of the years ended December 31, 2023 and 2022, respectively.

Operating Expenses

For the year ended December 31, 2023, operating expenses increased by $10.9 million, or 6%, compared to the year ended December 31, 2022. Changes in foreign exchange rates unfavorably impacted operating expenses by approximately $0.9 million as compared to the year ended December 31, 2022.

The following table presents the breakout of operating expenses by category as of December 31, 2023 and 2022:

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022","","$ Change","","% Change"],["Operating costs"],["Sales and marketing","$","70,235","","","$","60,949","","","$","9,286","","","15","%"],["Research and development","38,420","","","41,735","","","(3,315)","","","(8)","%"],["General and administrative","58,267","","","55,552","","","2,715","","","5","%"],["Restructuring and other related charges","17,311","","","13,310","","","4,001","","","30","%"],["Amortization of intangible assets","2,353","","","4,139","","","(1,786)","","","(43)","%"],["Total operating costs","$","186,586","","","$","175,685","","","$","10,901","","","6","%"]]
[[/GREPCENT_TABLE]]

Sales and Marketing Expenses

Sales and marketing expenses increased $9.3 million, or 15%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. The increase was driven by higher expenses for sales-related activities, higher hiring expenses, commission expenses and other employee compensation costs, and an increase in travel-related expenses due to increased customer activity and in-person company meetings.

Average full-time sales and marketing employee headcount for year ended December 31, 2023 was 339, compared to 344 for year ended December 31, 2022. Average headcount in 2023 was 1% lower than in 2022.

Research and Development Expenses

Research and development expenses decreased $3.3 million, or 8%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. The decrease in expense was driven primarily by the capitalization of research and development costs of $6.1 million, partially offset by an increase in contractor and consultant costs.

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Average full-time research and development employee headcount for year ended December 31, 2023 was 305, compared to 340 for year ended December 31, 2022. Average headcount in 2023 was 10% lower than in 2022.

General and Administrative Expenses

General and administrative expenses increased $2.7 million, or 5%, for the year ended December 31, 2023 compared to the year ended December 31, 2022. This increase in expense was due to higher salaries and stock-based compensation expense in 2023, partially offset by lower consulting fees related to our strategic plan as compared with the prior year period.

Average full-time general and administrative employee headcount for the years ended December 31, 2023 and December 31, 2022 was 139. There was no change in average general and administrative headcount from 2023 to 2022.

Restructuring and Other Related Charges

Restructuring and other related charges were $17.3 million for the year ended December 31, 2023, compared to $13.3 million for the year ended December 31, 2022, an increase of $4.0 million or 30%. The increase was due to severance, retention pay, and related benefit costs incurred in conjunction with our restructuring plans, real estate rationalization costs to align the real estate footprint with the Company’s needs, and vendor rationalization costs for contractually committed services the Company is no longer utilizing, offset by the impact of an impairment recognized in 2022 that did not recur in 2023.

Amortization of Intangible Assets

Amortization of intangible assets for the year ended December 31, 2023 was $2.4 million, compared to $4.1 million for the year ended December 31, 2022, a decrease of $1.8 million or 43%. The decrease was driven by certain intangible assets acquired in the prior years becoming fully amortized or impaired during 2022.

Segment Operating Income (Loss)

Information on our operating income (loss) by segment follows.

•Digital Agreements Operating loss for the year ended December 31, 2023 was $18.5 million, compared to operating income of $5.3 million for the prior year. The decrease in operating income (loss) was primarily driven by a change in expense allocations between the segments primarily impacting operating expenses, higher investments made in the first half of 2023 in sales and marketing, higher depreciation of capitalized software, and a one-time credit from a cloud service provider in the prior year, partially offset by higher revenue in 2023.

•Security Solutions For the year ended December 31, 2023, Security Solutions operating income was $60.2 million, which was $28.1 million, or 88%, higher than the prior year. This increase was driven by higher revenue, a change in expense allocations between the segments primarily impacting operating expenses, lower research and development costs, and lower amortization as a result of the Dealflo intangible asset impairment of $3.8 million in 2022.

Interest Income (expense), net

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[[/GREPCENT_TABLE]]

Interest income (expense), net, was $2.1 million for the year ended December 31, 2023, compared to $0.6 million for the year ended December 31, 2022. The increase in interest income is related to higher interest rates favorably impacting our invested excess cash.

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Other Income (Expense), Net

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022","","$ Change","","% Change"],["Other income (expense), net","$","(532)","","","$","14,827","","","$","(15,359)","","","NM"]]
[[/GREPCENT_TABLE]]

Other income (expense), net, includes subsidies received from foreign governments in support of our research and development in those countries, exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries’ functional currencies, and other miscellaneous non-operational, non-recurring income and expenses.

For the year ended December 31, 2023, other income (expense), net was $(0.5) million, compared to $14.8 million for the year ended December 31, 2022. The fluctuation was primarily driven by the $14.8 million gain in 2022 on the sale of our equity-method investment in Promon AS ("Promon") in January 2022.

Provision for income taxes

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands, except percentages)","2023","","2022","","$ Change","","% Change"],["Provision for income taxes","$","2,486","","","$","2,741","","","$","(255)","","(9)%"]]
[[/GREPCENT_TABLE]]

We recorded income taxes expense of $2.5 million and $2.7 million for the years ended December 31, 2023 and 2022, respectively. The decrease in expense recorded for the year ended December 31, 2023 was primarily attributable to the jurisdictional mix of profits, and a higher loss before taxes in 2023 compared to 2022.

Loss Carryforwards Available

At December 31, 2023, we have gross deferred tax assets of $53.3 million resulting from U.S. federal, foreign and state NOL carryforwards of $182.3 million and other foreign deductible carryforwards of $117.0 million. At December 31, 2023, we have a valuation allowance of $45.9 million against deferred tax assets related to certain carryforwards.

Key Business Metrics and Non-GAAP Financial Measures

In our quarterly earnings press releases and conference calls, we discuss the below key metrics and financial measures that are not calculated according to generally accepted accounting principles (“GAAP”). These metrics and non-GAAP financial measures help us monitor and evaluate the effectiveness of our operations and evaluate period-to-period comparisons. Management believes that these metrics and non-GAAP financial measures help illustrate underlying trends in our business. We use these metrics and non-GAAP financial measures to establish budgets and operational goals (communicated internally and externally), manage our business and evaluate our performance. We also believe that both management and investors benefit from referring to these metrics and non-GAAP financial measures as supplemental information in assessing our performance and when planning, forecasting, and analyzing future periods. We believe these metrics and non-GAAP financial measures are useful to investors both because they allow for greater transparency with respect to financial measures used by management in their financial and operational decision-making and also because they are used by investors and the analyst community to help evaluate the health of our business.

Annual Recurring Revenue

We use annual recurring revenue, or ARR, as an approximate measure to monitor the revenue growth of our recurring business. ARR represents the annualized value of the active portion of SaaS, term-based license, and maintenance and support contracts at the end of the reporting period. For term-based license arrangements, the amount included in ARR is consistent with the amount that we invoice the customer annually for the term-based license transaction. A customer with a one-year term-based license contract will be invoiced for the total value of the contract at the beginning of the contractual term, while a customer with a multi-year term-based license contract will be invoiced for each annual period at the beginning of each year of the contract. For contracts that include annual values that increase over time because there are additional deliverables in subsequent periods, we include in ARR only the annualized value of components of the contract that are considered active as of the date of the ARR calculation. We do not include the future committed increases in the contract value as of the date of the ARR calculation.

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We consider a contract to be active from when the product or service contractual term commences (the “start date”) until the right to use the product or service ends (the “expiration date”). Even if the contract with the customer is executed before the start date, the contract will not count toward ARR until the customer's right to receive the benefit of the products or services has commenced.

To the extent that we are negotiating a renewal with a customer within 90 days after the expiration of a recurring contract, we continue to include that revenue in ARR if we are actively in discussions with the customer for a new recurring contract or renewal and the customer has not notified us of an intention not to renew. We exclude from the calculation of ARR renewal contracts that are more than 90 days after their expiration date, even if we are continuing to negotiate a renewal at that time.

ARR is not calculated based on recognized or unearned revenue and there is no direct relationship between revenue recognized in accordance with ASC 606 and the Company’s ARR business metric. We believe ARR is a valuable operating measure to assess the health of our SaaS, term-based license, and maintenance and support contracts because it illustrates our customer recurring contracts as of the measurement date. ARR is not a forecast of future revenue, which can be impacted by contract start and end dates and renewal rates, and does not include revenue from perpetual licenses, purchases of Digipass authenticators, training, professional services or other sources of revenue that are not deemed to be recurring in nature.

ARR does not have any standardized meaning and is therefore unlikely to be comparable to similarly titled measures presented by other companies. ARR should be viewed independently of revenue and deferred revenue as ARR is an operating metric and is not intended to be combined with or replace these items. Investors should consider our ARR operating measure only in conjunction with our GAAP financial results.

At December 31, 2023, we reported ARR of $154.6 million, which was 11% higher than 2022 ARR of $138.7 million. Changes in foreign exchange rates during the year ended December 31, 2023 as compared to the prior year did not materially impact ARR. ARR growth was primarily driven by an increase in subscription contracts.

Net Retention Rate

Net Retention Rate, or NRR, is defined as the approximate year-over-year percentage growth in ARR from the same set of customers at the end of the prior year period. It measures the Company’s ability to increase revenue across our existing customer base through expanded use of our platform, offset by customers whose subscription contracts with us are not renewed or renew at a lower amount. The Company’s ability to drive growth and generate incremental revenue depends, in part, on our ability to maintain and grow our relationships with customers. NRR is an important way in which we track our performance in this area.

We previously referred to NRR as Dollar-Based Net Expansion ("DBNE"). There is no change in how we define or calculate NRR as compared to DBNE.

We reported NRR of 110% and 107% at December 31, 2023 and 2022, respectively. The year-over-year increase in NRR was primarily driven by an expansion in the use of our solutions at existing customers.

Adjusted EBITDA

We define Adjusted EBITDA as net income (loss) before interest, taxes, depreciation, amortization, long-term incentive compensation, restructuring and other related charges, and certain non-recurring items, including acquisition related costs, rebranding costs, and non-routine shareholder matters. We use Adjusted EBITDA as a simplified measure of performance for use in communicating our performance to investors and analysts and for comparisons to other companies within our industry.

As a performance measure, we believe that Adjusted EBITDA presents a view of our operating results that is most closely related to serving our customers. By excluding interest, taxes, depreciation, amortization, long-term incentive compensation, restructuring costs, and certain other non-recurring items, we are able to evaluate performance without considering decisions that, in most cases, are not directly related to meeting our customers’ requirements and were either made in prior periods (e.g., depreciation, amortization, long-term incentive compensation, non-routine shareholder matters), deal with the structure or financing of the business (e.g., interest, one-time strategic action costs, restructuring costs, impairment charges) or reflect the application of regulations that are outside of the control of our management team

45

(e.g., taxes). In addition, removing the impact of these items helps us compare our core business performance with that of our competitors.

Non-GAAP financial metrics such as Adjusted EBITDA are not measures of performance under GAAP and should not be considered in isolation or as alternatives or substitutes for the most directly comparable financial measures calculated in accordance with GAAP, but, rather, should be considered together with our consolidated financial statements, which are prepared in accordance with GAAP and included in Part IV, Item 15, Exhibits and Financial Statement Schedules.

The following table reconciles net income as reported on our consolidated statements of operations to non-GAAP Adjusted EBITDA:

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[[/GREPCENT_TABLE]]

(1) Includes cost of sales depreciation and amortization expense directly related to delivering cloud subscription revenue of $1.5 million and $0 for the years ended December 31, 2023 and 2022, respectively. Costs are recorded in “Cost of goods sold - Services and other” on the consolidated statements of operations.

(2) Long-term incentive compensation includes immaterial expense for cash incentive grants awarded to employees located in jurisdictions where we do not issue stock-based compensation due to tax, regulatory or similar reasons. The expense associated with these cash incentive grants was $0.3 million and $0.2 million for the years ended December 31, 2023 and 2022, respectively.

(3) For the year ended December 31, 2023, other non-recurring items consist of $1.6 million of fees related to non-recurring projects and our acquisition of ProvenDB, and $1.4 million of fees related to non-recurring items, primarily severance payable to our former chief executive officer. For the year ended December 31, 2022, other non-recurring items consist of $4.3 million of outside services related to our strategic action plan, and a $(14.8) million non-operating gain on the sale of our investment in Promon AS.

Adjusted EBITDA increased during the year ended December 31, 2023 compared to 2022, primarily due to higher revenue and gross profit dollars, partially offset by an increase in operating expenses net of depreciation of software capitalization costs, restructuring, and other non-recurring items.

Please see further discussion in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations for an analysis of what comprises Net loss in the consolidated statements of operations for the years ended December 31, 2023 and 2022, and additional detail around items excluded from Adjusted EBITDA.

Liquidity and Capital Resources

As of December 31, 2023, we had net cash balances (total cash and cash equivalents) of $42.5 million and short-term investments of $0. At December 31, 2022, we had net cash balances of $96.2 million and short-term investments of $2.3 million. Short-term investments at December 31, 2022 consisted of U.S. treasury bills and notes, government agency notes, corporate notes and bonds, and high-quality commercial paper with maturities at acquisition of more than three months and less than twelve months. The decrease in net cash balances from December 31, 2022 to December 31, 2023 resulted primarily from $3.5 million in repurchases of our common stock on the open market pursuant to our share repurchase program, $25.0 million in repurchases of our common stock pursuant to the Tender Offer, and $12.2 million in

46

severance payments associated with the 2023 Actions. Please see Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities for more information on share repurchases.

We are party to lease agreements that require letters of credit and guarantees to secure the obligations which totaled $0.9 million and $1.1 million at December 31, 2023 and 2022, respectively. Additionally, the Company maintained a cash guarantee with a payroll vendor in the amount of $0.1 million at both December 31, 2023 and 2022. The restricted cash related to the letters of credit and guarantees is recorded in "Restricted cash" on the consolidated balance sheets.

As of December 31, 2023, we held $37.1 million of cash and cash equivalents in subsidiaries outside of the United States. Of that amount, $36.5 million is not subject to repatriation restrictions, but may be subject to taxes upon repatriation.

We expect that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

Our cash flows are as follows:

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(In thousands)","2023","","2022"],["Cash provided by (used in):"],["Operating activities","$","(10,735)","","","$","(5,759)"],["Investing activities","$","(12,013)","","","$","46,587"],["Financing activities","$","(32,094)","","","$","(7,308)"],["Effect of foreign exchange rate changes on cash and cash equivalents","$","997","","","$","(372)"]]
[[/GREPCENT_TABLE]]

Operating Activities

Cash used in operating activities is primarily comprised of net income (loss), as adjusted for non-cash items, and changes in operating assets and liabilities. Non-cash adjustments consist primarily of amortization of intangible assets, deferred taxes, depreciation of property and equipment, and stock-based compensation. We expect cash inflows from operating activities to be affected by increases or decreases in sales and timing of collections. Our primary uses of cash from operating activities have been for personnel and vendor costs. We expect cash outflows from operating activities to be affected by changes in personnel costs and the payments of expenditures.

For the year ended December 31, 2023, $10.7 million of cash was used in operating activities. This was primarily driven by investments made in sales and marketing during the first half of the year, severance payments made associated with the 2023 Actions, and increases in inventories and income taxes payable. For the year ended December 31, 2022, $5.8 million of cash was used in operating activities.

Our working capital at December 31, 2023 was $31.5 million, a decrease of $56.1 million, or 64%, from $87.6 million at December 31, 2022. The decrease was due to a lower operating income driven by restructuring and other related charges as well as lower capital needs as we better manage the timing of cash collections and vendor payments.

Investing Activities

The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments, purchases of property and equipment, capitalized software activities, and activity in connection with acquisitions. We expect to continue to purchase property and equipment to support the continued growth of our business as well as to continue to invest in our infrastructure and activity in connection with acquisitions.

For the year ended December 31, 2023 cash of $12.0 million was used in investing activities, compared to cash of $46.6 million provided by investing activities during the year ended December 31, 2022. The cash used for the year ended December 31, 2023 was primarily attributable to additions to property and equipment, net (primarily capital software activities) and purchase of ProvenDB, offset by the maturities of short-term investments.

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Financing Activities

The changes in cash flows from financing activities primarily relate to the purchases of common stock under our share repurchase program and tax payments for restricted stock issuances.

For the year ended December 31, 2023, net cash used in financing activities was $32.1 million, which consisted of $29.2 million of common stock repurchases, both in open market repurchases and pursuant to the Tender Offer, and $2.9 million of tax payments for restricted stock issuances.

For the year ended December 31, 2022, net cash used in financing activities was $7.3 million, which consisted of $5.7 million of common stock repurchases and $1.6 million of tax payments for restricted stock issuances.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

Contractual Obligations and Commitments

We have unrecognized purchase obligations of $6.3 million for other software agreements related to the administration of our business which range from 1 to 3 years.

We have operating lease obligations of $8.9 million which will expire in the next 1 to 9 years. The operating lease obligations do not include common area maintenance charges or real estate taxes under our operating leases, for which we are also obligated. These charges are generally not fixed and can fluctuate from year to year.

We have taxes payable of $2.6 million due within 1 year, which primarily represent deemed repatriation tax from 2017. We had $0 of unrecognized tax benefits as of both December 31, 2023 and 2022.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.

On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, net realizable value of inventory and intangible assets. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue Recognition

We record revenue in accordance with ASC Topic 606 "Revenue from Contracts with Customers". We determine revenue recognition through the following steps:

•Identification of the contract, or contracts, with a customer;

•Identification of the performance obligations in the contract;

•Determination of the transaction price;

•Allocation of the transaction price to the performance obligations in the contract; and

•Recognition of revenue when, or as, we satisfy a performance obligation.

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Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those products or services, which excludes any sales incentives and amounts collected on behalf of third parties. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer, are excluded from revenue. Shipping and handling costs associated with outbound freight before control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in "Cost of goods sold".

Nature of Goods and Services

We derive our revenues primarily from product and license revenue, which includes hardware products and on-premises subscription revenue, and services and other, which is inclusive of cloud subscription revenue, maintenance and support, and professional services.

Subscription: Subscription includes cloud and on-premises subscription revenue, previously referred to as “subscription” and “term-based software licenses”, respectively.

We generate cloud subscription revenues from our Digital Agreements and Security Solutions cloud service offerings. Our standard customer arrangements do not provide the customer with the right to take possession of the software supporting the cloud-based application service at any time. As such, these arrangements are considered service contracts and revenue is recognized ratably over the service period of the contract. Customer payments are normally in advance for annual service.

Revenue from the sale of on-premises subscription revenue is recorded upon delivery which is the latter of when the customer receives the ability to access the software or when they are legally allowed to use the software. No significant obligations or contingencies exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized. We offer term licenses for on-premises subscription revenue ranging from one to five years in length. For term licenses, payments are either on installment or in advance. In limited circumstances, we integrate third-party software solutions into our software products. We have determined that, consistent with our conclusion under prior revenue recognition rules, generally we act as the principal with respect to the satisfaction of the related performance obligation and record the corresponding revenue on a gross basis from these transactions. For transactions in which we do not act as the principal, we recognize revenue on a net basis. The fees owed to the third parties are recognized as a component of cost of goods sold when the revenue is recognized.

Maintenance and support: Maintenance and support agreements generally call for us to provide software updates and technical support, respectively, to customers. The annual fee for maintenance and technical support is recognized ratably over the term of the maintenance and support agreement as this is the period the services are delivered. Customer payments are normally in advance for annual service.

Professional Services and other revenue: Professional services revenues are primarily comprised of implementing, automating and extending business processes, technology infrastructure, and software applications. Professional services revenues are recognized over time as services are rendered, usually over a period of time that is generally less than a few months. Most projects are performed on a time and materials basis while a portion of revenues is derived from projects performed on a fixed fee. For time and material contracts, revenues are generally recognized and invoiced by multiplying the number of hours expended in the performance of the contract by the contractual hourly rates. For fixed fee contracts, revenues are generally recognized using an input method based on the ratio of hours expended to total estimated hours to complete the services. Customer payments normally correspond with delivery. Professional services and other revenue includes perpetual licenses revenue, which was approximately 1% of total revenue for the year ended December 31, 2023 and approximately 2% of total revenue for the year ended December 31, 2022. Perpetual licenses grant the customer unlimited access to the software.

Hardware products: Revenue from the sale of security hardware is recorded upon shipment, which is the point at which control of the goods are transferred and the completion of the performance obligations, unless there are specific terms that would suggest control is transferred at a later date (e.g. delivery). No significant obligations or contingencies typically exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized. Customer invoices and subsequent payments normally correspond with delivery.

The Company also enters into separate service agreements with certain hardware customers to perform distribution services. In these situations, revenue is recognized prior to physical delivery of a good (i.e. “bill-and-hold

49

arrangements). The Company evaluates bill-and-hold arrangements, and records revenue accordingly when the following criteria are met:

•The reason for the bill-and-hold arrangement is substantive;

•The product is identified separately as belonging to the customer;

•The product currently is ready for physical transfer to the customer; and

•OneSpan does not have the ability to use the product or to direct it to another customer.

Multiple-Element Arrangements

In our typical multiple-element arrangement, the primary deliverables include:

1.A client component (i.e. an item that is used by the person being authenticated in the form of either a new standalone hardware device or software that is downloaded onto a device that the customer already owns);

2.Server system software that is installed on the customer’s systems (i.e., software on the server system that verifies the identity of the person being authenticated) or licenses for additional users on the server system software if the server system software had been installed previously; and

3.Post contract support ("PCS") in the form of maintenance on the server system software or support.

Our multiple-element arrangements may also include other items that are usually delivered prior to the recognition of any revenue and are incidental to the overall transaction such as initialization of the hardware device, customization of the hardware device itself or the packaging in which it is delivered, deployment services where we deliver the device to our customer’s end-use customer or employee and, in some limited cases, professional services to assist with the initial implementation of a new customer.

Significant Judgments

We enter into contracts to deliver a combination of hardware devices, software licenses, subscriptions, maintenance and support and, in some situations, professional services. The Company evaluates the nature of the goods or services promised in these arrangements to identify the distinct performance obligations. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment depending on the terms and conditions of the respective customer arrangement. When a hardware client device and licenses to server software are sold in a contract, they are treated as a single performance obligation because the software license is deemed to be a component of the hardware that is integral to the functionality of the hardware that is used by our customers for identity authentication. When a software client device is sold in a contract server software, the licenses are considered a single performance obligation to deliver the authentication solution to the customer. In either of these types of arrangements, maintenance and support and professional services are typically distinct separate performance obligations from the hardware or software solutions. Our contracts to deliver subscription services typically do not include multiple performance obligations; however, in certain limited cases customers may purchase professional services that are distinct performance obligations.

For contracts that contain multiple performance obligations, the transaction price is allocated to the separate performance obligations based on their estimated relative standalone selling price. Judgment is required to determine the stand-alone selling price (“SSP”) of each distinct performance obligation. We determine SSP for maintenance and support and professional services based on observable inputs; specifically, the range of prices charged to customers to renew annual maintenance and support contracts and the range of hourly rates we charge our customers in standalone professional services contracts. In instances where SSP is not directly observable, and when we sell at a highly variable price range, such as for transactions involving software licenses or subscriptions, we determine the SSP for those performance obligations using the residual approach.

50

Credit Losses

In accordance with Accounting Standards Update ("ASU") No. 2016-13, the Company evaluates its allowance based on expected losses rather than incurred losses, which is known as the current expected credit loss ("CECL") model. The allowance is determined using the loss rate approach and is measured on a collective (pool) basis when similar risk characteristics exist. Where financial instruments do not share risk characteristics, they are evaluated on an individual basis. The allowance is based on relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

Income Taxes

As a global company, we calculate and provide for income taxes in each tax jurisdiction in which we operate. The provision for income taxes includes the amounts payable or refundable for the current year, the effect of deferred taxes and impacts from uncertain tax positions. Our provision for income taxes is significantly affected by shifts in the geographic mix of our pre-tax earnings across tax jurisdictions, changes in tax laws and regulations, and tax planning opportunities available in each tax jurisdiction.

Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement and tax bases of our assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those differences are expected to be recovered or settled. Valuation allowances are established for deferred tax assets when it is more likely than not that a tax benefit will not be realized. We recognize the effect of a change in tax rates on deferred tax assets and liabilities and in income in the period that includes the enactment date.

We recognize tax benefits for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in our income tax returns that do not meet these recognition and measurement standards. Assumptions, judgments, and the use of estimates are required in determining whether the “more-likely-than-not” standard has been met when developing the provision for income taxes.

We recognize the tax impact of including certain foreign earnings in U.S. taxable income as a period cost. We have recognized deferred income taxes for local country income and withholding taxes that could be incurred on distributions of non-U.S. earnings because we do not plan to indefinitely reinvest such earnings.

We monitor for changes in tax laws and reflect the impacts of tax law changes in the period of enactment.

Recently Issued Accounting Pronouncements

For information regarding our new accounting pronouncements, see Note 2, Summary of Significant Accounting Policies, in the notes to consolidated financial statements included in Part IV, Item 15, Exhibits and Financial Statements Schedules.