Business context and reporting period
VASCO Data Security International, Inc. (now OneSpan Inc.) filed this Form 10-K for the fiscal year ended December 31, 2016. The company provides identity, authentication, anti-fraud and electronic-signature products and services, primarily to financial institutions and enterprises. Results are reported as one operating segment.
Financial performance and liquidity
Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $192.3 | $241.4 | -20% |
| Gross profit / margin | $130.7 / 67.9% | $143.5 / 59.5% | Profit -9%; margin +8.4 points |
| Operating income / margin | $9.6 / 5.0% | $50.5 / 20.9% | Income -81% |
| Net income | $10.5 | $42.2 | -75% |
| Diluted EPS | $0.27 | $1.06 | -75% |
| Operating cash flow | $28.5 | $69.0 | Down $40.5 |
- Revenue comprised $156.1 million of product and license sales and $36.2 million of services and other revenue. Services and other increased from $22.5 million in 2015.
- Cash and equivalents were $49.3 million, with $94.9 million of short-term investments at year-end. The company reported no debt and working capital of $139.2 million; its current ratio was 3.5:1.
- Cash declined $29.2 million during 2016. Investing activities used $56.5 million, including a net $49.9 million increase in short-term investments. Financing activities used $1.1 million.
- Operating expenses rose 30% to $121.1 million, including sales and marketing of $57.3 million, R&D of $23.2 million and intangible amortization of $8.8 million. R&D expense was $23.2 million versus $17.5 million.
- At December 31, 2016, total assets were $327.3 million, goodwill $54.4 million, net intangible assets $46.5 million, and stockholders’ equity $256.6 million per the balance sheet. The filing’s Selected Financial Data table reports equity of $254.6 million, a discrepancy to verify.
- Fourth-quarter 2016 revenue was $47.6 million, operating income $2.2 million and net income $5.0 million, compared with fourth-quarter 2015 revenue of $50.9 million, operating income $5.2 million and net income $3.5 million.
Material changes versus prior period
- The main driver of the annual revenue decline was lower Banking-market hardware sales to Rabobank. Rabobank card-reader revenue fell approximately $62.9 million year over year; total Banking revenue declined 31% to $143.4 million.
- Enterprise and Application Security revenue increased 51% to $48.9 million, primarily reflecting growth in hardware and non-hardware offerings and the contribution of eSignLive, acquired in November 2015. Excluding Rabobank and eSignLive, revenue increased 0.4% to $169.8 million.
- EMEA revenue fell 39% to $100.8 million; Asia-Pacific revenue increased 12% to $52.9 million. EMEA represented 52% of revenue, and the top 10 customers represented 36%, down from 50% in 2015.
- Gross margin improved as lower-margin Rabobank card-reader sales declined and the share of non-hardware revenue increased to 39% from 22%. However, higher operating costs—particularly sales and marketing, R&D and amortization—compressed operating margin substantially.
- The effective tax rate fell to 9% from 17%. The filing attributes the change mainly to increased losses in higher-tax jurisdictions, partly offset by a higher Swiss tax rate. Fourth-quarter earnings also included a $2.344 million tax benefit from eSignLive acquisition measurement-period adjustments.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance is provided. Management expects continued growth in demand for IT security, mobile and online transactions, and digital signatures, but cautions that annual results may be uneven and dependent on large orders and customer buying cycles. It expects Europe to face difficult economic conditions in 2017.
- Management said financial resources were adequate for operating needs over the next 12 months. Contractual obligations totaled $26.5 million, including $19.1 million of inventory purchase obligations expected to be fulfilled within one year and $7.2 million of operating leases.
- Material control weakness: Management concluded internal control over financial reporting and disclosure controls were not effective at year-end, due to deficiencies in eSignLive revenue accounting, acquisition valuation controls and post-acquisition monitoring. A product-revenue misstatement was corrected before issuance; other identified misstatements were described as immaterial. KPMG issued an adverse opinion on internal controls but an unqualified opinion on the financial statements. Remediation was planned for completion in 2017.
- Customer and execution risk: The business remains exposed to concentrated customers, long sales cycles, competition and pricing pressure, supplier concentration, foreign exchange movements, and the transition from hardware toward software and cloud offerings. Approximately 88% of 2016 revenue was generated outside the U.S.
- Legal and regulatory matters: OFAC had not concluded its review of a voluntary disclosure concerning possible distributor resale of products in Iran; the company had accrued $0.9 million for a potential penalty. The company also disclosed securities and derivative litigation and a 2017 Japanese patent suit involving CRONTO technology, with related customer indemnification exposure. Outcomes and potential liabilities were uncertain.
- The company revised prior-period presentation for service costs recorded in operating expenses, determining the errors were not material and did not change revenue or operating income. It also reported no goodwill or intangible-asset impairments in 2014–2016. No cash dividends were paid or anticipated in the foreseeable future.
Important facts for investors to verify
- Review the material weakness, corrected revenue misstatement, remediation progress and any subsequent auditor assessment.
- Assess whether growth outside the exceptional Rabobank order can offset continued Banking-market volatility, and track eSignLive’s revenue, losses and integration costs.
- Confirm the balance-sheet equity figure: the balance sheet reports $256.6 million, while Selected Financial Data reports $254.6 million.
- Monitor cash generation, working capital, receivables and the quality and maturity profile of short-term investments.
- Follow the OFAC review, securities and derivative cases, and CRONTO patent litigation for changes in exposure or potential business restrictions.