VASCO Data Security International, Inc. — Q3 2011 Form 10-Q
Entity note: The supplied filing is for VASCO Data Security International, Inc., not Onespan Inc. It covers the quarter and nine months ended September 30, 2011. Financial amounts below are in U.S. dollars, thousands, unless stated otherwise.
Business context and reporting period
VASCO designed and sold hardware and software security products, including DIGIPASS authentication solutions, and offered a cloud-based authentication platform. Banking and finance was its largest market, and EMEA its largest region. The filing reports acquisitions of DigiNotar and Alfa & Ariss during 2011; DigiNotar’s business was classified as discontinued operations after its bankruptcy.
Financial results and liquidity
- Q3 revenue: $41.4 million, up 57% from $26.3 million. Banking revenue rose 68% to $33.4 million; enterprise and application security revenue rose 24% to $8.0 million.
- Q3 profitability: Gross profit was $27.8 million, with a 67.1% gross margin versus 70.5% a year earlier. Operating income was $7.4 million versus $2.5 million; continuing-operations net income was $5.9 million versus $2.2 million. Including a $3.7 million discontinued-operations loss, net income was $2.2 million, or $0.06 diluted EPS, versus $2.2 million, or $0.06, in Q3 2010.
- Nine-month results: Revenue was $119.6 million, up 59%; operating income was $15.7 million versus $4.8 million; continuing-operations net income was $12.9 million versus $4.2 million. Net income including discontinued operations was $7.4 million, or $0.19 diluted EPS, versus $4.2 million, or $0.11.
- Cash flow: Continuing-operations operating cash flow was $8.2 million for the first nine months, down from $21.2 million. Continuing investing activities used $9.4 million, including $7.2 million for intangible assets and $1.3 million for DigiNotar; discontinued operations used a further $6.3 million. Cash declined $8.0 million from year-end to $77.5 million.
- Balance sheet: Cash was $77.5 million; working capital was $99.2 million. Current assets were $128.9 million and current liabilities $29.7 million. The balance sheet reports no debt; total liabilities were $31.1 million and stockholders’ equity $126.5 million.
- Margins and costs: Nine-month gross margin was 63.6%, down from 70.3%. Operating expenses rose 26% to $60.4 million, while their share of revenue fell to 50.4% from 63.9%. Management reported continuing-operations EBITDA of $18.8 million for nine months, a non-GAAP measure.
Material changes versus the prior comparable period
- Revenue growth was led by banking, up 83% for the first nine months; enterprise and application security revenue declined 2% over that period. Banking represented 83% of nine-month revenue, compared with 72% in 2010.
- Gross margin declined as banking and card-reader sales increased, large banking orders carried lower pricing, and higher-margin enterprise/application and non-hardware revenue formed a smaller share of sales. Card readers were 22% of nine-month revenue versus 15% in 2010.
- Cash from continuing operations fell despite higher earnings, primarily reflecting increases in receivables and inventory and lower accounts payable. Receivables rose to $28.8 million from $21.7 million at year-end; inventory rose to $16.8 million from $10.7 million.
- Foreign exchange affected comparisons: management estimated currency movements increased nine-month revenue by $5.1 million and operating expenses by $3.3 million. Foreign-currency transaction losses were $0.5 million for the nine months, compared with gains of $0.1 million in 2010.
Outlook, risks, contingencies and unusual items
- No specific numerical revenue or earnings guidance was provided. Management expected continued strong banking-market growth and expected enterprise/application security to remain a smaller share of revenue than in comparable 2010 periods. It also said it planned to focus on growing non-hardware revenue.
- Management believed cash resources were sufficient for operating needs over the next 12 months, while warning that economic weakness could delay customer orders and require business-plan changes or restructuring.
- DigiNotar suffered a breach involving fraudulent certificate requests; Dutch authorities terminated its qualified-certificate registration, and it was declared bankrupt on September 20, 2011. VASCO recorded a $3.962 million after-tax disposal loss, including goodwill and intangible impairments. DigiNotar contributed $1.764 million of revenue for the nine months before its operations were discontinued.
- VASCO said the DigiNotar incident had not affected its information systems and did not expect a material impact on its traditional authentication business. It did not plan to continue DigiNotar’s certificate-authority business but expected to use acquired intellectual property in its own products. Recovery of escrow funds, potential claims, bankruptcy costs, further impairment, and integration of the intellectual property remained uncertain.
- The FTC issued a Civil Investigative Demand in connection with its non-public investigation of the DigiNotar incident; the filing states the FTC had not alleged wrongdoing by VASCO. The company cautioned that potential claims and unanticipated costs could increase losses.
- Other risks cited include reliance on European banking customers, currency movements, customer concentration, competitive pricing, evolving cyber threats, and the security exposure associated with cloud-based services. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the filing entity and ticker: this 2011 report is filed by VASCO, despite the Onespan request metadata.
- Track the DigiNotar bankruptcy, any claims or further costs, escrow recovery, and whether the acquired intellectual property is successfully integrated.
- Assess whether strong banking revenue growth can continue without further gross-margin pressure from product mix, card-reader pricing, and large orders.
- Monitor operating cash conversion, receivables, inventory, and the effect of foreign exchange on reported results.
- Review the distinction between continuing-operations results, discontinued-operations losses, and management’s non-GAAP EBITDA measure.