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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission file number
(Exact Name of Registrant as Specified in Its Charter)
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(Address of Principal Executive Offices) (Zip Code)
(
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: |
| Trading Symbol |
| Name of each exchange on which registered: |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer ,a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ◻ | ⌧ | |
Non-accelerated filer | ◻ | Emerging growth company | |
Smaller reporting company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
There were
OneSpan Inc.
Form 10-Q
For the Quarter Ended September 30, 2020
Table of Contents
2
OneSpan Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
September 30, | December 31, | |||||
2020 |
| 2019 | ||||
ASSETS |
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Current assets |
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Cash and equivalents | $ | | $ | | ||
Short term investments |
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Accounts receivable, net of allowances of $ |
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Inventories, net |
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Prepaid expenses |
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Contract assets | | | ||||
Other current assets |
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Total current assets |
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Property and equipment, net |
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Operating lease right-of-use assets | | | ||||
Goodwill |
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Intangible assets, net of accumulated amortization |
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Deferred income taxes | | | ||||
Contract assets - non-current | | | ||||
Other assets |
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Total assets | $ | | $ | | ||
LIABILITIES AND STOCKHOLDERS' EQUITY |
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Current liabilities |
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Accounts payable | $ | | $ | | ||
Deferred revenue |
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Accrued wages and payroll taxes |
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Short-term income taxes payable |
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Other accrued expenses |
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Deferred compensation |
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Total current liabilities |
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Long-term deferred revenue | | | ||||
Long-term lease liability | | | ||||
Other long-term liabilities |
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Long-term income taxes payable | | | ||||
Deferred income taxes |
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Total liabilities |
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Stockholders' equity |
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Preferred stock: |
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Common stock: $ |
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Additional paid-in capital |
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Accumulated income |
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Accumulated other comprehensive loss |
| ( |
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Total stockholders' equity |
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Total liabilities and stockholders' equity | $ | | $ | | ||
See accompanying notes to unaudited condensed consolidated financial statements.
3
OneSpan Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three months ended | Nine months ended | ||||||||||||
September 30, | September 30, | ||||||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||
Revenue |
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Product and license | $ | | $ | | $ | | $ | | |||||
Services and other |
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Total revenue |
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Cost of goods sold |
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Product and license |
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Services and other |
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Total cost of goods sold |
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Gross profit |
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Operating costs |
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Sales and marketing |
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Research and development |
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General and administrative |
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Amortization of intangible assets |
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Total operating costs |
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Operating income (loss) |
| ( |
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Interest income, net |
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Other income (expense), net |
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| ( |
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Income (loss) before income taxes |
| ( |
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| ( |
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Provision for income taxes |
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Net income (loss) | $ | ( | $ | | $ | ( | $ | | |||||
Net income (loss) per share |
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Basic | $ | ( | $ | $ | ( | $ | | ||||||
Diluted | $ | ( | $ | $ | ( | $ | | ||||||
Weighted average common shares outstanding |
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Basic |
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Diluted |
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See accompanying notes to unaudited condensed consolidated financial statements.
4
OneSpan Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||
Net income (loss) |
| $ | ( |
| $ | |
| $ | ( |
| $ | |
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Other comprehensive loss | |||||||||||||
Cumulative translation adjustment, net of tax |
| |
| ( |
| ( |
| ( |
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Pension adjustment, net of tax |
| ( |
| ( |
| ( |
| ( |
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Comprehensive income (loss) |
| $ | |
| $ | |
| $ | ( |
| $ | ( |
|
See accompanying notes to unaudited condensed consolidated financial statements.
5
OneSpan Inc.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)
For the three and nine months ended September 30, 2020:
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| Accumulated |
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Additional | Other | Total | |||||||||||||||
Common Stock | Paid-In | Accumulated | Comprehensive | Stockholders' | |||||||||||||
Description | Shares | Amount | Capital | Income | Income (Loss) | Equity | |||||||||||
Balance at December 31, 2019 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
Cumulative impact of change in accounting principle, net of tax | — | — | — | ( | — | ( | |||||||||||
Net income (loss) |
| — |
| — |
| — |
| |
| — |
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Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Restricted stock awards |
| |
| — |
| |
| — |
| — |
| | |||||
Tax payments for stock issuances |
| ( |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at March 31, 2020 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
Net income (loss) |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
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Restricted stock awards |
| |
| — |
| |
| — |
| — |
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Tax payments for stock issuances |
| ( |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at June 30, 2020 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
Net income (loss) |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
| |
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Restricted stock awards |
| |
| — |
| |
| — |
| — |
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Tax payments for stock issuances |
| ( |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at September 30, 2020 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
6
OneSpan Inc.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)
For the three and nine months ended September 30, 2019:
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| Accumulated |
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Additional | Other | Total | |||||||||||||||
Common Stock | Paid-In | Accumulated | Comprehensive | Stockholders' | |||||||||||||
Description | Shares | Amount | Capital | Income | Income (Loss) | Equity | |||||||||||
Balance at December 31, 2018 |
| |
| |
| |
| |
| ( |
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Net income (loss) |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
| |
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Restricted stock awards |
| ( |
| — |
| |
| — |
| — |
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Tax payments for stock issuances |
| — |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at March 31, 2019 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
Net income (loss) |
| — |
| — |
| — |
| ( |
| — |
| ( | |||||
Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Restricted stock awards |
| |
| — |
| |
| — |
| — |
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Tax payments for stock issuances |
| ( |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at June 30, 2019 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
Net income (loss) |
| — |
| — |
| — |
| |
| — |
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Foreign currency translation adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Restricted stock awards |
| |
| — |
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| — |
| — |
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Tax payments for stock issuances |
| ( |
| — |
| ( |
| — |
| — |
| ( | |||||
Pension adjustment, net of tax |
| — |
| — |
| — |
| — |
| ( |
| ( | |||||
Balance at September 30, 2019 |
| | $ | | $ | | $ | | $ | ( | $ | | |||||
See accompanying notes to unaudited condensed consolidated financial statements.
7
OneSpan Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine months ended September 30, | |||||||
| 2020 |
| 2019 | ||||
Cash flows from operating activities: |
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Net income (loss) | $ | ( | $ | | |||
Adjustments to reconcile net income (loss) from operations to net cash provided by (used in) operations: |
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Depreciation and amortization of intangible assets |
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Loss on disposal of assets |
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Deferred tax benefit |
| ( |
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Stock-based compensation |
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Changes in operating assets and liabilities: |
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Accounts receivable, net |
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| ( | |||
Inventories, net |
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Contract assets |
| ( |
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Accounts payable |
| ( |
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Income taxes payable |
| ( |
| ( | |||
Accrued expenses |
| ( |
| ( | |||
Deferred compensation |
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Deferred revenue |
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Other assets and liabilities |
| ( |
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Net cash provided by (used in) operating activities |
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Cash flows from investing activities: |
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Purchase of short term investments |
| ( |
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Maturities of short term investments |
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Additions to property and equipment |
| ( |
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Other |
| ( |
| — | |||
Net cash used in investing activities |
| ( |
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Cash flows from financing activities: |
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Tax payments for restricted stock issuances |
| ( |
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Net cash used in financing activities | ( |
| ( | ||||
Effect of exchange rate changes on cash |
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Net increase (decrease) in cash |
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Cash, cash equivalents, and restricted cash, beginning of period |
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Cash, cash equivalents, and restricted cash, end of period (1.) | $ | | $ | | |||
| (1.) |
| September 30, 2020 | September 30, 2019 | December 31, 2019 | ||||||
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Cash and cash equivalents | $ | | $ | | $ | | |||
Restricted cash included in other non-current assets |
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Cash, cash equivalents and restricted cash | $ | | $ | | $ | | |||
See accompanying notes to unaudited condensed consolidated financial statements.
8
OneSpan Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Unless otherwise noted, references in this Quarterly Report on Form 10-Q to “OneSpan,” “Company,” “we,” “our,” and “us,” refer to OneSpan Inc. and its subsidiaries.
Note 1 – Description of the Company and Basis of Presentation
Description of the Company
OneSpan Inc. and its wholly owned subsidiaries design, develop, market and support hardware and software security systems that manage and secure access to information assets. OneSpan has operations in Austria, Australia, Belgium, Brazil, Canada, China, France, Japan, The Netherlands, Singapore, Switzerland, the United Arab Emirates, the United Kingdom (U.K), and the United States (U.S.).
In accordance with ASC 280, Segment Reporting, our operations are reported as a single operating segment. The chief operating decision maker is the Chief Executive Officer who reviews the statement of operations of the Company on a consolidated basis, makes decisions and manages the operations of the Company as a single operating segment.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of OneSpan and its subsidiaries and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles in the United States (“U.S. GAAP”) for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the results of the interim periods presented. All significant intercompany accounts and transactions have been eliminated. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ended December 31, 2020, particularly in light of the novel coronavirus (COVID-19) pandemic and its effects on domestic and global economies. To limit the spread of COVID-19, governments have imposed, and may continue to impose, among other things, travel and business operation restrictions and stay-at-home orders and social distancing guidelines, causing some businesses to adjust, reduce or suspend operating activities. These disruptions and restrictions could adversely affect our operating results due to, among other things, reduced demand for our services and solutions as a result of our customers having to adjust, reduce or suspend operating activities. Beginning in the Summer of 2020 and continuing through the third quarter ended September 30, 2020, we have experienced softened demand for certain of our products and services due to, we believe, global economic uncertainty connected with the continued seriousness of the COVID-19 pandemic.
For additional information, see Part II, Item 1A – Risk Factors of this Form 10-Q for additional information regarding the potential impact of COVID-19 on the Company.
Revision of Previously Issued Financial Statements
We have revised amounts reported in previously issued financial statements for the periods presented in this Quarterly Report on Form 10-Q related to immaterial errors. The errors relate to certain contracts with customers involving term-based software licenses and related maintenance and support services. The net contract assets that originated from a portion of these contracts in prior periods were not properly accounted for in subsequent periods, which caused overstatements of revenue in prior periods.
9
We evaluated the aggregate effects of the errors to our previously issued financial statements in accordance with SEC Staff Accounting Bulletins No. 99 and No. 108 and, based upon quantitative and qualitative factors, determined that the errors were not material to the previously issued financial statements and disclosures included in our Annual Reports on Form 10-K for the years ended December 31, 2019 and 2018, or for any quarterly periods included therein or through our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020.
The following tables present the effects of the aforementioned revisions on our condensed consolidated balance sheet as of December 31, 2019, our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2019, our unaudited condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2019, our unaudited condensed consolidated statement of stockholders’ equity for the three and nine months ended September 30, 2019, our unaudited condensed consolidated statement of stockholders’ equity for the three months ended March 31, 2020, and our unaudited condensed consolidated statement of cash flows for the nine months ended September 30, 2019 (in thousands).
Condensed Consolidated Balance Sheet
December 31, 2019 | |||||||||
in thousands |
| As Previously Reported |
| Adjustments | As Revised | ||||
Contract assets | $ | | $ | ( | $ | | |||
Total current assets | | ( | | ||||||
Contract assets - non-current | | ( | | ||||||
Total assets | | ( | | ||||||
Short-term income taxes payable | | ( | | ||||||
Total current liabilities | | ( | | ||||||
Long-term deferred revenue | | — | | ||||||
Long-term income taxes payable | | — | | ||||||
Total liabilities | | ( | | ||||||
Accumulated income | | ( | | ||||||
Accumulated other comprehensive loss | — | ||||||||
Total stockholders' equity | | ( | | ||||||
Total liabilities and stockholders' equity | | ( | | ||||||
Condensed Consolidated Statements of Operations (Unaudited)
Three Months ended September 30, 2019 | Nine Months ended September 30, 2019 | |||||||||||||||||
| As Previously Reported |
| Adjustments | As Revised |
| As Previously Reported |
| Adjustments | As Revised | |||||||||
Revenue |
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Product and license | $ | | $ | | $ | | $ | | $ | ( | $ | | ||||||
Services and other |
| | ( |
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Total revenue |
| | ( |
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Gross Profit |
| | ( |
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| | ( |
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Operating income |
| | ( |
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Income before income taxes |
| | ( |
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Provision for income taxes |
| | ( |
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| | ( |
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Net Income | | ( | | | ( | | ||||||||||||
10
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)
Three Months ended September 30, 2019 | Nine Months ended September 30, 2019 | |||||||||||||||||
As Previously Reported |
| Adjustments | As Revised |
| As Previously Reported |
| Adjustments | As Revised | ||||||||||
Net income | $ | | $ | ( | $ | | $ | | $ | ( | $ | | ||||||
Comprehensive income (loss) | | ( | | | ( | ( | ||||||||||||
Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)
Total Stockholders' Equity | |||||||||
in thousands |
| As Previously Reported |
| Adjustments | As Revised | ||||
Balance at December 31, 2018 | $ | | $ | ( | $ | | |||
Net income (loss) | ( | ( | ( | ||||||
Balance at March 31, 2019 | | ( | | ||||||
Net income (loss) | ( | ( | ( | ||||||
Balance at June 30, 2019 | | ( | | ||||||
Net income (loss) | | ( | | ||||||
Balance at September 30, 2019 | | ( | | ||||||
Balance at December 31, 2019 | $ | | $ | ( | $ | | |||
Net income (loss) | | ( | | ||||||
Balance at March 31, 2020 | | ( | | ||||||
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months ended September 30, 2019 | |||||||||
in thousands | As Previously Reported |
| Adjustments | As Revised | |||||
Cash flows from operating activities: |
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Net income | $ | | $ | ( | $ | | |||
Changes in operating assets and liabilities: |
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Contract assets |
| ( |
| |
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Income taxes payable | ( | ( | ( | ||||||
Net cash used in operating activities |
| ( |
| — |
| ( | |||
For the three months ended March 31, 2020, the impacts of the adjustments resulted in a decrease of $
Principles of Consolidation
The consolidated financial statements include the accounts of OneSpan Inc. and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
11
Foreign Currency Translation and Transactions
The financial position and results of the operations of the majority of the Company’s foreign subsidiaries are measured using the local currency as the functional currency. Accordingly, assets and liabilities are translated into U.S. Dollars using current exchange rates as of the balance sheet date. Revenue and expenses are translated at average exchange rates prevailing during the year. Translation adjustments arising from differences in exchange rates are charged or credited to other comprehensive income (loss). Gains and losses resulting from foreign currency transactions are included in the condensed consolidated statements of operations in other income (expense), net. Foreign exchange transaction gains aggregated $
The financial position and results of our operations in Singapore, Switzerland, and Canada are measured in U.S. Dollars. For these subsidiaries, gains and losses that result from foreign currency transactions are included in the consolidated statements of operations in other income (expense), net.
Share Repurchase Program
On June 10, 2020, the Board of Directors authorized a share repurchase program (“program”), pursuant to which the Company can repurchase up to $
Note 2 – Summary of Significant Accounting Policies
Except for certain changes which resulted from the adoption of ASU 2016-13, there have been no changes to the significant accounting policies described in the Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 16, 2020 that have had a material impact on the Company’s condensed consolidated financial statements and related notes.
Cash, Cash Equivalents and Restricted Cash.
We are in a lease agreement that required a letter of credit in the amount of $
Short Term Investments
The Company’s short term investments are in debt securities which consist of U.S treasury bills and notes, U.S. government agency notes, corporate notes, and high quality commercial paper with maturities at acquisition of more than three months and less than twelve months The Company classifies its investments in debt securities as available-for-sale. The Company adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments, on January 1, 2020, which amended our accounting for available-for-sale debt securities. Credit impairments are recorded through an allowance rather than a direct write-down of the security and are recorded through a charge to the condensed consolidated statement of operations. Unrealized gains or losses not related to credit impairments are recorded in accumulated other comprehensive gain/(loss) in the condensed consolidated balance sheets. The Company reviews available-for-sale debt securities for impairments related to credit losses and other factors each quarter. As of September 30, 2020 and December 31, 2019, the unrealized gains and losses were not material.
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Accounts Receivable, net of Allowance for Credit Losses
The Company adopted ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, on January 1, 2020. As a result of the adoption, the Company amended its accounting policies for the allowance for credit losses. In accordance with ASU No. 2016-13, the Company evaluates its allowance based on expected losses rather than incurred losses, which is known as the current expected credit loss (“CECL”) model. The allowance is determined using the loss rate approach and is measured on a collective (pool) basis when similar risk characteristics exist. Where financial instruments do not share risk characteristics, they are evaluated on an individual basis. The allowance is based on relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
Equity Method Investment
We apply the equity method of accounting to our investment in Promon AS (Promon), because we exercise significant influence, but not controlling interest, in the investee. Promon is a technology company headquartered in Norway that specializes in mobile app security, whose solutions focus largely on Runtime Application Self-Protection (RASP). We exercise significant influence over Promon as a result of our
Recently Issued Accounting Pronouncements
In September 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326), which amends the Board’s guidance on the impairment of financial instruments. The ASU adds an impairment model that is based on expected losses rather than incurred losses, which is known as the current expected credit loss (“CECL”) model. The CECL model applies to most debt instruments (other than those measured at fair value), trade and other receivables, financial guarantee contracts, and loan commitments. This ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company adopted ASC 326 as of January 1, 2020, using the cumulative-effect transition method with the required prospective approach. The cumulative-effect transition method enables an entity to record an allowance for expected credit losses at the date of adoption without restating comparative periods. The cumulative-effect adjustment for adoption of ASC 326 resulted in a decrease of $
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment. This standard eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge (i.e. Step 2 of the current guidance), instead measuring the impairment charge as the excess of the reporting unit's carrying amount over its fair value (i.e. Step 1 of the current guidance). The guidance was effective for us beginning in the first quarter of 2020, and should be applied prospectively. Early adoption is permitted for impairment testing dates after January 1, 2017. We adopted this standard on January 1, 2020 on a prospective basis. The adoption of this standard did not have a material impact on our consolidated financial statements.
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In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which amends ASC 820, Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The ASU is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019, with early adoption permitted for removed or modified disclosures, and delayed adoption of the additional disclosures until their effective date. We adopted this standard on January 1, 2020 on a retrospective basis. The adoption of this standard did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which helps entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (CCA) by providing guidance for determining when an arrangement includes a software license and when an arrangement is solely a hosted CCA service. Under ASU 2018-15, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. The new guidance also prescribes the balance sheet, income statement, and cash flow classification of the capitalized implementation costs and related amortization expense, and requires additional quantitative and qualitative disclosures. We adopted this standard on January 1, 2020 on a prospective basis. The adoption of this standard did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Topic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans (ASU 2018-14), which modifies the disclosure requirements for defined benefit pension plans and other postretirement plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020, and earlier adoption is permitted. We are currently evaluating the effect that the ASU will have on our consolidated financial statements and related disclosures.
In December 2019, the FASB issued ASU 2019-12, Simplification for Accounting for Income Taxes, which removes certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. The ASU also adds guidance to reduce complexity in certain areas, including recognizing deferred taxes for tax goodwill and allocating taxes to members of a consolidated group. ASU 2019-12 is effective beginning January 1, 2021. The Company is evaluating the impact of adoption of the new standard on its consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topics 321, 323 and 815. The new standard addresses accounting for the transition into and out of the equity method and measurement of certain purchased options and forward contracts to acquire investments. The standard is effective for the Company for annual and interim periods beginning after July 1, 2022, with early adoption permitted. Adoption of the standard requires changes to be made prospectively. The Company is evaluating the impact of adoption of the new standard on its consolidated financial statements.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Statements. The amendments in this update represent changes to clarify or improve codification and correct unintended application. This standard was effective immediately upon issuance and its adoption did not have a material impact on the Company’s consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This update provides optional expedients and exceptions for applying generally accepted accounting principles to certain contract modifications and hedging relationships that reference London Inter-bank Offered Rate (LIBOR) or another reference rate expected to be discontinued. The guidance is effective upon issuance and can be applied through December 31, 2022. The Company is currently evaluating the potential impact of the new standard on its consolidated financial statements.
From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, our management believes that the
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issued standards that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
Note 3 – Revenue
We recognize revenue in accordance with ASC 606 “Revenue from Contracts with Customers” (“Topic 606”), as described below.
Disaggregation of Revenues
The following tables present our revenues disaggregated by major products and services, geographical region and timing of revenue recognition.
Revenue by major products (in thousands)
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||
Hardware products | $ | | $ | | $ | | $ | | |||||
Software licenses | | | | | |||||||||
Subscription | | | | | |||||||||
Professional services | | | | | |||||||||
Maintenance, support and other | | | | | |||||||||
Total Revenue | $ | | $ | | $ | | $ | | |||||
Revenue by location of customer for the three months ended September 30, 2020 and 2019 (in thousands)
EMEA |
| Americas |
| APAC |
| Total | |||||||
Total Revenue: |
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2020 | $ | | $ | | $ | | $ | | |||||
2019 | $ | | $ | | $ | | $ | | |||||
Percent of Total: |
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2020 |
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2019 |
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| | % |
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Revenue by location of customer for the nine months ended September 30, 2020 and 2019 (in thousands)
| EMEA |
| Americas |
| APAC |
| Total |
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Total Revenue: |
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2020 | $ | | $ | | $ | | $ | | |||||
2019 | $ | | $ | | $ | | $ | | |||||
Percent of Total: |
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2020 |
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2019 |
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Timing of revenue recognition (in thousands)
Three months ended September 30, | Nine months ended September 30, | ||||||||||
2020 |
| 2019 | 2020 |
| 2019 | ||||||
Products and Licenses transferred at a point in time | $ | | $ | | $ | | $ | | |||
Services transferred over time | | | | | |||||||
Total Revenue | $ | | $ | | $ | | $ | | |||
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Contract balances
The following table provides information about receivables, contract assets and contract liabilities from contracts with customers.
September 30, | December 31, | |||||
2020 | 2019 | |||||
Receivables, inclusive of trade and unbilled | $ | | $ | | ||
Contract Assets (current and non-current) | $ | | $ | | ||
Contract Liabilities (Deferred Revenue current and non-current) | $ | | $ | | ||
Contract assets relate primarily to multi-year term license arrangements and the remaining contractual billings. These contract assets are transferred to receivables when the right to billing occurs, which is normally over
As a practical expedient, we do not adjust the promised amount of consideration for the effects of a significant financing component when we expect, at contract inception, that the period between our transfer of a promised product or service to a customer and when the customer pays for that product or service will be or less. We do not typically include extended payment terms in our contracts with customers.
Revenue recognized during the nine months ended September 30, 2020 included $
Transaction price allocated to the remaining performance obligations
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of the reporting period.
in thousands | Total | ||||||||||||||
Future revenue related to current unsatisfied performance obligations | $ | | $ | | $ | | $ | | $ | | |||||
The Company applies practical expedients and does disclose information about remaining performance obligations (a) that have original expected durations of or less, or (b) where revenue is recognized as invoiced.
Costs of obtaining a contract
The Company incurs incremental costs related to commissions, which can be directly tied to obtaining a contract. The Company capitalizes commissions associated with certain new contracts and amortizes the costs over a period of benefit based on the transfer of goods or services that we have determined to be up to
Applying the practical expedient, the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period for the assets that the Company otherwise would have recognized is or less. These costs are included in Sales and Marketing expense in the condensed consolidated statements of operations.
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The following tables provide information related to the capitalized costs and amortization recognized in the current and prior periods:
in thousands | September 30, 2020 | December 31, 2019 | |||||
Capitalized costs to obtain contracts, current | $ | | $ | | |||
Capitalized costs to obtain contracts, non-current | $ | | $ | |
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
in thousands | 2020 | 2019 | 2020 | 2019 | |||||||||
Amortization of capitalized costs to obtain contracts | $ | | $ | $ | | $ | |||||||
Impairments of capitalized costs to obtain contracts | $ | - | $ | - | $ | - | $ | - | |||||
Note 4 – Inventories, net
Inventories, net, consisting principally of hardware and component parts, are stated at the lower of cost or net realizable value. Cost is determined using the FIFO method.
Inventories, net are comprised of the following:
September 30, | December 31, | |||||
| 2020 |
| 2019 | |||
(in thousands) | ||||||
Component parts | $ | | $ | | ||
Work-in-process and finished goods |
| |
| | ||
Total | $ | | $ | | ||
Note 5 – Goodwill
Goodwill activity for the three months ended September 30, 2020 consisted of the following:
in thousands | |||
Net balance at December 31, 2019 |
| $ | |
Net foreign currency translation |
| ( | |
Net balance at September 30, 2020 | $ | | |
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Note 6 – Intangible Assets
Intangible asset activity for the nine months ended September 30, 2020 is detailed in the following table.
| ||||||||||||
in thousands |
| Acquired Technology |
| Customer Relationships |
| Other |
| Total Intangible Assets | ||||
Net balance at December 31, 2019 | $ | | $ | | $ | | $ | | ||||
Additions |
| | — | |
| | ||||||
Disposals | — | — | ( | ( | ||||||||
Net foreign currency translation |
| ( | ( | — |
| ( | ||||||
Amortization expense |
| ( | ( | ( |
| ( | ||||||
Net balance at September 30, 2020 | $ | | $ | | $ | | $ | | ||||
September 30, 2020 balance at cost | $ | | $ | | $ | | $ | | ||||
Accumulated amortization |
| ( |
| ( |
| ( |
| ( | ||||
Net balance at September 30, 2020 | $ | | $ | | $ | | $ | | ||||
Certain intangible assets are denominated in functional currencies besides the U.S. dollar and are subject to currency fluctuations.
Note 7 – Property and Equipment
The major classes of property and equipment are as follows:
in thousands |
| September 30, 2020 |
| December 31, 2019 | ||
Office equipment and software | $ | | $ | | ||
Leasehold improvements | | | ||||
Furniture and fixtures |
| |
| | ||
Total |
| |
| | ||
Accumulated depreciation |
| ( |
| ( | ||
Property and equipment, net | $ | | $ | | ||
Depreciation expense was $
Note 8 – Fair Value Measurements
The fair values of cash equivalents, receivables, net, and accounts payable approximate their carrying amounts
due to their short duration. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing base upon its own market assumptions.
The Company classifies its investments in debt securities as available-for-sale. As described in Note 2- Summary of Significant Accounting Policies, the January 1, 2020 adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments, amended our accounting for available-for-sale debt securities. We review available-for-sale det securities for impairments related to losses and other factors each quarter. The unrealized gains and losses on the available-for-sale debt securities were not material as of September 30, 2020 and December 31, 2019.
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The estimated fair value of our financial instruments has been determined by using available market information and appropriate valuation methodologies, as defined in ASC 820, Fair Value Measurements. The fair value hierarchy consists of the following three levels:
| ● | Level 1 – Inputs are quoted prices in active markets for identical assets or liabilities. |
| ● | Level 2 – Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived primarily from or corroborated by observable market data. |
| ● | Level 3 – Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable. |
The following tables summarize assets that are measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019:
Fair Value Measurement at Reporting Date Using | |||||||||
in thousands | September 30, 2020 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||
Assets: | |||||||||
U.S. Treasury Notes | $ | | - | $ | | - | |||
Corporate Notes / Bonds | $ | | - | $ | | - | |||
Commercial Paper | $ | | - | $ | | - | |||
U.S. Treasury Bills | $ | | - | $ | | - | |||
U.S. Government Agencies | $ | | - | $ | | - | |||
Fair Value Measurement at Reporting Date Using | |||||||||
in thousands | December 31, 2019 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||
Assets: | |||||||||
U.S. Treasury Notes | $ | | - | $ | | - | |||
Corporate Notes / Bonds | $ | | - | $ | | - | |||
Commercial Paper | $ | | - | $ | | - | |||
U.S. Treasury Bills | $ | | - | $ | | - | |||
U.S. Government Agencies | $ | | - | $ | | - | |||
Note 9 – Allowance for credit losses
As described in Note 2 - Summary of Significant Accounting Policies, the January 1, 2020 adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments, amended our accounting policies for the allowance for credit losses.
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The changes in the allowance for credit losses during the nine months ended September 30, 2020 were as follows:
in thousands | |||
Balance at December 31, 2019 | $ | | |
Impact of ASU 2016-13 adoption | | ||
Balance at January 1, 2020 | | ||
Provision | | ||
Write-offs | ( | ||
Net foreign currency translation | | ||
Balance at September 30, 2020 | $ | |
A higher allowance for credit losses was recorded during the nine months ended September 30, 2020 primarily due to the adverse impact the COVID-19 pandemic has had on factors that affect our estimate of future credit losses.
Note 10 – Leases
Operating lease cost details for the three and nine months ended September 30, 2020 and 2019 are as follows:
Three months ended | Nine months ended | |||||||||||
September 30, | September 30, | |||||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | |||||
(in thousands) | (in thousands) | |||||||||||
Building rent | $ | | $ | | $ | | $ | | ||||
Automobile rentals |
| |
| |
| |
| | ||||
Total net operating lease costs | $ | | $ | | $ | | $ | | ||||
At September 30, 2020, the weighted average remaining lease term for our operating leases is
During the nine months ended September 30, 2020, there were $
Maturities of our operating leases are as follows:
As of September 30, 2020 | |||
(in $ thousands) | |||
2020 (remaining 3 months) | $ | | |
2021 | | ||
2022 | | ||
2023 | | ||
2024 | | ||
Later years | | ||
Less imputed interest | ( | ||
Total lease liabilities | $ | | |
Note 11 – Income Taxes
For the three and nine months ended September 30, 2020, the Company utilized the discrete effective tax rate method, as allowed by ASC 740-270-30-18, “Income Taxes—Interim Reporting,” to calculate its interim income tax provision. The discrete method is applied when the application of the estimate annual effective tax rate yields an estimate that is not reliable and the actual effective rate for the year-to-date is the best estimate of the annual effective tax rate. The Company believes that the use of the estimated annual effective tax rate method is not reliable since small changes in the projected ordinary annual income would result in significant changes in the estimated annual effective tax
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rate. Our global effective tax rate is higher than the U.S. statutory tax rate of
At December 31, 2019, we had deferred tax assets of $
Certain non-U.S. operations have incurred net operating losses (NOLs), which are currently subject to a valuation allowance. These NOLs may become deductible to the extent these operations become profitable. For each of our operations, we evaluate whether it is more likely than not that the tax benefits related to NOLs will be realized. As part of this evaluation, we consider evidence such as tax planning strategies, historical operating results, forecasted taxable income, and recent financial performance. In the year that certain non-U.S. operations record a loss, we do not recognize a corresponding tax benefit, thus increasing our effective tax rate. Upon determining that it is more likely than not that the NOLs will be realized, we will reduce the tax valuation allowances related to these NOLs, which will result in a reduction of our income tax expense and our effective tax rate in the period.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. Among other provision, the law provides relief to U.S. federal corporate taxpayers through temporary adjustments to net operating loss rules, changes to limitations on interest expense deductibility, the acceleration of available refunds for minimum tax credit carryforwards, and depreciation method changes. We do not expect the provisions of the legislation to have a significant impact on our effective tax rate nor the income tax payable and deferred income tax positions of the Company.
Note 12 – Long-Term Compensation Plan and Stock Based Compensation (share counts in thousands)
Under the OneSpan Inc. 2019 Omnibus Incentive Plan, we award restricted stock units subject to time-based vesting, restricted stock units which are subject to the achievement of future performance criteria and restricted stock units that are subject to the achievement of market conditions.
We awarded
We awarded restricted stock unit grants during the nine months ended September 30, 2020, subject to the achievement of market and service conditions, which allow for up to
We awarded restricted stock units subject to the achievement of service and future performance criteria during the nine months ended September 30, 2020, which allow for up to
The Company currently believes that certain restricted stock units subject to the achievement of future performance criteria, awarded during the twelve months ended December 31, 2019 and 2018, will not be earned. The compensation costs recorded for the
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The following table details long-term compensation plan and stock-based compensation expense for the three and nine months ended September 30, 2020 and 2019:
Three months ended | Nine months ended | ||||||||||||
September 30, | September 30, |
| |||||||||||
| 2020 |
| 2019 |
| 2020 |
| 2019 | ||||||
in thousands | (in thousands) | (in thousands) | |||||||||||
Restricted stock | $ | | $ | | $ | | $ | | |||||
Long-term compensation plan |
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Total compensation | $ | | $ | | $ | | $ | | |||||
Note 13 – Earnings per Share (share counts in thousands)
Basic earnings per share is based on the weighted average number of shares outstanding and excludes the dilutive effect of common stock equivalents. Diluted earnings per share is based on the weighted average number of shares outstanding and includes the dilutive effect of common stock equivalents to the extent they are not anti-dilutive. Because the Company is in a net loss position for the three and nine months ended September 30, 2020, diluted net loss per share for these periods excludes the effects of common stock equivalents, which are anti-dilutive. For the three and nine months ended September 30, 2019, the anti-dilutive effect of our securities is immaterial.
The details of the earnings per share calculations for the three and nine months ended September 30, 2020 and 2019 are as follows:
September 30, | September 30, |
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in thousands, except per share data |
| 2020 |
| 2019 |
| 2020 |
| 2019 | |||||
Net income (loss) | $ | ( | $ | | $ | ( | $ | | |||||
Weighted average common shares outstanding: |
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Incremental shares with dilutive effect: |
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Restricted stock awards |
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Diluted |
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Net income (loss) per share: |
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Basic | $ | ( | $ | | $ | ( | $ | | |||||
Diluted | $ | ( | $ | | $ | ( | $ | | |||||
Note 14 – Legal Proceedings and Contingencies
We are a party to or have intellectual property subject to litigation and other proceedings that arise in the ordinary course of our business. These types of matters could result in fines, penalties, compensatory or treble damages or non-monetary sanctions or relief. We believe the probability is remote that the outcome of each of these matters, including the legal proceedings described below, will have a material adverse effect on the corporation as a whole, notwithstanding that the unfavorable resolution of any matter may have a material effect on our financial results in any particular interim reporting period. Among the factors that we consider in this assessment are the nature of existing legal proceedings and claims, the asserted or possible damages or loss contingency (if estimable), the progress of the case, existing law and precedent, the opinions or views of legal counsel and other advisers, our experience in similar cases and the experience of other companies, the facts available to us at the time of assessment and how we intend to respond to the proceeding or claim. Our assessment of these factors may change over time as individual proceedings or claims progress.
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Although we cannot predict the outcome of legal or other proceedings with certainty, where there is at least a reasonable possibility that a loss may have been incurred, U.S. GAAP requires us to disclose an estimate of the reasonably possible loss or range of loss or make a statement that such an estimate cannot be made. We follow a process in which we seek to estimate the reasonably possible loss or range of loss, and only if we are unable to make such an estimate do we conclude and disclose that an estimate cannot be made. Accordingly, unless otherwise indicated below in our discussion of legal proceedings, a reasonably possible loss or range of loss associated with any individual legal proceeding cannot be estimated.
We include various types of indemnification clauses in our agreements. These indemnifications may include, but are not limited to, infringement claims related to our intellectual property, direct damages and consequential damages. The type and amount of such indemnifications vary substantially based on our assessment of risk and reward associated with each agreement. We believe the estimated fair value of these indemnification clauses is minimal, and we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions. We have no liabilities recorded for these clauses as of September 30, 2020.
We have been involved in an ongoing dispute with a German company, Onespin solutions GmbH, regarding the co-existence of, or alleged infringement with, its trademark in certain jurisdictions for “ONESPIN” and our trademark in certain jurisdictions for “ONESPAN”. Onespin sells integrated circuit integrity verification solutions for use in the system on chip software development process flow. Subsequent to the end of the third quarter we reached an immaterial settlement with OneSpin on these matters. While certain administrative steps and filings will occur pursuant to the settlement, we consider this matter to now be closed.
A complaint was filed on August 20, 2020 against OneSpan and certain of its officers, asserting claims for purported violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), and SEC Rule 10b-5 promulgated thereunder, based on certain alleged material misstatements and omissions. The case is captioned Almendariz v. OneSpan Inc., et al., No. 1:20-cv-04906 (N.D. Ill.) (the “Securities Class Action”). Specifically, the plaintiff in the Securities Class Action alleges, among other things, that certain statements about OneSpan’s business were misleading because of defendants’ failure to disclose that OneSpan purportedly had inadequate internal procedures and controls over financial reporting and related disclosures; and OneSpan purportedly downplayed the negative impacts of immaterial errors in its financial statements.
A complaint, related in subject matter to the Securities Class Action, was filed on October 23, 2020 against certain of OneSpan’s officers and directors, and names OneSpan as a nominal defendant. The case is captioned Klein v. Boroditzky, et al., No. 1:20-cv-06310 (N.D. Ill.) (the “Derivative Action” and, collectively with the Securities Class Action, the “Litigation”). The plaintiff asserts claims for breach of fiduciary duty, abuse of control and corporate waste, as well as a claim for contribution under Sections 10(b) and 21D of the Exchange Act, based on the same alleged wrongdoing pled in the Securities Class Action. We believe that the claims in the Litigation are meritless and intend to defend against them vigorously.
From time to time, we have been involved in litigation and claims incidental to the conduct of our business, such as compensation claims from current or former employees in Europe. We expect that to continue. Excluding matters specifically disclosed above, we are not a party to any lawsuit or proceeding that, in management’s opinion, is likely to have a material adverse effect on its business, financial condition or results of operations.
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations (in thousands, except headcount, ratios, time periods and percentages)
Unless otherwise noted, references in this Quarterly Report on Form 10-Q to “OneSpan,” “Company,” “we,” “our,” and “us” refer to OneSpan Inc. and its subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q, contains forward-looking statements within the meaning of applicable U.S. Securities laws, including statements regarding the potential benefits, performance, and functionality of our
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products and solutions, including future offerings; our expectations, beliefs, plans, operations and strategies relating to our business and the future of our business; our acquisitions to date and our strategy related to future acquisitions; and our expectations regarding our financial performance in the future. Forward-looking statements may be identified by words such as "seek", "believe", "plan", "estimate", "anticipate", expect", "intend", and statements that an event or result "may", "will", "should", "could", or "might" occur or be achieved and any other similar expressions. These forward-looking statements involve risks and uncertainties, as well as assumptions which, if they do not fully materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could materially affect our business and financial results include, but are not limited to: market acceptance of our products and solutions and competitors’ offerings; the potential effects of technological changes; our ability to effectively identify, purchase and integrate acquisitions; the execution of our transformative strategy on a global scale; the increasing frequency and sophistication of hacking attacks; claims that we have infringed the intellectual property rights of others; changes in customer requirements; price competitive bidding; changing laws, government regulations or policies; pressures on price levels; investments in new products or businesses that may not achieve expected returns; impairment of goodwill or amortizable intangible assets causing a significant charge to earnings; exposure to increased economic and operational uncertainties from operating a global business as well as those factors set forth in our Form 10-K (and other forms) filed with the Securities and Exchange Commission. In particular, we direct you to the risk factors contained under the captions "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K. In addition, we direct you to our financial statements and the accompanying Notes to Financial Statements contained in this Report. Our SEC filings and other important information can be found on the Investor Relations section of our website at investors.onespan.com. We do not have any intent, and disclaim any obligation, to update the forward-looking information to reflect events that occur, circumstances that exist, or changes in our expectations after the date of this Report.
Revision of Previously Issued Financial Statements
This information should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in “Part I, Item 1” of this Quarterly Report. We have revised our prior period financial statements to reflect the correction of immaterial errors as described in this Quarterly Report in Notes to Condensed Consolidated Financial Statements, Note 1 – Description of the Company and Basis of Presentation, “Revision of Previously Issued Financial Statements”.
COVID-19 Pandemic Response and Impact
In March 2020, the World Health Organization recognized a novel strain of coronavirus (COVID-19) as a pandemic. In response to the pandemic, the United States and various foreign, state and local governments have, among other actions, imposed travel and business restrictions and required or advised communities in which we do business to adopt stay-at-home orders and social distancing guidelines, causing some businesses to adjust, reduce or suspend operating activities. The pandemic and the various governments’ response have caused significant and widespread uncertainty, volatility and disruptions in the U.S. and global economies, including in the regions in which we operate.
Outlook and Financial Results
Beginning in the Summer of 2020 and continuing through the three months ended September 30, 2020, we have experienced softened demand for certain of our products and services due to economic uncertainty connected with the continued seriousness of the COVID-19 pandemic.
In addition, we have begun to experience less demand than originally projected in our hardware business. As a result, our hardware revenues for 2020 could be substantially below such revenues as compared to 2019. We believe this is primarily due to the increased hardware demand we saw last year in Europe due to our customers needing to meet banking regulations imposed by Payment Services Directive 2 (“PSD2”). In addition, other factors could be contributing to the current and expected demand environment such as less demand for hardware in a pandemic environment, a more pronounced shift to digital alternatives, and fewer large projects that often had a significant positive effect on hardware revenue results in the past.
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In the current and future periods, we may experience weaker customer demand, requests for discounts or extended payment terms, customer bankruptcies, supply chain disruption, employee staffing constraints and difficulties, government restrictions or other factors that could negatively impact the Company and its business, operations and financial results.
As we cannot predict the duration or scope of the pandemic or its impact on economic and financial markets, any negative impact to our results cannot be reasonably estimated, but it could be material. We continue to monitor closely the Company’s financial health and liquidity and the impact of the pandemic on the Company. We are able to serve the needs of our customers while taking steps to protect the health and safety of our employees, customers, partners, and communities. See Part II – Item 1A – Risk Factors of this Form 10-Q for additional information regarding the potential impact of COVID-19 on the Company.
Overview
We design, develop and market digital solutions for identity, security, and business productivity that protect and facilitate electronic transactions via mobile and connected devices. We are a global leader in providing anti-fraud and digital transaction management solutions to financial institutions and other businesses. Our solutions secure access to online accounts, data, assets, and applications for global enterprises; provide tools for application developers to easily integrate security functions into their web-based and mobile applications; and facilitate end-to-end financial agreement automation including digital identity verification, customer due diligence, electronic signature, secure storage and document management. Our core technologies, multi-factor authentication, identity verification and transaction signing, strengthen the process of preventing hacking attacks against online and mobile transactions to allow companies to transact business safely with remote customers.
We offer cloud based and on premises solutions using both open standards and proprietary technologies. Some of our proprietary technologies are patented. Our products and services are used for authentication, fraud mitigation, e-signing transactions and documents, and identity management in Business-to-Business (“B2B”), Business-to-Employee (“B2E”) and Business-to-Consumer (“B2C”) environments. Our target market is business processes using electronic interface, particularly the Internet, where there is risk of unauthorized access. Our products can increase security associated with accessing business processes, reduce losses from unauthorized access and reduce the cost of the process by automating activities previously performed manually.
Our Business Model
We offer our products through a product sales and licensing model or through our services platform, which includes our cloud-based service offering.
Our solutions are sold worldwide through our direct sales force, as well as through distributors, resellers, systems integrators, and original equipment manufacturers. Our sales force is able to offer customers a choice of an on-site implementation using our traditional on-premises model or a cloud implementation for some solutions using our services platform.
Industry Growth
We believe the markets for authentication, fraud mitigation, agreement automation, and electronic signature solutions will continue to grow driven by new government regulations, growing awareness of the impact of cyber-crime, increasing focus on the digital experience for mobile and online users, and the growth in electronic commerce. The issues driving growth are global; however, the rate of adoption in each country is a function of local culture, competitive position, economic conditions, and the use of technology may vary significantly.
Economic Conditions
Our revenue may vary significantly with changes in the economic conditions in the countries in which we currently sell products. With our current concentration of revenue in Europe and specifically in the banking and finance
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vertical market, significant changes in the economic outlook for the European banking market may have a significant effect on our revenue.
The COVID-19 pandemic and the various governments’ response have caused significant and widespread uncertainty, volatility and disruptions in the U.S. and global economies, including in the regions in which we operate. See Part II, Item 1A – Risk Factors of this Form 10-Q for additional information regarding the potential impact of COVID-19 on the Company.
Cybersecurity Risks
Our use of technology is increasing and is critical in three primary areas of our business:
| 1. | Software and information systems that we use to help us run our business more efficiently and cost effectively; |
| 2. | The products we have traditionally sold and continue to sell to our customers for integration into their software applications contain technology that incorporates the use of secret numbers and encryption technology; and |
| 3. | New products and services that we introduced to the market are focused on processing information through our servers or in the cloud. |
We believe that the risks and consequences of potential incidents in each of the above areas are different.
In the case of the information systems we use to help us run our business, we believe that an incident could disrupt our ability to take orders or deliver product to our customers, but such a delay in these activities would not have a material impact on our overall results. To minimize this risk, we actively use various forms of security and monitor the use of our systems regularly to detect potential incidents as soon as possible.
In the case of products that we have traditionally sold, we believe that the risk of a potential cyber incident is minimal. We offer our customers the ability to either create the secret numbers themselves or have us create the numbers on their behalf. When asked to create the numbers, we do so in a secure environment with limited physical access and store the numbers on a system that is not connected to any other network, including other OneSpan networks, and similarly, is not connected to the Internet.
In the case of our cloud-based solutions, which involve the processing of customer information, we believe a cyber incident could have a material impact on our business. While our revenue from cloud-based solutions comprises a minority of our revenue today, we believe that these solutions will provide substantial future growth. A cyber incident involving these solutions in the future could substantially impair our ability to grow the business and we could suffer significant monetary and other losses and significant reputational harm.
To minimize the risk, we review our product security and procedures on a regular basis. Our reviews include the processes and software code we are currently using as well as the hosting platforms and procedures that we employ. We mitigate the risk of cyber incidents through a series of reviews, tests, tools and training. Certain insurance coverages may apply to certain cyber incidents. Overall, we expect the cost of securing our networks will increase in future periods, whether through increased staff, systems or insurance coverage.
While we did not experience any cyber incidents in the first nine months of 2020 that had a significant impact on our business, it is possible that we could experience an incident in 2020 or future years, which could result in unanticipated costs.
Currency Fluctuation
During the three and nine months ended September 30, 2020, approximately 90% and 89%, respectively, of our revenue was generated outside of the United States. While the majority of our revenues are generated outside of the
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United States, a significant amount of our revenue earned during the three and nine months ended September 30, 2020 was denominated in U.S. Dollars. During the three and nine months ended September 30, 2020, we estimate that approximately 33% and 42%, respectively, of our revenue was denominated in U.S. Dollars.
In addition, during the three and nine months ended September 30, 2020, approximately 73% and 73% of our operating expenses were incurred outside of the United States. As a result, changes in currency exchange rates, especially the Euro exchange rate and the Canadian Dollar exchange rate, can have a significant impact on revenue and expenses.
In general, to minimize the net impact of currency fluctuations on operating income, we attempt to denominate an amount of billings in a currency such that it would provide a hedge against the operating expenses incurred in that currency. We expect that changes in currency rates may also impact our future results if we are unable to match amounts of revenue with our operating expenses in the same currency. If the amount of our revenue in Europe denominated in Euros continues as it is now or declines, we may not be able to balance fully the exposures of currency exchange rates on revenue and operating expenses.
The financial position and the results of operations of our foreign subsidiaries, with the exception of our subsidiaries in Switzerland, Singapore and Canada, are measured using the local currency as the functional currency. Accordingly, assets and liabilities are translated into U.S. Dollars using current exchange rates as of the balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the period. Translation adjustments arising from differences in exchange rates generated other comprehensive gain of $3.5 million for the three months ended September 30, 2020 and other comprehensive loss of $0.4 million for the nine months ended September 30, 2020. For the three and nine months ended September 30, 2019, translation adjustments generated other comprehensive loss of $3.0 million and $3.5 million, respectively. These amounts are included as a separate component of stockholders’ equity. The functional currency for our subsidiaries in Switzerland, Singapore and Canada is the U.S. Dollar.
Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations in other income (expense), net. Foreign exchange transaction gains aggregated $0.4 million for the three months ended September 30, 2020, compared to $1.9 million of foreign exchange transaction losses aggregated for the three months ended September 30, 2019. During the nine months ended September 30, 2020, foreign exchange transaction losses aggregated $0.1 million compared to losses aggregated of $2.6 million during the nine months ended September 30, 2019.
Components of Operating Results
Revenue
We generate revenue from the sale of our hardware products, software licenses, subscriptions, maintenance and support, and professional services. We believe comparison of revenues between periods is heavily influenced by the timing of orders and shipments reflecting the transactional nature of significant parts of our business.
| ● | Product and license revenue. Product and license revenue includes hardware products and software licenses, which can be provided on a perpetual or term basis. |
| ● | Service and other revenue. Service and other revenue includes subscription solutions (which is our definition of software-as-a-service solutions), maintenance and support, and professional services. |
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Cost of Goods Sold
Our total cost of goods sold consists of cost of product and license revenue and cost of service and other revenue. We expect our cost of goods sold to increase in absolute dollars as our business grows, although it may fluctuate as a percentage of total revenue from period to period.
| ● | Cost of product and license revenue. Cost of product and license revenue primarily consists of direct product and license costs. |
| ● | Cost of service and other revenue. Cost of service and other revenue primarily consists of costs related to subscription solutions, including personnel and equipment costs, and personnel costs of employees providing professional services and maintenance and support. |
Gross Profit
Gross profit as a percentage of total revenue, or gross margin, has been and will continue to be affected by a variety of factors, including our average selling price, manufacturing costs, the mix of products sold, and the mix of revenue among products, subscriptions and services. We expect our gross margins to fluctuate over time depending on these factors.
Operating Expenses
Our operating expenses are generally based on anticipated revenue levels and fixed over short periods of time. As a result, small variations in revenue may cause significant variations in the period-to-period comparisons of operating income or operating income as a percentage of revenue.
Generally, the most significant factor driving our operating expenses is headcount. Direct compensation and benefit plan expenses generally represent between 55% and 65% of our operating expenses, respectively. In addition, a number of other expense categories are directly related to headcount. We attempt to manage our headcount within the context of the economic environments in which we operate and the investments we believe we need to make for our infrastructure to support future growth and for our products to remain competitive.
Historically, operating expenses have been impacted by changes in foreign exchange rates. We estimate the change in currency rates in the first nine months of 2020 compared to the same period in 2019 resulted in an increase in operating expenses of approximately $0.2 million.
The comparison of operating expenses can also be impacted significantly by costs related to our stock-based and long-term incentive plans. Operating expenses for the three and nine months ended September 30, 2020 included $1.3 million and $4.2 million, respectively of expenses related to stock-based and long-term incentive plan costs compared to $0.8 million and $3.3 million of stock-based and long-term incentive plan cost for the three and nine months ended September 30, 2019, respectively.
| ● | Sales and marketing. Sales and marketing expenses consist primarily of personnel costs, commissions and bonuses, trade shows, marketing programs and other marketing activities, travel, outside consulting costs, and long-term incentive compensation. We expect sales and marketing expenses to increase in absolute dollars as we continue to invest in sales resources in key focus areas, although our sales and marketing expenses may fluctuate as a percentage of total revenue. |
| ● | Research and development. Research and development expenses consist primarily of personnel costs and long-term incentive compensation. We expect research and development expenses to increase in absolute dollars as we continue to invest in our future solutions, although our research and development expenses may fluctuate as a percentage of total revenue. |
| ● | General and administrative. General and administrative expenses consist primarily of personnel costs, legal and other professional fees, and long term incentive compensation. We expect general and |
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| administrative expenses to increase in absolute dollars although our general and administrative expenses may fluctuate as a percentage of total revenue. |
| ● | Amortization of intangible assets. Acquired intangible assets are amortized over their respective amortization periods, and are periodically evaluated for impairment. |
Interest Income, Net
Interest income, net consists of income earned on our cash equivalents and short term investments. Our cash equivalents and short term investments are invested in short-term instruments at current market rates.
Other Income (Expense), Net
Other income (expense), net primarily includes exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries’ functional currencies, subsidies received from foreign governments in support of our research and development in those countries and other miscellaneous non-operational expenses.
Income Taxes
Our effective tax rate reflects our global structure related to the ownership of our intellectual property (“IP”). All our IP in our traditional authentication business is owned by two subsidiaries, one in the U.S. and one in Switzerland. These two subsidiaries have entered into agreements with most of the other OneSpan entities under which those other entities provide services to our U.S. and Swiss subsidiaries on either a percentage of revenue or on a cost plus basis or both. Under this structure, the earnings of our service provider subsidiaries are relatively constant. These service provider companies tend to be in jurisdictions with higher effective tax rates. Fluctuations in earnings tend to flow to the U.S. company and Swiss company. In 2020, earnings flowing to the U.S. company are expected to be taxed at a rate of 21% to 25%, while earnings flowing to the Swiss company are expected to be taxed at a rate ranging from 11% to 12%, plus Swiss withholding tax of an additional 5%. A Canadian and UK subsidiary currently sell to and service global customers directly. In addition, many of our OneSpan entities operate as distributors for all of our OneSpan products.
As the majority of our revenues are generated outside of the U.S., our consolidated effective tax rate is strongly influenced by the effective tax rate of our foreign operations. Changes in the effective rate related to foreign operations reflect changes in the geographic mix of earnings and the tax rates in each of the countries in which it is earned. The statutory tax rate for the primary foreign tax jurisdictions ranges from 11% to 35%.
The geographic mix of earnings of our foreign subsidiaries primarily depends on the level of pretax income of our service provider subsidiaries and the benefit realized in Switzerland through the sales of product. The level of pretax income in our service provider subsidiaries is expected to vary based on:
| 1. | the staff, programs and services offered on a yearly basis by the various subsidiaries as determined by management, or |
| 2. | the changes in exchange rates related to the currencies in the service provider subsidiaries, or |
| 3. | the amount of revenues that the service provider subsidiaries generate. |
For items 1 and 2 above, there is a direct impact in the opposite direction on earnings of the U.S. and Swiss entities. Any change from item 3 is generally expected to result in a larger change in income in the U.S. and Swiss entities in the direction of the change (increased revenues expected to result in increased margins/pretax profits and conversely decreased revenues expected to result in decreased margins/pretax profits).
In addition to the provision of services, the intercompany agreements transfer the majority of the business risk to our U.S. and Swiss subsidiaries. As a result, the contracting subsidiaries’ pretax income is reasonably assured while the pretax income of the U.S. and Swiss subsidiaries varies directly with our overall success in the market.
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In November 2015, we acquired OneSpan Canada Inc. (formerly eSignLive), a foreign company with substantial IP and net operating losses and other tax carryforwards. The tax benefit of the carryforwards has been fully reserved as realization has not been deemed more likely than not.
In May 2018, we acquired Dealflo Limited (“Dealflo”), a foreign company with substantial IP and net operating losses. The tax benefit of the loss carryforwards will be reserved to the extent they exceed the deferred tax liabilities recognized upon acquisition as realization has not been deemed more likely than not.
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Results of Operations
Revenue
Revenue by Product: We generate revenue from the sale of our hardware products, software licenses, subscriptions, professional services, and maintenance and support. Product and license revenue includes hardware products and software licenses. Service and other revenue includes subscription solutions (which is our definition of software-as-a-service solutions), maintenance and support, and professional services.
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | |||||||
(in thousands) | (in thousands) | ||||||||||||
Revenue |
|
|
|
|
|
|
|
|
| ||||
Product and license | $ 30,249 | $ 61,215 | -51% | $ 103,893 | $ 132,675 | -22% | |||||||
Services and other | 21,190 | 18,476 |
| 15% | 58,870 | 50,278 |
| 17% | |||||
Total revenue | $ 51,439 | $ 79,691 |
| -35% | $ 162,763 | $ 182,953 |
| -11% | |||||
| |||||||||||||
% of Total Revenue | |||||||||||||
Product and license | 59% | 77% | 64% | 73% | |||||||||
Services and other | 41% | 23% | 36% | 27% | |||||||||
Total revenue decreased $28.3 million or 35%, during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. The overall decrease in revenue was comprised of a $20.3 million decrease in hardware revenue, a $5.8 million decrease in perpetual software license revenue, and a decrease in recurring revenue, which is the portion of our revenue subject to future renewal. Recurring revenue, comprised of subscription, term-based software license, and maintenance, support and other revenue, decreased $1.2 million or 5% during the three months ended September 30, 2020, compared to the three months ended September 30, 2019. Total revenue decreased $20.2 million or 11%, during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, driven by a $29.7 million decrease in hardware revenue and a $5.8 million decrease in perpetual software license revenue, partially offset by an increase in recurring revenue. Recurring revenue increased $15.2 million or 27% during the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019. Year-over-year revenue comparisons were affected by the one-time positive impact on 2019 revenue from the PSD2 regulation deadline. We also experienced reduced demand for our hardware and term software license products due to an uncertain near-term business outlook for certain of our customers as a result of the pandemic.
Product and license revenue decreased $31.0 million or 51% during the three months ended September 30, 2020 compared to the three months ended September 30, 2019, which was largely driven by a decrease in hardware sales. Hardware sales were heightened during the three months ended September 30, 2019 because of the PSD2 regulation deadline, as well as lower demand due to the pandemic. Software license sales also decreased during the three months ended September 30, 2020 compared to the three months ended September 30, 2019, which we attribute to softened demand as a result of the pandemic. For the nine months ended September 30, 2020, product and license revenue decreased $28.8 million or 22% compared to the nine months ended September 30, 2019, which was driven by lower hardware sales, partially offset by higher software license revenue. The software license revenue increase was driven by an increase in revenue generated from term-based software licenses. The hardware sales decrease was primarily driven by PSD2 driven demand during the nine months ended September 30, 2019, as well as softened demand due to the pandemic.
Services and other revenue increased by $2.7 million, or 15% during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. For the nine months ended September 30, 2020, services and other revenue increased $8.6 million or 17% compared to the nine months ended September 30, 2019. The increase for both the three and nine month periods ended September 30, 2020 compared to the same periods in 2019 was driven by higher subscription and maintenance revenue.
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We believe comparison of revenues between periods is heavily influenced by the timing of orders and shipments reflecting the transactional nature of significant parts of our business. As a result of the volatility in our business, we believe that the overall strength of our business is best evaluated over a longer term where the impact of transactions in any given period is not as significant as in a quarter-over-quarter comparison.
Revenue by Geographic Regions: We classify our sales by customer location in three geographic regions: 1) EMEA, which includes Europe, Middle East and Africa; 2) the Americas, which includes sales in North, Central, and South America; and 3) Asia Pacific (APAC), which also includes Australia, New Zealand, and India. The breakdown of revenue in each of our major geographic areas was as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||
| 2020 | 2019 | % Change | 2020 |
| 2019 | % Change | |||||
(in thousands) | (in thousands) | |||||||||||
Revenue |
|
|
|
|
|
|
|
| ||||
EMEA | $ 26,684 | $ 48,694 | -45% | $ 88,624 | $ 107,554 | -18% | ||||||
Americas | 12,305 | 15,605 |
| -21% | 38,570 | 42,762 |
| -10% | ||||
APAC | 12,450 | 15,392 | -19% | 35,569 | 32,637 | 9% | ||||||
Total revenue | $ 51,439 | $ 79,691 |
| -35% | $ 162,763 | $ 182,953 |
| -11% | ||||
| ||||||||||||
% of Total Revenue | ||||||||||||
EMEA | 52% | 61% | 54% | 59% | ||||||||
Americas | 24% | 20% | 24% | 23% | ||||||||
APAC | 24% | 19% | 22% | 18% | ||||||||
Revenue generated in EMEA during the three months ended September 30, 2020 was $22.0 million, or 45% lower than the three months ended September 30, 2019. For the nine months ended September 30, 2020, revenue generated in EMEA was $18.9 million or 18% lower than the same period in 2019, driven by lower hardware sales, partially offset by higher software license revenue and higher maintenance revenue. Hardware revenue comparisons for both periods were affected by the one-time positive impact on 2019 revenue from the PSD2 regulation deadline.
Revenue generated in the Americas during the three months ended September 30, 2020 was $3.3 million, or 21% lower than the three months ended September 30, 2019, driven by a decrease in software license revenue. For the nine months ended September 30, 2020, revenue generated in the Americas was $4.2 million or 10% lower than the same period in 2019, driven by lower software license revenue.
Revenue generated in the Asia Pacific region during the three months ended September 30, 2020 was $2.9 million, or 19% lower than the three months ended September 30, 2019, driven by lower revenue from software licenses, hardware and maintenance. For the nine months ended September 30, 2020, revenue generated in the Asia Pacific region was $2.9 million or 9% higher than the same period in 2019, driven by higher software, maintenance, and hardware revenue.
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Cost of Goods Sold and Gross Margin
Three months ended September 30, | Nine months ended September 30, | |||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | ||||||
(in thousands) | (in thousands) | |||||||||||
Cost of goods sold |
|
|
|
|
|
|
|
|
| |||
Product and license | $ 10,064 | $ 22,199 | -55% | $ 33,378 | $ 46,966 | -29% | ||||||
Services and other | 5,414 | 4,470 |
| 21% | 16,395 | 13,622 |
| 20% | ||||
Total cost of goods sold | $ 15,478 | $ 26,669 |
| -42% | $ 49,773 | $ 60,588 |
| -18% | ||||
Gross profit | $ 35,961 | $ 53,022 | -32% | $ 112,990 | $ 122,365 | -8% | ||||||
| ||||||||||||
Gross margin | ||||||||||||
Product and license | 67% | 64% | 68% | 65% | ||||||||
Services and other | 74% | 76% | 72% | 73% | ||||||||
Total gross margin | 70% | 67% | 69% | 67% | ||||||||
The cost of product and license revenue decreased $12.1 million or 55% during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. During the nine months ended September 30, 2020, the cost of product and license revenue decreased $13.6 million or 29% compared to the nine months ended September 30, 2019. The decrease in cost of product and license during both periods was primarily driven by lower hardware sales.
The cost of services and other revenue increased by $0.9 million, or 21% during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. For the nine months ended September 30, 2020, the cost of services and other revenue increased by $2.8 million, or 20% compared to the nine months ended September 30, 2019. The increase in cost of services and other revenue for both periods is reflective of higher subscription revenue, which has increased cloud-based infrastructure costs.
Gross profit decreased $17.1 million, or 32% during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. During the nine months ended September 30, 2020 gross profit decreased by $9.4 million, or 8% compared to the nine months ended September 30, 2019. Gross profit margin was 70% and 69% for the three and nine months ended September 30, 2020, respectively, compared to 67% and 67% for the three and nine months ended September 30, 2019, respectively. The overall increase in profit margins for the three months ended September 30, 2020 was driven by higher product and license margins, largely attributable to lower hardware revenue as a percentage of overall sales. The increase in profit margins for the nine months ended September 30, 2020 was driven by stronger margins for product and license as well as services and other.
The majority of our inventory purchases are denominated in U.S. Dollars. Our sales are denominated in various currencies including the Euro. The impact of changes in currency rates are estimated to have increased revenue by approximately $1.8 million and less than $0.1 million for the three and nine months ended September 30, 2020, respectively. Had currency rates in 2020 been equal to rates in 2019, the gross profit margins would have been approximately 3.4 percentage points and zero percentage points lower for the three and nine months ended September 30, 2020, respectively.
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Operating Expenses
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | ||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Operating costs |
|
|
|
|
|
|
|
|
| |||||||
Sales and marketing | $ | 14,576 | $ | 14,156 | 3% | $ | 44,129 | $ | 44,579 | -1% | ||||||
Research and development | 10,643 | 9,956 |
| 7% | 31,178 | 32,428 |
| -4% | ||||||||
General and administrative | 10,737 | 9,490 | 13% | 33,851 | 29,540 |
| 15% | |||||||||
Amortization of intangible assets | 2,360 | 2,335 | 1% | 7,049 | 7,051 |
| -- | |||||||||
Total operating costs | $ | 38,316 | $ | 35,937 |
| 7% | $ | 116,207 | $ | 113,598 |
| 2% | ||||
Sales and Marketing Expenses
Sales and marketing expenses for the three months ended September 30, 2020 were $14.6 million, an increase of $0.4 million or 3%, from the three months ended September 30, 2019. The increase in expense for the three months ended September 30, 2020 was primarily driven by higher personnel costs due to higher headcount, as well as increased marketing spend, partially offset by lower travel costs. Sales and marketing expenses for the nine months ended September 30, 2020 were $44.1 million, a decrease of $0.5 million from the same period in 2019. Costs associate with higher headcount during the nine months ended September 30, 2020 were partially offset by lower outside service and travel spend.
Average full-time sales, marketing, support, and operating employee headcount for the three and nine months ended September 30, 2020 was 353 and 345, respectively, compared to 318 and 319 for the three and nine months ended September 30, 2019, respectively. Headcount was 11% and 8% higher for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019.
Research and Development Expenses
Research and development expenses for the three months ended September 30, 2020, were $10.6 million, an increase of $0.7 million, or 7%, from the three months ended September 30, 2019, driven primarily by higher personnel due to higher headcount. Research and development costs for the nine months ended September 30, 2020 were $31.2 million, a decrease of $1.3 million or 4%, from the same period in 2019. The decreases in expense for the nine month period ended September 30, 2020 was primarily driven by lower cloud computing costs for our test environment and lower travel costs, partially offset by higher personnel costs.
Average full-time research and development employee headcount for the three and nine months ended September 30, 2020 was 326 and 322, respectively, compared to 304 and 301 for the three and nine months ended September 30, 2019, respectively. Average headcount was approximately 7% higher for both the three and nine months ended September 30, 2020, when compared to the same periods in 2019.
General and Administrative Expenses
General and administrative expenses for the three months ended September 30, 2020, were $10.7 million, an increase of $1.2 million or 13%, from the three months ended September 30, 2019. General and administrative expenses for the nine months ended September 30, 2020, were $33.9 million, an increase of $4.3 million or 15%, compared to the same period in 2019. The increase in general and administrative expenses for the three and nine months ended September 30, 2020, compared to the same periods in 2019 was primarily driven by higher personnel costs which included additional stock comp due to an increase in eligible participants. The increase in expense was also driven by higher consulting spend, additional expense for subscription software tools implemented throughout 2019, and higher bad debt expense driven by a higher allowance for the likely adverse impact of the COVID-19 pandemic. Lower travel costs partially offset spend increases.
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Average full-time general and administrative employee headcount for the three and nine months ended September 30, 2020 was 126 and 122, compared to 115 and 112 for the three and nine months ended September 30, 2019, respectively. Average headcount was approximately 10% and 9% higher for the three and nine months ended September 30, 2020, respectively, when compared to the same periods in 2019.
Amortization of Intangible Assets
Amortization of intangible assets for the three and nine months ended September 30, 2020 was $2.4 million and $7.0 million, respectively. There was an increase of less than $0.1 million or 1% for the three months ended September 30, 2020 compared to the same period in the prior year. For the nine months ended September 30, 2020, the expense decreased by less than $0.1 million or less than 1% compared to the same period in the prior year.
Interest Income, net
Three months ended September 30, | Nine months ended September 30, | |||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | ||||||
(in thousands) | (in thousands) | |||||||||||
Interest income, net | $ 56 | $ 228 | -75% | $ 389 | $ 432 | -10% | ||||||
Interest income, net was less than $0.1 million and $0.4 million for the three and nine months ended September 30, 2020, as compared to $0.2 million and $0.4 million for the same periods in 2019. The decrease in interest income, net for both the three and nine months ended September 30, 2020 compared to the same periods in 2019 reflects a decrease in interest rates during the nine months ended September 30, 2020.
Other income (expense), net
Three months ended September 30, | Nine months ended September 30, | |||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | ||||||
(in thousands) | (in thousands) | |||||||||||
Other income (expense), net | $ 716 | $ (1,611) | nm | $ 887 | $ (1,711) | nm | ||||||
Other income (expense), net primarily includes subsidies received from foreign governments in support of our research and development in those countries, exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries’ functional currencies, and other miscellaneous non-operational, non-recurring expenses.
Other income (expense), net for the three and nine months ended September 30, 2020 was $0.7 million and $0.9 million, respectively, compared to $(1.6) million and $(1.7) million for the comparable periods of 2019. Higher income for both the three and nine month periods ended September 30, 2020 was primarily driven by exchange gains on transactions that are denominated in currencies other than our subsidiaries’ functional currencies.
Provision for Income Taxes
Three months ended September 30, | Nine months ended September 30, | |||||||||||
| 2020 | 2019 | % Change | 2020 | 2019 | % Change | ||||||
(in thousands) | (in thousands) | |||||||||||
Provision for income taxes | $ 95 | $ 3,855 | -98% | $ 1,758 | $ 4,208 | -58% | ||||||
The Company recorded income tax expense of $0.1 million for the three months ended September 30, 2020 compared to $3.9 million for the three months ended September 30, 2029. The Company recorded income tax expense for the nine months ended September 30, 2020 of $1.8 million, compared to $4.2 million for the nine months ended September 30, 2019. The decrease in expense for both periods was attributable to decreased profits in the period excluding losses at entities where we cannot record a tax benefit.
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For the three and nine months ended September 30, 2020, the Company utilized the discrete effective tax rate method, as allowed by ASC 740-270-30-18, “Income Taxes—Interim Reporting,” to calculate its interim income tax provision. The discrete method is applied when the application of the estimate annual effective tax rate yields an estimate that is not reliable and the actual effective tax rate for the year-to-date is the best estimate of the annual effective tax rate. The discrete method treats the year to date period as if it was the annual period and determines the income tax expense or benefit on that basis. The Company believes that the use of the estimated annual effective tax rate method is not reliable since small changes in the projected ordinary annual income would result in significant changes in the estimated annual effective tax rate.
Liquidity and Capital Resources
At September 30, 2020, we had net cash balances (total cash and cash equivalents) of $85.9 million and short-term investments of $26.8 million. Short term investments consist of U.S. treasury bills and notes, government agency notes, corporate notes and bonds, and high quality commercial paper with maturities at acquisition of more than three months and less than twelve months.
At December 31, 2019, we had net cash balances of $84.3 million and short-term investments of $25.5 million.
We are in a lease agreement that required a letter of credit in the amount of $0.8 million to secure the obligation. The restricted cash related to this letter of credit is recorded in other non-current assets on the Condensed Consolidated Balance Sheet at September 30, 2020 and December 31, 2019. Our working capital at September 30, 2020 was $135.5 million compared to $136.0 million at December 31, 2019.
As of September 30, 2020, we held $83.2 million of cash and cash equivalents in subsidiaries outside of the United States. Of that amount, $82.6 million is not subject to repatriation restrictions, but may be subject to taxes upon repatriation.
We believe that our financial resources are adequate to meet our operating needs over the next twelve months.
Our cash flows are as follows:
Nine months ended September 30, | |||||
| 2020 | 2019 | |||
(in thousands) | |||||
Cash provided by (used in): |
|
|
|
| |
Operating activities | $ 7,429 | $ (13,662) | |||
Investing activities | (4,123) | (7,609) |
| ||
Financing activities | (1,963) | (394) | |||
Effect of foreign exchange rate changes on cash and cash equivalents | 306 | (154) | |||
Operating Activities
Cash generated by operating activities is primarily comprised of net income, as adjusted for non-cash items, and changes in operating assets and liabilities. Non-cash adjustments consist primarily of amortization and impairment of intangible assets, depreciation of property and equipment, and stock-based compensation. We expect cash inflows from operating activities to be affected by increases or decreases in sales and timing of collections. Our primary uses of cash from operating activities have been for personnel costs. We expect cash outflows from operating activities to be affected by increases in personnel cost as we grow our business.
For the nine months ended September 30, 2020, net cash provided by operating activities was $7.4 million, compared to net cash used in operating activities of $13.7 million during the nine months ended September 30, 2019. The fluctuation is primarily driven by a lower accounts receivable balance, a lower inventory balance, and the timing of cash receipts accrued in deferred revenue.
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Investing Activities
The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments, purchases of property and equipment, and activity in connection with acquisitions. We expect to continue to purchase property and equipment to support the continued growth of our business as well to continue to invest in our infrastructure and activity in connection with acquisitions.
For the nine months ended September 30, 2020, net cash used in investing activities was $4.1 million, compared to net cash used in investing activities of $7.6 million for the nine months ended September 30, 2019. The decrease is related to the timing of the purchases and maturities of our short term investments.
Financing Activities
Cash used in financing activities is comprised of tax payments for restricted stock issuances.
For the nine months ended September 30, 2020, net cash used in financing activities was $2.0 million, compared to net cash used in financing activities of $0.4 million for the nine months ended September 30, 2019. The increase is due to a higher volume of vested shares during the nine months ended September 30, 2020, compared to the comparable period in 2019.
On June 10, 2020, the Board of Directors authorized a share repurchase program (“program”), pursuant to which the Company can repurchase up to $50.0 million of issued and outstanding common stock. Share purchases under the program will take place in open market transactions or in privately negotiated transactions and may be made from time to time depending on market conditions, share price, trading volume, and other factors. The timing of the repurchases and the amount of stock repurchased in each transaction is subject to OneSpan’s sole discretion and will depend upon market and business conditions, applicable legal and credit requirements and other corporate considerations. As of September 30, 2020, no shares had been repurchased under the program. The authorization is effective until June 10, 2022 unless the total amount has been used or authorization has been cancelled.
Critical Accounting Policy
Our accounting policies are fully described in Note 1 - Summary of Significant Accounting Policies, to our Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2019 and Note 2 – Summary of Significant Accounting Policies to our Interim Unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020. We believe our most critical accounting policies include revenue recognition, purchase accounting and related fair value measurements and accounting for income taxes.
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in our market risk during the nine months ended September 30, 2020. For additional information, refer to “Item 7A. Quantitative and Qualitative Disclosures about Market Risk”, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
Item 4 - Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, who, respectively, are our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure (i) the information required to be disclosed by us in our reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or
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submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Controls
There were no changes in our internal control over financial reporting (as that term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting
Inherent Limitations on the Effectiveness of Controls
Internal control over financial reporting has inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements will not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
PART II. OTHER INFORMATION
Item 1 - Legal Proceedings
We are a party to or have intellectual property subject to litigation and other proceedings that arise in the ordinary course of our business. These types of matters could result in fines, penalties, compensatory or treble damages or non-monetary sanctions or relief. We believe the probability is remote that the outcome of each of these matters, including the legal proceedings described below, will have a material adverse effect on the corporation as a whole, notwithstanding that the unfavorable resolution of any matter may have a material effect on our financial results in any particular interim reporting period.
We cannot predict the outcome of legal or other proceedings with certainty, including the legal proceedings which are summarized in “Note 14 – Legal Proceedings and Contingencies” included in our Notes to Condensed Consolidated Financial Statements, incorporated herein by reference, and “Note 15 – Commitments and Contingencies” in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the U.S. Securities and Exchange Commission. Any reasonably possible material loss or range of loss associated with any individual legal proceeding that can be estimated, is provided in Note 14 to the Condensed Consolidated Financial Statements contained herein.
Item 1A – Risk Factors
The following risk factor is provided to update the risk factors previously disclosed under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
While we believe the coronavirus could have a negative impact on our financial results in the future, the impact is difficult to assess at this time.
The effects of the COVID-19 pandemic have materially affected how we and our customers are operating our businesses, and the duration and extent to which this will impact our future results of operations and overall financial performance remains uncertain.
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In December 2019, a novel coronavirus disease (“COVID-19”) was reported and in January 2020, the World Health Organization (“WHO”) declared it a Public Health Emergency of International Concern. On February 28, 2020, the WHO raised its assessment of the COVID-19 threat from high to very high at a global level due to the continued increase in the number of cases and affected countries, and on March 11, 2020, the WHO characterized COVID-19 as a pandemic. A significant outbreak of epidemic, pandemic, or contagious diseases in the human population could result in a widespread health crisis that could adversely affect the broader economies, financial markets and overall demand environment for our products.
As a result of the COVID-19 pandemic, we temporarily closed our offices in March 2020 (including our corporate headquarters) in many countries except where we have been able to accommodate limited essential employees such as for the shipping of our hardware authentication tokens under revised procedures.We re-opened a limited number of our offices during the third quarter of 2020 with limited capacity under revised procedures. We are unable to predict further re-openings or whether the initial re-openings will be successful or remain in place. We implemented certain travel restrictions, remote work arrangements and other measures and while our early experience with this new situation has been satisfactory to date, it has disrupted how we normally operate our business and may in the longer term impact our productivity, innovation and effectiveness such that our results are adversely affected. We have shifted certain of our customer events to virtual-only experiences and we may deem it advisable to similarly alter, postpone or cancel entirely additional customer, employee or industry events in the future. Because we operate in multiple international locations, we expect there to be variability and additional complications from differing conditions and inconsistent guidance from numerous public health agencies.
In our hardware business, we are exposed to specific risks related to manufacturing, supply chain, shipping and distribution- all of which have been impacted by the COVID-19 pandemic. As a result of COVID-19, we experienced some delays and increased costs related to fulfilling our hardware orders. Such issues have been primarily resolved however we may be unable to satisfy certain customer orders for our products in the future if orders substantially increase and/or supply chain problems emerge. In addition, the global economic uncertainty associated with the COVID-19 pandemic has affected many of our customers and we believe one of those effects has been decreased orders of hardware authentication tokens. We are not able to predict at this time whether and to what extent such orders may return or in what specific quantities. This risk is in addition to the other risks associated with our hardware business as stated elsewhere in “Risk Factors.”
In our software business, we experienced some increased sales for products used in remote employee access and electronic signature in 2020 that we attribute in part to the COVID-19 pandemic. This increase may have been temporary, and we are unable to predict whether it will continue or decline. Moreover, the conditions caused by the COVID-19 pandemic can affect the rate of IT spending, the decision to start new IT projects, the timing of existing projects and the priority our customers place on various projects. While these factors may be positive for some of our software solutions such as electronic signature, these factors may be negative for our other software solutions, such as risk analysis software. The COVID-19 pandemic could adversely affect our customers’ ability or willingness to attend our events or to purchase our offerings, delay prospective customers’ purchasing decisions, adversely impact our ability to provide on-site sales meetings or professional services to our customers, delay the provisioning of our offerings, lengthen payment terms, reduce the value or duration of their contracts, or affect attrition rates, all of which could adversely affect our future sales, operating results and overall financial performance. During the Summer of 2020, we began to experience some of the aforementioned scenarios, and this continued through the Fall of 2020, due to, we believe, global economic uncertainty connected with the continued seriousness of the COVID-19 pandemic. While we hope that the negative consequences on our business associated with the COVID-19 pandemic will subside in 2021, we cannot predict the impact with certainty.
If the restrictions on our employees, customers and others in the world continue or increase in order to limit the spread of COVID-19, the potential effects could continue and could be exacerbated, and our results of operations and overall financial performance may be harmed. The duration and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of the virus, the extent and effectiveness of containment actions and the impact of these and other factors on our
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employees, customers, partners and vendors. If we are not able to respond to and manage the impact of such events effectively, our business will be harmed.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about purchases by the Company of its shares of common stock during the second quarter of 2020:
Total Number | |||||||||
of Shares | Maximum | ||||||||
Purchased as | Dollar Value of Shares | ||||||||
Total | Part of Publicly | that May Yet Be | |||||||
Number of | Average | Announced | Purchased Under | ||||||
Shares Purchased | Price Paid | Plans or | the Plans or | ||||||
Period |
| (1) |
| per Share |
| Programs (2) |
| Programs (2) | |
July 1, 2020 through July 31, 2020 |
| 21,720 | $ | 27.58 |
| — |
| 50,000,000 | |
August 1, 2020 through August 31, 2020 |
| 5,340 | $ | 31.14 |
| — |
| 50,000,000 | |
September 1, 2020 through September 30, 2020 |
| 1,351 | $ | 20.79 |
| — |
| 50,000,000 | |
| (1.) | All transactions represent surrender of vested shares in satisfaction of tax withholdings by grantees under the 2019 Omnibus Incentive Plan. |
| (2.) | On June 10, 2020, the Board of Directors authorized a share repurchase program (“program”), pursuant to which the Company can repurchase up to $50.0 million of issued and outstanding common stock. Share purchases under the program will take place in open market transactions or in privately negotiated transactions and may be made from time to time depending on market conditions, share price, trading volume, and other factors. The timing of the repurchases and the amount of stock repurchased in each transaction is subject to OneSpan’s sole discretion and will depend upon market and business conditions, applicable legal and credit requirements and other corporate considerations. The authorization is effective until June 10, 2022 unless the total amount has been used or authorization has been cancelled. |
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Item 5 – Other Information
As disclosed in the Company’s current report on Form 8-K filed June 15, 2020, the Company held its annual meeting of stockholders on June 10, 2020. Among the matters submitted to a vote of the stockholders was an advisory vote to approve the frequency of future advisory votes on executive compensation. The stockholders approved, on an advisory basis, a frequency of every year for future advisory votes to approve the Company’s executive compensation (“say on pay”). There were 19,121,924 votes cast for a frequency of every year; 25,085 votes cast for a frequency of every two years; 13,861,687 votes cast for a frequency of every three years; and 18,235 abstentions.
Based on these results, the Board of Directors has determined that the Company will hold say on pay votes every year, until the next required advisory vote on the frequency of say on pay votes.
Item 6 - Exhibits
Exhibit 101.INS – XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
Exhibit 101.SCH – XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL – XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.LAB – XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE – XBRL Taxonomy Extension Presentation Linkbase Document
Exhibit 101.DEF – XBRL Taxonomy Extension Definition Linkbase Document
Exhibit 104 – The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
*Certain exhibits, schedules and annexes have been omitted pursuant to Item 601(b)(2) of Regulation S-K. OneSpan undertakes to furnish copies of any such omitted items upon request by the Securities and Exchange Commission.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 5, 2020.
OneSpan Inc. | |
/s/ Scott Clements | |
Scott Clements | |
Chief Executive Officer (Principal Executive Officer) | |
/s/ Mark S. Hoyt | |
Mark S. Hoyt | |
Chief Financial Officer | |
(Principal Financial Officer and Principal Accounting Officer) |
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