VASCO Data Security International, Inc. (now OneSpan Inc.) — Q3 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2016. VASCO designed and sold hardware and software security and authentication products and services. Unless noted, financial amounts below are in millions of U.S. dollars; the filing presents them in thousands. The 2015 acquisition of electronic-signature provider eSignLive contributed to 2016 operations.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $43.6 | $60.0 | $144.7 | $190.6 |
| Gross profit / margin | $32.1 / 73.5% | $36.3 / 60.4% | $104.6 / 72.3% | $112.4 / 59.0% |
| Operating income | $0.9 | $13.5 | $7.4 | $45.3 |
| Net income | $0.5 | $11.2 | $5.5 | $38.7 |
| Diluted earnings per share | $0.01 | $0.28 | $0.14 | $0.97 |
- Operating cash flow from continuing operations was $24.9 million for the first nine months, versus $47.8 million a year earlier. Investing activities used $71.3 million, largely reflecting net purchases of short-term investments.
- At September 30, cash and equivalents were $31.5 million and short-term investments were $110.1 million. Working capital was $136.9 million. The company reported no debt; total liabilities were $58.9 million.
- Cash and equivalents fell from $78.5 million at year-end 2015, while short-term investments increased from $45.0 million. Management said resources were adequate for operating needs over the next 12 months.
Material changes versus the prior comparable period
- Revenue declined 27% in Q3 and 24% for the first nine months. Management attributed much of the comparison decline to a large 2015 delivery of CRONTO card readers to Rabobank. Excluding Rabobank and eSignLive, revenue from other customers fell 5.1% in Q3 but rose 2% year to date.
- Banking revenue fell 43% in Q3 and 35% year to date; excluding Rabobank, the declines were 14% and 1%. Enterprise and Application Security revenue grew 89% in Q3 and 55% year to date. That market’s share of revenue rose to 31% in Q3 from 12% a year earlier.
- Gross margin improved substantially as lower-margin card-reader sales made up a smaller share of revenue and higher-margin software and Enterprise and Application Security sales increased. Card readers represented 7% of Q3 revenue versus 35% a year earlier.
- Operating expenses rose 37% in Q3 and 45% year to date, reflecting eSignLive, higher headcount, incentive compensation and acquired-intangible amortization. These costs, alongside lower revenue, reduced operating income sharply.
- eSignLive accounted for 9% of Q3 revenue and 6% of year-to-date revenue. Its acquisition-date purchase-price allocation remained preliminary; a $9.1 million reduction to a deferred-tax valuation allowance reduced goodwill by the same amount.
Outlook, commentary, risks and unusual items
- The filing provides no specific revenue or earnings guidance. Management described demand as transactional and quarterly results as volatile, and said longer-term trends may better reflect customer-base growth. It cited European economic and banking-market uncertainty, changing bank priorities, and currency movements as factors that could affect results.
- Management expected a 28% full-year 2016 effective tax rate before discrete items; discrete items raised the estimated full-year rate to 37%. The Q3 effective tax rate was 61%.
- VASCO accrued $0.9 million for possible OFAC penalties related to products a European distributor may have resold to parties in Iran. The company reported no direct sales to Iran or OFAC-listed parties in its five-year review and had received a BIS “no action” letter, but OFAC had not concluded its review. The company said the ultimate penalty could differ from the accrual and did not expect a material adverse effect.
- A securities class action and derivative claims relating to alleged public-disclosure and oversight failures remained outstanding; certain derivative cases were stayed. The company said it intended to defend the securities action and believed it was without merit.
- Cybersecurity incidents involving its cloud-based services could materially harm future business and reputation, according to management. Other stated risks include competition, changing technology and regulation, customer concentration, and risks integrating eSignLive.
- The company reported effective disclosure controls. It was still documenting and testing eSignLive’s financial-reporting controls for inclusion in its year-end 2016 assessment.
Most important facts for investors to verify
- How much revenue and cash generation can be sustained without another unusually large Rabobank-type order, and whether recent growth in Enterprise and Application Security continues.
- Whether eSignLive integration delivers expected growth and synergies, and how final acquisition accounting affects goodwill, amortization and taxes.
- The outcome of the pending OFAC review and the securities and derivative litigation, including any changes to reserves or disclosures.
- Whether higher operating costs and headcount can be supported by revenue growth, and how the elevated tax rate affects future earnings.
- Liquidity composition and access: cash declined while short-term investments rose, and some foreign-held balances may incur tax on repatriation.