OneSpan Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; filed November 5, 2020. OneSpan provides digital identity, security, authentication, and transaction-management solutions, including hardware, software licenses, subscriptions, and services. The company reports as one operating segment.
Financial results
Amounts in millions of U.S. dollars, except per-share data and percentages. Comparisons are year over year.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $51.4 | $79.7 | $162.8 | $183.0 |
| Gross profit / margin | $36.0 / 70% | $53.0 / 67% | $113.0 / 69% | $122.4 / 67% |
| Operating income (loss) | $(2.4) | $17.1 | $(3.2) | $8.8 |
| Net income (loss) | $(1.7) | $11.8 | $(3.7) | $3.3 |
| Diluted EPS | $(0.04) | $0.30 | $(0.09) | $0.08 |
- Revenue mix: Q3 product and license revenue fell 51% to $30.2 million, while services and other revenue rose 15% to $21.2 million. For the nine-month period, product and license revenue declined 22% to $103.9 million; services and other grew 17% to $58.9 million.
- Cash flow: Operating activities provided $7.4 million in the first nine months, compared with $13.7 million used in the prior-year period. Investing activities used $4.1 million and financing activities used $2.0 million. Cash and equivalents increased $1.6 million from year-end to $85.9 million.
- Liquidity and obligations: Short-term investments were $26.8 million; cash plus short-term investments totaled $112.7 million. Working capital was $135.5 million. The balance sheet reports no financial borrowings; lease liabilities totaled $15.1 million, including $12.5 million long-term.
- Other balance-sheet measures: Total assets were $369.5 million and stockholders’ equity was $259.2 million at September 30, 2020. Deferred revenue, current and long-term, totaled $49.3 million.
Changes and drivers
- Q3 revenue decreased 35%; nine-month revenue decreased 11%. Management cited lower hardware and perpetual software-license sales, softened demand amid COVID-19 uncertainty, and comparison with elevated 2019 hardware sales associated with the PSD2 banking-regulation deadline.
- Hardware revenue fell $20.3 million in Q3 year over year and $29.7 million for the nine-month period. Recurring revenue declined 5% in Q3 but rose 27% over nine months, supported by subscription and maintenance growth.
- Despite lower gross profit dollars, gross margin improved to 70% in Q3 and 69% year to date, partly because hardware represented a smaller share of sales and product/license margins were higher.
- Operating costs rose 7% in Q3 and 2% year to date. Year-to-date general and administrative costs increased 15%, with higher personnel, stock compensation, consulting, software-tool, and bad-debt costs among the drivers.
Outlook, risks, and unusual items
- Outlook: No quantitative earnings or revenue guidance is provided in the filing. Management warned that 2020 hardware revenue could be substantially below 2019. It said pandemic-related demand weakness began in summer 2020 and continued through Q3; the size and duration of any effects could not be reasonably estimated and could be material.
- COVID-19 exposure: Risks include weaker customer demand, delayed projects and purchasing decisions, discount or extended-payment requests, customer financial distress, supply-chain disruptions, and operating constraints. Management noted some increased demand for remote-access and e-signature products, but said it may be temporary. Hardware order delays and added costs had occurred, with most issues reportedly resolved at the time of filing.
- Share repurchase: The board authorized up to $50 million of repurchases through June 10, 2022; no program repurchases had been made by September 30. Shares shown as purchased in the quarter were surrendered for employee tax withholding, not bought under the program.
- Financial-statement revision: OneSpan revised prior-period figures for errors in accounting for certain term-license and maintenance contracts, determining the errors were immaterial to previously issued statements. As revised, 2019 nine-month revenue was reduced by $0.6 million and net income by $0.5 million. A separate $0.3 million reduction to opening 2020 accumulated income followed adoption of the expected-credit-loss standard.
- Credit losses: The allowance for credit losses rose to $3.8 million from $2.5 million at year-end, including a $1.5 million provision; the company attributed the increase primarily to pandemic-related factors affecting expected losses.
- Legal matters: A securities class action and a related derivative action were pending, alleging misstatements and failures relating to internal procedures and prior-period errors. OneSpan said it considered the claims meritless and intended to defend them; it said a separate trademark dispute was settled after quarter-end for an immaterial amount.
- Controls: Management concluded disclosure controls were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Track hardware demand and the extent to which the 2019 PSD2 comparison and COVID-19 effects explain continuing revenue declines.
- Assess whether subscription, maintenance, and other recurring growth can offset weakness in hardware and license sales, including the resulting margin and cloud-infrastructure cost trends.
- Review operating cash flow, receivables and credit-loss allowances, deferred revenue, and the concentration of cash held outside the United States.
- Monitor developments and potential financial consequences of the securities and derivative litigation, and verify the status of the $50 million repurchase authorization.
- Review the corrected contract accounting and related control disclosures; the filing describes the prior errors as immaterial, while the related litigation alleges otherwise.