OneSpan Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. OneSpan, formerly VASCO Data Security International, designs security, authentication, identity-verification and digital-transaction solutions. It reports as one operating segment. Unless otherwise noted, amounts below are in U.S. dollars.
Financial results and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $52.5 million | $51.1 million | $147.5 million | $138.8 million |
| Gross profit | $34.5 million | $36.6 million | $105.2 million | $98.6 million |
| Gross margin | 66% | 72% | 71% | 71% |
| Operating income (loss) | $(3.1) million | $5.1 million | $(4.1) million | $5.0 million |
| Net income (loss) | $(0.9) million | $2.8 million | $(0.1) million | $3.4 million |
| Diluted EPS | $(0.02) | $0.07 | $(0.00) | $0.09 |
- Q3 revenue increased 3%; nine-month revenue increased 6%. Services and other revenue grew 23% in both comparisons, while product and license revenue fell 4% in Q3 and rose 1% year to date.
- Q3 gross margin declined six percentage points, primarily due to lower hardware margins and higher token costs. Nine-month margin was unchanged year over year.
- Operating costs rose 19% in Q3 and 17% year to date, including higher sales and marketing, R&D and administrative spending. Management attributed increases in part to headcount, cloud-service test costs, Dealflo and rebranding.
- For the nine months, operating cash flow was $(9.2) million, versus $15.0 million generated in 2017. Investing activities provided $23.5 million, including $80.0 million of investment maturities and offset by $53.1 million paid for Dealflo. Cash increased $13.3 million to $91.9 million.
- At September 30, cash and equivalents were $91.9 million, short-term investments were zero, working capital was $112.0 million, and total liabilities were $83.5 million. The company reported no debt. It held $48.2 million of cash outside the U.S.; $47.7 million was not subject to repatriation restrictions, though repatriation may incur taxes.
Material changes and notable items
- Dealflo acquisition: On May 30, OneSpan acquired the remaining 99% interest, increasing ownership from 1% to 100%. Consideration was $53.9 million net of cash acquired, including $53.1 million cash paid. Preliminary purchase accounting included $39.9 million of goodwill and $16.1 million of identifiable intangibles; valuation remained incomplete. Dealflo contributed $2.3 million of revenue and a $2.9 million net loss after acquisition through September.
- Revenue accounting: OneSpan adopted ASC 606 using the modified retrospective method. It increased opening accumulated income by $11.9 million, net of tax. ASC 606 increased reported revenue by $0.5 million in Q3 and $3.0 million for the first nine months; prior-year figures were not restated. Thus reported growth comparisons include an accounting-policy effect.
- Other income and taxes: Nine-month other income included a $1.2 million government subsidy for authentication-technology development. A tax benefit of $1.7 million in Q3 and $0.9 million year to date reflected, among other items, a tax true-up related to U.S. tax reform. The company estimated 2018 tax expense before discrete items at approximately $2.0 million.
- OFAC matter: OFAC closed its review of the company’s voluntary disclosure with no penalties or other amounts assessed. OneSpan reversed a previously recorded $0.9 million accrual, benefiting Q3 and year-to-date results.
- Intangibles: The company recorded $0.5 million of impairment charges during the first nine months, related to the rebranding. No goodwill impairment was recorded.
Outlook, risks and contingencies
- No specific revenue or earnings guidance was provided. Management said financial resources were adequate for operating needs over the next 12 months and expected to continue investing in sales resources, R&D, infrastructure and property and equipment.
- Management cautioned that results can vary with order and shipment timing, economic conditions—particularly in European banking—and product and revenue mix. Foreign-currency movements can affect results; the stronger U.S. dollar reduced revenue by an estimated $1.4 million in Q3 and $3.7 million year to date versus 2017 exchange rates.
- The company identified cybersecurity incidents affecting cloud solutions as a potentially material business and reputational risk, and highlighted acquisition integration, competition, changing customer requirements, intellectual-property claims and possible goodwill or intangible-asset impairment as other risks.
- Several legal matters remained disclosed. The Bunk securities case was dismissed without prejudice, and plaintiffs agreed to seek dismissal with prejudice, subject to court approval. A Japanese patent decision upholding invalidity was appealed; a separate U.S. patent case remained stayed. Management said it could not predict litigation outcomes, but believed the matters were not likely to have a material adverse effect on the company as a whole.
- OneSpan expected adoption of the new lease standard in 2019 to have a material financial-statement impact; disclosed future minimum lease payments were $17.1 million at December 31, 2017.
Important facts for investors to verify
- How much of reported revenue growth reflects underlying demand versus ASC 606’s timing changes, and whether the strong growth in subscriptions and maintenance continues.
- Whether operating costs and Dealflo losses translate into improved growth and profitability; Q3 and nine-month operating results were losses despite revenue growth.
- The sustainability of operating cash generation and the effect of working-capital movements, acquisition spending and the absence of short-term investments on liquidity.
- Final Dealflo purchase-price allocation, acquired-asset valuations and subsequent performance against acquisition expectations.
- The remaining effects of tax-reform estimates, foreign-currency exposure and adoption of lease accounting, along with the status and resolution of outstanding legal matters.