OneSpan Inc. — Q3 2019 Form 10-Q
Business context and reporting period. OneSpan designs and sells digital identity, security and transaction-management solutions, including hardware, software licenses, subscriptions, maintenance and services. This unaudited quarterly report covers the three and nine months ended September 30, 2019; amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $79.7 million | $52.5 million | $183.6 million | $147.5 million |
| Gross profit / margin | $53.1 million / 67% | $34.5 million / 66% | $123.0 million / 67% | $105.2 million / 71% |
| Operating income (loss) | $17.1 million | ($3.1 million) | $9.4 million | ($4.1 million) |
| Net income (loss) | $11.9 million | ($0.9 million) | $3.7 million | ($0.1 million) |
| Diluted EPS | $0.30 | ($0.02) | $0.09 | ($0.00) |
- Q3 revenue rose 52% year over year, led by product and license revenue, up 66%; services and other revenue increased 19%. For the first nine months, revenue grew 24%.
- Q3 operating income improved substantially from the year-earlier loss. Nine-month operating income also turned positive, although gross margin declined four percentage points year over year to 67%.
- Operating cash flow was negative $13.7 million in the first nine months, compared with negative $9.2 million a year earlier. Management attributed the greater use of cash primarily to receivable timing and higher inventory purchases.
- Cash and equivalents were $54.9 million and short-term investments were $26.4 million at September 30, totaling $81.3 million. Working capital was $126.4 million. Cash and equivalents plus short-term investments totaled $99.5 million at December 31, 2018.
- No borrowings or conventional debt balance is shown in the supplied balance sheet. Operating lease liabilities totaled $14.2 million, including $2.9 million current and $11.3 million long term.
Material changes versus the prior comparable period
- EMEA revenue increased 93% in Q3 and 66% year to date. EMEA represented 61% of Q3 revenue, compared with 48% a year earlier.
- APAC revenue declined 5% in Q3 and 22% year to date; Americas revenue increased 41% in Q3 and 6% year to date.
- Nine-month research and development expense increased 42%, primarily reflecting higher employee headcount. Sales and marketing expense fell 5%, and general and administrative expense fell 8%.
- Foreign-exchange transaction losses were $1.9 million in Q3 and $2.6 million year to date, versus losses of $0.1 million and $0.2 million in the comparable 2018 periods. Currency movements reduced revenue by an estimated $2.4 million in Q3 and $6.4 million year to date.
- OneSpan adopted the new lease accounting standard on January 1, 2019, recognizing right-of-use assets and lease liabilities. Prior-period figures were not adjusted.
Outlook, risks, contingencies and unusual items
- Management said financial resources should be adequate for operating needs over the next 12 months. The filing provides no specific revenue or earnings guidance. Management notes that order and shipment timing can make quarterly revenue volatile and says longer-term trends are more useful for evaluating performance.
- Management estimated a 43% annual tax rate for 2019 before discrete items, citing forecast losses in jurisdictions where tax benefits cannot be recognized. The ultimate tax expense depends on the geographic mix of earnings.
- Management identified currency exposure, particularly the euro and Canadian dollar; dependence on European banking customers; competitive and technology changes; cybersecurity threats; acquisition integration; and potential goodwill or intangible-asset impairment as risks. Cloud-based products are a minority of current revenue, but a cyber incident affecting them could materially harm the business.
- Dealflo, acquired in 2018, generated $5.6 million of revenue and a $5.3 million net loss in the first nine months of 2019. The filing recorded no goodwill impairment in the period.
- OneSpan reported a material weakness in internal control over financial reporting, and management concluded disclosure controls were not effective as of September 30, 2019. Remediation was ongoing, with completion expected during fiscal 2019. The company also completed implementation of a new global ERP system during the first nine months.
- The StrikeForce patent litigation was dismissed with prejudice in April 2019. Management said other ordinary-course matters were not expected to have a material adverse effect overall; reasonably possible losses for individual proceedings generally could not be estimated.
Important facts for investors to verify
- Whether the material weakness was remediated by year-end as management expected, and whether the new ERP system operates effectively.
- Whether the negative operating cash flow and increased receivables unwind, and how collections and inventory levels develop.
- Whether revenue growth and profitability persist beyond a strong Q3, given transaction timing, EMEA concentration and APAC declines.
- Whether foreign-exchange effects, lower year-to-date gross margin and the estimated 43% tax rate continue to pressure results.
- How Dealflo’s operating losses and the company’s lease obligations affect future earnings and liquidity.