VASCO Data Security International, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The filing is under VASCO Data Security International, Inc. (now Onespan Inc.). Financial amounts below are in millions of U.S. dollars unless stated otherwise. 2016 comparative operating results were revised to correct previously disclosed immaterial errors.
Business context
VASCO designs and sells identity, authentication, anti-fraud, electronic-signature and digital transaction solutions, including hardware, software and cloud services. It reports one operating segment. Results can fluctuate with the timing of orders and shipments; Europe remains an important market, although the Americas grew substantially in Q3.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $51.1 | $43.6 | $138.8 | $144.7 |
| Gross profit | $36.6 | $30.1 | $98.6 | $98.7 |
| Gross margin | 71.7% | 68.9% | 71.1% | 68.2% |
| Operating income | $5.1 | $0.9 | $5.0 | $7.4 |
| Net income | $2.8 | $0.5 | $3.4 | $5.5 |
| Diluted EPS | $0.07 | $0.01 | $0.09 | $0.14 |
| Operating cash flow | Not separately provided for the quarter | $15.0 | $24.9 |
Q3 revenue rose 17%, while nine-month revenue fell 4%. Q3 growth reflected a 12% increase in product and license revenue and a 35% increase in services and other revenue. For the first nine months, product and license revenue fell 12%, partly offset by 32% growth in services and other. Nine-month gross profit was nearly flat despite lower revenue; margin improved as software solutions made up a larger share of revenue.
Operating income for the first nine months declined despite higher gross margin, as operating costs increased. Q3 general and administrative expense increased 29% year over year, primarily due to headcount, professional fees and facilities expense. The nine-month tax provision was $3.0 million; management estimated a 40% 2017 annual tax rate before discrete items, with the rate affected by geographic earnings mix and valuation allowances.
Liquidity, debt and balance sheet
At September 30, 2017, cash and equivalents were $49.3 million and short-term investments were $109.5 million. Working capital was $159.4 million, up 15% from year-end 2016. The company reported no debt. Operating cash flow was $15.0 million for the first nine months, down from $24.9 million in 2016; management attributed the increase in cash and investments and working capital primarily to operating cash flow. VASCO said its financial resources were adequate for operating needs over the next 12 months. It held $30.8 million in cash and short-term investments outside the United States; most was not subject to repatriation restrictions but could incur tax upon repatriation.
Changes, outlook and risks
- Regional revenue in Q3 was flat in EMEA, up 78% in the Americas and up 9% in Asia Pacific. Nine-month revenue decreased 7% in EMEA and 28% in Asia Pacific, while the Americas increased 56%. Management attributed the Asia Pacific and EMEA nine-month declines mainly to lower hardware sales.
- Management expected research and development expense to increase as it invests in new products. The filing provides no quantified revenue or earnings guidance.
- VASCO expected to adopt the new revenue standard in Q1 2018 using the cumulative-effect method. Its preliminary assessment indicated some term-license revenue could be recognized upon delivery rather than over the contract term, and certain sales commissions may be capitalized; the impact remained under evaluation.
- Foreign currency movements affected reported revenue and costs. Management cited economic uncertainty in Europe, changing bank spending priorities, cybersecurity threats, competition, customer concentration and reliance on certain products and suppliers as risks. It warned that a cyber incident involving hosted services could materially harm the business.
- Disclosure controls and procedures were deemed ineffective at September 30, 2017 because of a material weakness in internal control over financial reporting relating to the acquisition and integration of Silanis Technology. Management was implementing remediation and expected completion during 2017.
- In August, the company sold subsidiary Able N.V. to an employee for a de minimis amount and recorded a $0.227 million loss. It also provided Able an unsecured €1.5 million credit line; no amount had been drawn by quarter-end.
- Contingencies include an unresolved OFAC review relating to possible distributor resale of products to Iran; VASCO had accrued $0.9 million for potential penalties and said the outcome remained uncertain. Other matters include securities and derivative litigation and patent disputes involving CRONTO technology in Japan and a U.S. patent suit. The company is defending the claims; the Japanese matter could materially affect the business if adverse.
Key facts for investors to verify
- Whether Q3 revenue growth and improved gross margin persisted beyond a quarter, particularly as order timing is volatile and nine-month revenue remained below 2016.
- Progress in converting services and software growth into sustained operating income and cash generation.
- The actual impact of adopting the new revenue standard, including timing of term-license revenue and capitalization of commissions.
- Remediation and independent assessment of the material weakness in internal controls.
- Developments in the OFAC review and outstanding securities and patent litigation, including potential exposure beyond recorded accruals.
- Foreign exchange, geographic earnings mix and tax-rate effects, plus the ability to sustain liquidity while meeting lease and other commitments.