OneSpan Inc. (OSPN) — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless stated otherwise. OneSpan develops digital identity, security and business-productivity solutions, including authentication hardware and software, cloud subscriptions, maintenance and professional services. It reports one operating segment. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $47.6 | $45.4 | Up 5% |
| Gross profit / margin | $31.6 / 66% | $34.7 / 76% | Profit down 9%; margin down 10 percentage points |
| Operating income (loss) | $(5.5) | $1.6 | Turned to loss |
| Net income (loss) | $(5.7) | $1.8 | Turned to loss |
| Diluted EPS | $(0.14) | $0.04 | Turned to loss |
| Operating cash flow | $(3.7) | $9.7 | Down $13.5 |
- Revenue mix: Product and license revenue fell 5% to $31.9 million, reflecting lower software-license sales partly offset by higher hardware sales. Services and other revenue rose 32% to $15.7 million, driven by subscription and maintenance revenue. Hardware revenue was $24.3 million versus $17.5 million; subscription revenue was $5.3 million versus $3.0 million.
- Regional results: EMEA revenue increased 39% to $25.6 million, while Americas declined 20% to $12.7 million and APAC declined 17% to $9.3 million. EMEA represented 54% of revenue, compared with 40% a year earlier.
- Margins and costs: Gross margin deterioration reflected a larger share of lower-margin hardware and lower service margins, including higher cloud-service costs. Management estimated currency movements reduced revenue by approximately $1.8 million; at prior-year exchange rates, Q1 2019 gross margin would have been about 3.8 percentage points higher. Cost of goods sold rose 49% to $16.0 million.
- Operating expenses: Total operating costs increased 12% to $37.1 million. R&D rose 81% to $10.5 million, citing higher cloud test-environment costs, increased headcount and $1.7 million of Dealflo-related R&D costs. Sales and marketing was nearly flat at $14.4 million; G&A declined 8% to $9.9 million.
- Other items: Other expense was $0.6 million versus $0.4 million of other income, primarily reflecting foreign-exchange transaction losses; the company reported $0.9 million of such losses versus a $0.2 million gain a year earlier. The income-tax benefit was $0.3 million versus $0.6 million of expense.
Liquidity, cash flow and balance sheet
- At March 31, cash and equivalents were $69.9 million and short-term investments were $25.4 million, totaling $95.3 million. Working capital was $113.4 million, down 5% from year-end 2018. Management said resources were adequate for operating needs over the next 12 months.
- Operating cash use was $3.7 million. Investing activities used $2.7 million, including net purchases of short-term investments; financing activities used $0.2 million. Cash, cash equivalents and restricted cash ended the quarter at $70.8 million, down $6.8 million from the beginning of the period.
- The balance sheet reports no conventional borrowings. Following adoption of the new lease standard, operating lease liabilities totaled $10.9 million ($3.1 million current and $7.9 million long term); the corresponding right-of-use asset was $8.8 million. Total liabilities were $107.5 million and stockholders’ equity was $248.0 million.
Outlook, risks and notable developments
- No specific revenue or earnings guidance is provided. Management cautions that order and shipment timing can make quarterly revenue volatile and says the business is better assessed over longer periods. It expects continued investment in sales resources, R&D, infrastructure and business growth.
- The estimated 2019 annual tax rate before discrete items was approximately 59%, primarily due to forecast losses in jurisdictions where tax benefits are not recognized because of valuation allowances; actual tax expense depends on the geographic mix of earnings.
- Management identifies foreign-exchange exposure, economic conditions—particularly in European banking—cybersecurity incidents (especially affecting cloud services), competition, changing customer requirements, acquisition integration and potential impairment of goodwill or intangible assets as risks. It reported no significant cyber incident in Q1 and no material change in market risk.
- Dealflo, acquired in May 2018, contributed $1.9 million of Q1 2019 revenue and $1.4 million of net losses. Its preliminary purchase-price allocation included $38.2 million of goodwill. Management said certain acquisition tax valuations remained unfinished.
- OneSpan adopted the lease accounting standard on January 1, 2019, recording $9.2 million of right-of-use assets and lease liabilities at transition, with no retained-earnings impact. The company also completed implementation of a new global ERP system during Q1.
- Disclosure controls and procedures were deemed ineffective at March 31, 2019 because of a previously identified material weakness in internal control over financial reporting. Management said remediation was underway and expected to be completed in 2019.
- The StrikeForce patent-infringement claims against OneSpan were dismissed with prejudice on April 16, 2019; the company considered the matter closed. Management said other proceedings were not expected to have a material adverse effect overall, though an individual matter could affect a particular interim period.
Most important facts for investors to verify
- Whether services and subscription growth can continue, and whether software-license weakness in the Americas and APAC persists.
- Whether gross margins recover as product mix and cloud-service costs change, and how much future results remain exposed to currency movements.
- Whether higher R&D spending and the Dealflo business produce improved growth and profitability; Dealflo remained loss-making in the quarter.
- Progress in remediating the material weakness, and whether the new ERP system operates effectively within the company’s financial controls.
- Liquidity and cash-generation trends, including lease commitments and the effect of geographic earnings mix on the unusually high estimated tax rate.