Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations (in thousands, except head count, ratios, time periods and percentages)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under Item 1A – Risk Factors and elsewhere in this Form 10-K. These risks could cause our actual results to differ materially from any future performance suggested below. Please see “Forward Looking Statements” at the beginning of this Form 10-K.
The Company has excluded discussion of the comparison of the years ended December 31, 2019 and 2018 from this Form 10-K., which can be found in the annual report on Form 10-K for the period ended December 31, 2019, filed on March 16, 2020.
Revision of Previously Issued Financial Statements
This information should be read in conjunction with the consolidated financial statements and the notes thereto included in this Annual Report. We have revised our prior period financial statements to reflect the correction of immaterial errors as described in this Annual Report in Notes to the Consolidated Financial Statements, Note 3 – 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
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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.
Financial Results and Outlook
Beginning in the Summer of 2020 and continuing through the year ended December 31, 2020, we experienced lengthened sales cycles and reduced demand for some of our security solutions due to economic uncertainty connected with the COVID-19 pandemic. The most significant impact of the pandemic on our business has been a sharp drop in demand for our hardware authentication products and delays in the implementation of certain software security solutions.
In addition, we believe demand for our hardware offerings declined in favor of our mobile and cloud security solutions as customers increasingly adopted digital alternatives in 2020. Finally, we saw strong demand for our hardware solutions in Europe during 2019 that did not repeat in 2020 due to many of our customers complying with banking regulations imposed by Payment Services Directive 2 (“PSD2”). As a result, our hardware revenues for 2020 were substantially below such revenues as compared to 2019.
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 I – Item 1A – Risk Factors of this Form 10-K 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, electronic signature and electronic notarization. Our core technologies, multi-factor authentication, electronic signature, and transaction signing, strengthen the process of preventing hacking attacks against online and mobile transactions. This allows companies to transact business safely and with an improved customer experience for 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 an electronic interface, particularly the Internet, where there is risk of account takeover or new account fraud. Our products can increase security associated with accessing business processes, reduce losses from unauthorized access, help customers comply with regulations, enhance the end-user experience, and reduce the cost of business processes by automating activities previously performed manually.
Online and mobile application owners and publishers benefit from our expertise in multi-factor authentication, document signing, transaction signing, application security, remote customer onboarding, and in mitigating hacking attacks. Our convenient and proven security solutions enable low friction and trusted interactions between businesses, employees, and consumers across a variety of online and mobile platforms.
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Our primary growth strategy is to make digital banking more accessible, secure, easy and valuable. Our key growth objectives include:
● Increasing sales to existing customers and acquiring new customers;
● Expanding our channel partner ecosystem; and
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 offerings.
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
Economic instability related to the COVID-19 pandemic impacted our results for the year ended December 31, 2020. As economic conditions recover, we believe the global markets for authentication, fraud mitigation, agreement automation, and electronic signature solutions will continue to grow driven by dynamic and growing threat environments, increased focus on the digital experience for mobile and online users, new government regulations, and continued growth in electronic commerce. The rate of growth in each country around the world may vary significantly based on local culture, competitive position, economic conditions, and the use of technology.
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 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 responses of governments around the world 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 I, Item 1A – Risk Factors of this Form 10-K for additional information regarding the potential impact of COVID-19 on the Company.
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Cybersecurity Risks
Our use of technology is increasing and is critical in three primary areas of our business:
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 are not aware of any cyber incidents during the year ended December 31, 2020 that had a significant impact on our business, it is possible that we could experience an incident in future years, which could result in unanticipated costs.
Currency Fluctuations
In 2020, approximately 88% of our revenue and approximately 73% of our operating expenses were generated/incurred outside of the U.S. In 2019, approximately 89% of our revenue and approximately 72% of our operating expenses were generated/incurred outside of the U.S. In 2018, approximately 91% of our revenue and approximately 71% of our operating expenses were generated/incurred outside of the U.S. 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.
While the majority of our revenue is generated outside of the U.S., a significant amount of our revenue earned during the year ended December 31, 2020 was denominated in U.S. Dollars. In 2020, approximately 44% of our revenue was denominated in U.S. Dollars, 51% was denominated in Euros and 5% was denominated in other currencies. In 2019,
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approximately 47% of our revenue was denominated in U.S. Dollars, 49% was denominated in Euros and 9% was denominated in other currencies. In 2018, approximately 58% of our revenue was denominated in U.S. Dollars, 30% was denominated in Euros, and 12% was denominated in other currencies.
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 being 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 year. Translation adjustments arising from differences in exchange rates generated comprehensive gain of $4.5 million in 2020, comprehensive gain of $1.5 million in 2019 and comprehensive loss of $5.5 million in 2018. 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). Foreign exchange transaction gains aggregated less than $0.1 million for the year ended December 31, 2020. We reported foreign exchange transaction losses of $1.5 million and $0.2 million during the years ended December 31, 2019 and 2018, respectively.
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.
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.
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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 60% and 65% of our operating expenses. 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 2020 compared to 2019 resulted in an increase in operating expenses of approximately $0.7 million in 2020.
The comparison of operating expenses can also be impacted significantly by costs related to our stock-based and long-term incentive plans. For full-year 2020, 2019, and 2018, operating expenses included $6.0 million, $5.3 million, and $6.1 million, respectively, related to stock-based and long-term incentive plans. Long-term incentive plan compensation expense includes both cash and stock-based incentives.
Interest Income, Net
Interest income 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.
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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:
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.
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
The following tables summarize our consolidated results of operations for the periods presented.
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.
Years ended December 31, Change
(in thousands)
Revenue
Professional services 5,689 5,759 (70) (1)%
Total revenue decreased $37.8 million or 15%, during the year ended December 31, 2020 compared to the year ended December 31, 2019. The overall decrease in revenue was comprised of a $45.2 million decrease in hardware revenue and a $13.7 million decrease in perpetual software license revenue, partially offset by an increase 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, increased $21.1 million or 26% during the year ended December 31, 2020, compared to the year ended December 31, 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 products and perpetual software licenses due to an uncertain near-term business outlook for certain of our customers as a result of the pandemic.
Product and license revenue decreased $50.3 million or 27% during the year ended December 31, 2020 compared to the year ended December 31, 2019, which was largely driven by a decrease in hardware sales. Hardware sales increased during the year ended December 31, 2019 related to the PSD2 regulation deadline. The decrease in hardware sales in 2020 is attributed to a reduction in demand following the PSD2 deadline, increased adoption of digital alternatives, and reduced demand due to the pandemic. Perpetual software license sales also decreased during the year ended December 31, 2020 compared to the year ended December 31, 2019, which we attribute to our strategy focused on growing recurring software revenue over perpetual licenses combined with softened demand as a result of the pandemic.
Services and other revenue increased by $12.5 million, or 18% during the year ended December 31, 2020 compared to the year ended December 31, 2020. The increase for the year ended December 31, 2020 compared to the same period in 2019 was driven by higher subscription and maintenance revenue.
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.
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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:
Years ended December 31,
(in thousands)
Revenue
% of Total Revenue
EMEA 54% 58%
Americas 25% 24%
APAC 21% 18%
For the year ended December 31, 2020, revenue generated in EMEA was $28.9 million or 20% lower than the same period in 2019, driven by lower hardware sales, partially offset by higher maintenance and professional services revenue. Hardware revenue comparisons were affected by the one-time positive impact on 2019 revenue from the PSD2 regulation deadline.
For the year ended December 31, 2020, revenue generated in the Americas was $8.4 million or 14% lower than the same period in 2019, driven by lower hardware and software license revenue, partially offset by higher subscription revenue.
For the year ended December 31, 2020, revenue generated in the Asia Pacific region was $0.5 million or 1% lower than the same period in 2019, driven by lower hardware revenue, partially offset by higher maintenance and professional services revenue.
Cost of Goods Sold and Gross Margin
Year ended December 31,
(in thousands)
Cost of goods sold
Gross margin
Product and license 69% 65%
Services and other 74% 74%
Total gross margin 71% 68%
The cost of product and license revenue decreased $21.6 million or 34% during the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease in cost of product and license was driven by lower hardware sales.
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The cost of services and other revenue increased by $3.1 million, or 16% during the year ended December 31, 2020 compared to the year ended December 31, 2019. The increase in cost of services and other revenue is reflective of higher subscription revenue, which has increased cloud-based infrastructure costs.
Gross profit decreased $19.3 million, or 11% during the year ended December 31, 2020 compared to the year ended December 31, 2019. Gross profit margin was 71% for the year ended December 31, 2020, compared to 68% for the year ended December 31, 2019. The increase in profit margin for the year ended December 31, 2020 was driven by stronger margins for product and license.
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 $2.0 million for the year ended December 31, 2020. Had currency rates in 2020 been equal to rates in 2019, the gross profit margins would have been approximately one percentage point lower for the year ended December 31, 2020.
Operating Expenses
Year ended December 31,
(in thousands)
Operating costs
Amortization of intangible assets 9,122 9,470 (348) (4)%
Sales and Marketing Expenses
Sales and marketing expenses decreased $0.6 million, or 1% during the year ended December 31, 2020 compared to the year ended December 31, 2019. Lower travel spend were partially offset by costs associated with higher headcount during the year ended December 31, 2020.
Average full-time sales and marketing employee headcount for year ended December 31, 2020 was 356, compared to 319 for year ended December 31, 2019. Average headcount in 2020 was 12% higher than in 2019.
Research and Development Expenses
Research and development expenses decreased $1.3 million, or 3% during the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease in expense for the year ended December 31, 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 year ended December 31, 2020 was 328, compared to 302 for year ended December 31, 2019. Average headcount in 2020 was 9% higher than in 2019.
General and Administrative Expenses
General and administrative expenses increased $2.4 million, or 6% during the year ended December 31, 2020 compared to the year ended December 31, 2019. The increase in general and administrative expenses for the year ended December 31, 2020 was 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 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 year ended December 31, 2020 was 125, compared to 113 for the year ended December 31, 2019. Average headcount in 2020 was 11% higher than in 2019.
Amortization of Intangible Assets
Amortization of intangible assets for the year ended December 31, 2020 was $9.1 million, compared to $9.5 million for the year ended December 31, 2019, a decrease of $0.3 million or 4%. The decrease was driven by certain technology assets becoming fully amortized during the year.
Interest Income, net
Year ended December 31,
(in thousands)
Interest income, net $ 404 $ 747 ($ 343) (46)%
Interest income, net was $0.4 million for the year ended December 31, 2020, compared to $0.7 million for the year ended December 31, 2019. The decrease in interest income for 2020 compared to 2019 reflects a decrease in interest rates during the year ended December 31, 2020.
Other Income, Net
Year ended December 31,
(in thousands)
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, non-recurring expenses.
Other income (expense), net for the year ended December 31, 2020 was $1.4 million, compared to $(0.5) million for the year ended December 31, 2019. Higher income for the year ended December 31, 2020 was primarily driven by exchange gains on transactions that are denominated in currencies other than our subsidiaries’ functional currencies.
Provision for income taxes
Year ended December 31,
(in thousands)
Income tax expense for the year ended December 31, 2020 was $2.0 million compared to $6.5 million for the year ended December 31, 2019. The decrease in expense was attributable to decreased profits in the period excluding losses at entities where we cannot record a tax benefit, as well as a higher uncertain tax positions recorded in 2019 of $1.6 million.
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Loss Carryforwards Available
At December 31, 2020, we have gross deferred tax assets of $30.0 million resulting from foreign and state NOL carryforwards of $119.5 million and other foreign deductible carryforwards of $64.7 million. At December 31, 2020, we have a valuation allowance of $19.8 million against deferred tax assets related to certain carryforwards. See Note 13 – Income taxes for more information regarding carryforwards and valuation allowances.
Liquidity and Capital Resources
As of December 31, 2020, we had net cash balances (total cash and cash equivalents) of $88.4 million and short-term investments of $26.9 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 Consolidated Balance Sheet at December 31, 2020 and December 31, 2019.
As of December 31, 2020, we held $52.0 million of cash and cash equivalents in subsidiaries outside of the United States. Of that amount, $51.4 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:
Year ended December 31,
(in thousands)
Cash provided by (used in):
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 year ended December 31, 2020, $14.9 million of cash was provided by operating activities. Cash of $18.2 million and $1.2 million was provided by operating activities for the years ended December 31, 2019 and 2018, respectively.
Our working capital at December 31, 2020 was $131.9 million, a decrease of $4.1 million or 3% from $136.0 million at December 31, 2019. The decrease is due to lower accounts receivable and higher deferred revenue, driven by the timing of revenue contracts with customers.
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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 year ended December 31, 2020 and December 31, 2019, cash of $4.7 million and $9.9 million, respectively, was used in investing activities, which was primarily driven by the purchase of property and equipment, as well as purchases of short term investments which were partially offset by the maturity of short term investments.
For the year ended December 31, 2018, cash of $0.2 million was provided by investing activities, which was driven by the maturity of short term investments, partially offset by the purchase of Dealflo and purchase of short term investments.
Financing Activities
The changes in cash flows from financing activities primarily related to the purchases of common stock under our share repurchase program and tax payments for restricted stock issuances.
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. During the year ended December 31, 2020, the Company repurchased 0.3 million shares of the Company’s stock for $5.0 million in the aggregate at an average cost of $20.10 per share under its repurchase program. The authorization is effective until June 10, 2022 unless the total amount has been used or authorization has been cancelled.
For the year ended December 31, 2020, net cash used in financing activities was $7.1 million, which was comprised of $5.0 million of common stock repurchased and $2.0 million of tax payments for restricted stock issuances.
Cash of $0.6 million and $1.0 million was used in financing activities during the years ended December 31, 2019 and December 31, 2018, respectively. The cash usage was comprised of tax payments for restricted stock issuances in both periods.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Contractual Obligations and Commitments
The following summarizes our contractual obligations and commitments as of December 31, 2020:
Payments due by period
2-3 4-5 More than
Total 1 year years years 5 years
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We have purchase obligations of $23.9 million, including $12.7 million of inventory purchase obligations which are expected to be consummated in the next 12 months, $5.8 million of committed hosting arrangements which will be used in the next one to four years, and $5.4 million for other software agreements related to the administration of our business which range from one to five years.
The operating lease obligations above do not include common area maintenance (“CAM”) charges or real estate taxes under our operating leases, for which the Company is also obligated. These charges are generally not fixed and can fluctuate from year to year.
Taxes payable primarily represents deemed repatriation tax from 2017. The Company had $0.5 million, $2.9 million and $0.4 million of unrecognized tax benefits as of December 31, 2020, December 31, 2019 and December 31, 2018, respectively, which have been set aside in a reserve in accordance with ASC 740 Income Taxes. The amounts are not included in the above table as the timing of payment of such obligations, if any, is not determinable.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, net realizable value of inventory and intangible assets. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect significant judgments and estimates used in the preparation of its consolidated financial statements.
Revenue Recognition
On January 1, 2018, we adopted FASB Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers”,or “Topic 606” using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606. We recorded a net increase to opening Retained Earnings of $11.9 million, net of tax, as of January 1, 2018 due to the cumulative impact of adopting Topic 606, with the impact primarily related to the accounting impacts of our customer contracts that include a term license to our software, as well as the impact of accounting for costs incurred to obtain our contracts. See Note 6 - Revenue for further details. We determine revenue recognition through the following steps:
● Identification of the contract, or contracts, with a customer;
● Identification of the performance obligations in the contract;
● Determination of the transaction price;
● Recognition of revenue when, or as, we satisfy a performance obligation.
Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those products or services, which excludes any sales incentives and amounts collected on behalf of third parties. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue. Shipping and handling costs associated with outbound freight
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after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.
Nature of Goods and Services
We derive our revenues primarily from Product and License Revenue, which includes hardware products and software licenses, and Services and Other, which is inclusive of software-as-a-service (which we refer to as “subscription”, or “SaaS”), maintenance and support, and professional services.
Product Revenue: Revenue from the sale of security hardware is recorded upon shipment, which is the point at which control of the goods are transferred and the completion of the performance obligations, unless there are specific terms that would suggest control is transferred at a later date (e.g. delivery). No significant obligations or contingencies typically exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized. Customer invoices and subsequent payments normally correspond with delivery.
License Revenue: Revenue from the sale of software licenses is recorded upon the latter of when the customer receives the ability to access the software or when they are legally allowed to use the software. No significant obligations or contingencies exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized. Contracts with customers for distinct licenses of intellectual property include perpetual licenses, which grant the customer unlimited access to the software, and term licenses which limit the customer’s access to the software to a specific time period. We offer term licenses ranging from one to five years in length. Customer payments normally correspond with delivery for perpetual licenses. For term licenses, payments are either on installment or in advance. In limited circumstances, we integrate third party software solutions into our software products. We have determined that, consistent with our conclusion under prior revenue recognition rules, generally we act as the principal with respect to the satisfaction of the related performance obligation and record the corresponding revenue on a gross basis from these transactions. For transactions in which we do not act as the principal, we would recognize revenue on a net basis. The fees owed to the third parties are recognized as a component of cost of goods sold when the revenue is recognized.
Subscription Revenue: We generate subscription revenues from our cloud services offerings. Subscription revenues mostly include fees from customers for access to the OneSpan Sign, TID, and Dealflo solutions. Our standard customer arrangements do not provide the customer with the right to take possession of the software supporting the cloud-based application service at any time. As such, these arrangements are considered service contracts and revenue is recognized ratably over the service period of the contract. Customer payments are normally in advance for annual service.
Maintenance, Support and Other: Maintenance and support agreements generally call for us to provide software updates and technical support, respectively, to customers. The annual fee for maintenance and technical support is recognized ratably over the term of the maintenance and support agreement as this is the period the services are delivered. Customer payments are normally in advance for annual service.
Professional Services: Professional services revenues are primarily comprised of implementing, automating and extending business processes, technology infrastructure, and software applications. Professional services revenues are recognized over time as services are rendered, usually over a period of time that is generally less than a few months. Most projects are performed on a time and materials basis, while a portion of revenues is derived from projects performed on a fixed fee. For time and material contracts, revenues are generally recognized and invoiced by multiplying the number of hours expended in the performance of the contract by the contractual hourly rates. For fixed fee contracts, revenues are generally recognized using an input method based on the ratio of hours expended to total estimated hours to complete the services. Customer payments normally correspond with delivery.
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Multiple-Element Arrangements
In our typical multiple-element arrangement, the primary deliverables include:
1.A client component (i.e. an item that is used by the person being authenticated in the form of either a new standalone hardware device or software that is downloaded onto a device that the customer already owns);
2.Server system software that is installed on the customer’s systems (i.e., software on the server system that verifies the identity of the person being authenticated) or licenses for additional users on the server system software if the server system software had been installed previously; and
3.Post contract support (PCS) in the form of maintenance on the server system software or support.
Our multiple-element arrangements may also include other items that are usually delivered
prior to the recognition of any revenue are incidental to the overall transaction such as initialization of the hardware device, customization of the hardware device itself or the packaging in which it is delivered, deployment services where we deliver the device to our customer’s end-use customer or employee and, in some limited cases, professional services to assist with the initial implementation of a new customer.
Significant Judgments
We enter into contracts to deliver a combination of hardware devices, software licenses, subscriptions, maintenance and support and, in some situations, professional services. The Company evaluates the nature of the goods or services promised in these arrangements to identify the distinct performance obligations. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment depending on the terms and conditions of the respective customer arrangement. When a hardware client device and licenses to server software are sold in a contract, they are treated as a single performance obligation because the software license is deemed to be a component of the hardware that is integral to the functionality of the hardware that is used by our customers for identity authentication. When a software client device is sold in a contract server software, the licenses are considered a single performance obligation to deliver the authentication solution to the customer. In either of these types of arrangements, maintenance and support and professional services are typically distinct separate performance obligations from the hardware or software solutions. Our contracts to deliver subscription services typically do not include multiple performance obligations; however, in certain limited cases customers may purchase professional services that are distinct performance obligations.
For contracts that contain multiple performance obligations, the transaction price is allocated to the separate performance obligations based on their estimated relative standalone selling price. Judgment is required to determine the stand-alone selling price (“SSP”) of each distinct performance obligation. We determine SSP for maintenance and support and professional services based on observable inputs; specifically, the range of prices charged to customers to renew annual maintenance and support contracts and the range of hourly rates we charge our customers in standalone professional services contracts. In instances where SSP is not directly observable, and when we sell at a highly variable price range, such as for transactions involving software licenses or subscriptions, we determine the SSP for those performance obligations using the residual method.
Credit Losses
We adopted ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, on January 1, 2020. As a result of the adoption, we amended the 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.
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Income Taxes
As a global company, we calculate and provide for income taxes in each tax jurisdiction in which we operate. The provision for income taxes includes the amounts payable or refundable for the current year, the effect of deferred taxes and impacts from uncertain tax positions. Our provision for income taxes is significantly affected by shifts in the geographic mix of our pre-tax earnings across tax jurisdictions, changes in tax laws and regulations, and tax planning opportunities available in each tax jurisdiction.
Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement and tax bases of our assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those differences are expected to be recovered or settled. Valuation allowances are established for deferred tax assets when it is more likely than not that a tax benefit will not be realized. We recognize the effect of a change in tax rates on deferred tax assets and liabilities and in income in the period that includes the enactment date.
We recognize tax benefits for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in our income tax returns that do not meet these recognition and measurement standards. Assumptions, judgments, and the use of estimates are required in determining whether the “more likely than not” standard has been met when developing the provision for income taxes.
We recognize the tax impact of including certain foreign earnings in U.S. taxable income as a period cost. We have recognized deferred income taxes for local country income and withholding taxes that could be incurred on distributions of non-U.S. earnings because we do not plan to indefinitely reinvest such earnings.
We monitor for changes in tax laws and reflect the impacts of tax law changes in the period of enactment.
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 $0.3 million in Accounts receivable, net of allowances and Retained Earnings as of January 1, 2020.
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.
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
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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. The adoption of the standard was not materially impactful to our consolidated financial statements and 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 was effective beginning January 1, 2021. The adoption of this standard did not have a material impact on our 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 adoption of this standard did not have a material impact on the Company’s 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 issued standards that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
Item 7A - Quantitative and Qualitative Disclosures about Market Risk (In thousands)
Foreign Currency Exchange Risk – In 2020, approximately 88% of our business was conducted outside the United States, primarily in Europe, Latin America and Asia/Pacific. A significant portion of our business operations is transacted in foreign currencies. As a result, we have exposure to foreign exchange fluctuations. We are affected by both foreign currency translation and transaction adjustments. Translation adjustments result from the conversion of the foreign subsidiaries’ balance sheets and income statements to U.S. Dollars at year-end exchange rates and weighted average exchange rates, respectively. Translation adjustments resulting from this process are recorded directly into stockholders’ equity. Transaction adjustments result from currency exchange movements when one of our companies transacts business in a currency that differs from its local currency. These adjustments are recorded as gains or losses in our statements of operations. Our business transactions are spread across numerous countries and currencies. This geographic diversity reduces the risk to our operating results. As noted in Management’s Discussion and Analysis above, we attempt to minimize the net impact of currency on operating earnings by denominating an amount of billings in a currency such that it would provide a hedge against the operating expenses being incurred in that currency.
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Interest Rate Risk – We have minimal interest rate risk. We had no debt outstanding at December 31, 2020. Our cash, cash equivalents, and short term investments are invested in short-term instruments at current market rates. If rates were to increase or decrease by one percentage point, the Company’s interest income would increase or decrease approximately $0.3 million annually.
Item 8 - Financial Statements and Supplementary Data
The information in response to this item is included in our consolidated financial statements, together with the report thereon of KPMG LLP, appearing on pages F-1 through F-41 of this Form 10-K, and in Item 7 under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A - Controls and Procedures
Evaluation of Disclosure 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 the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of December 31, 2020. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure (i) 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 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. Based upon that evaluation, our management have concluded that the Company's disclosure controls and procedures are effective as of December 31, 2020, to give reasonable assurance that the information required by us in reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time period specified in the rules and forms of the SEC, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
The management of OneSpan Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Our management, led by our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2020, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013).
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Management’s evaluation of our internal control over financial reporting determined that the Company’s internal control over financial reporting was effective based on those criteria as of December 31, 2020.
KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements as of and for the year ended December 31, 2020 included in this Annual Report on Form 10-K, and has issued its report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020, included on page 53 of this annual report.
Changes in Internal Control over Financial Reporting
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 quarter ended December 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting
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.
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
OneSpan Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited OneSpan Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement scheduleII (collectively, the consolidated financial statements), and our report dated February 25, 2021 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
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inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Chicago, Illinois
February 25, 2021
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Item 9B – Other Information
On February 24, 2021, Naureen Hassan informed the Company’s Board of Directors that she will resign from the Board of Directors, effective March 1, 2021, as she has accepted a position in the public sector that precludes her continued role as a Board member of a publicly traded company.
Ms. Hassan did not advise the Company of any disagreement with the Company on any matters relating to its operations, policies or practices.
PART III
Item 10 - Directors, Executive Officers and Corporate Governance
All information in response to this Item is incorporated by reference to the “Directors and Executive Officers” and “Section 16(a) Beneficial Ownership Compliance” sections of OneSpan’s Proxy Statement to be filed with the SEC for the 2021 Annual Meeting of Stockholders.
The following sets forth certain information with regard to each executive officer of the Corporation. There are no family relationships between any of the executive officers, and there is no arrangement or understanding between any executive officer and any other person pursuant to which the executive officer was selected.
SCOTT M. CLEMENTS—Mr. Clements has served as OneSpan’s President and Chief Executive Officer since July 2017. From November 2016 to July 2017, he served as the Company’s President and Chief Operating Officer, and prior to that, Mr. Clements served as the Company’s Chief Strategy Officer since he joined the Company in December 2015. Before joining OneSpan, Mr. Clements spent eleven years at Tyco International where he most recently served as Corporate Senior Vice President, Business Development focused on technology acquisitions. Prior to that, Mr. Clements served as President of Tyco Retail Solutions and also as Tyco’s Chief Technology Officer. Before joining Tyco, Mr. Clements spent a decade at Honeywell International in domestic and international financial and operational leadership roles. Mr. Clements is 58 years old.
MARK S. HOYT—In November 2015, the Board of Directors appointed Mr. Hoyt to the positions of Chief Financial Officer and Treasurer. In March 2018, the Board also appointed Mr. Hoyt an Executive Vice President. Prior to joining the Company, Mr. Hoyt was the Chief Financial Officer of operations in Europe, Middle East and Africa for Groupon, Inc., and was based in Switzerland from 2012 to 2015, and from 2010 to 2012, he was Vice President of International Financial Operations of Groupon, Inc. and was based in Chicago. Mr. Hoyt is 53 years old.
STEVEN R. WORTH —Mr. Worth has served as OneSpan’s General Counsel, Chief Compliance Officer and Corporate Secretary since April 2016. Mr. Worth also has executive responsibility for corporate information security and product related security compliance. Prior to joining OneSpan, Mr. Worth spent five years at cloud software company SilkRoad Technology where he served as an Executive Vice President. Prior to that, Mr. Worth served five years as Vice President, General Counsel and Corporate Secretary of Diamond Management and Technology Consultants, an international publicly traded technology services company. Earlier in his career, Mr. Worth practiced law with the international firm Winston & Strawn. Mr. Worth is 50 years old.
Item 11 - Executive Compensation
The information in response to this Item is incorporated by reference to the “Executive Compensation” section of OneSpan’s Proxy Statement to be filed with the SEC for the 2021 Annual Meeting of Stockholders.
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information in response to this Item is incorporated by reference to the “Security Ownership of Certain Beneficial Owners, Directors and Management” section of OneSpan’s Proxy Statement to be filed with the SEC for the 2021 Annual Meeting of Stockholders.
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Item 13 - Certain Relationships and Related Transactions, and Director Independence
The information in response to this Item is incorporated by reference to the “Directors and Executive Officers” and “Transactions with Related Persons” sections of OneSpan’s Proxy Statement to be filed with the SEC for the 2021 Annual Meeting of Stockholders.
Item 14 - Principal Accounting Fees and Services
The information in response to this Item is incorporated by reference to the “Report of the Audit Committee” section of OneSpan’s Proxy Statement to be filed with the SEC for the 2021 Annual Meeting of Stockholders.
PART IV
Item 15 - Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this Form 10-K.
(1) The following consolidated financial statements and notes thereto, and the related independent auditors’ report, are included on pages F-1 through F-41 of this Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2020 and 2019
Consolidated Statements of Operations for the Years Ended December 31, 2020, 2019 and 2018
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2020, 2019 and 2018
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2020, 2019 and 2018
Consolidated Statements of Cash Flows for the Years Ended December 31, 2020, 2019 and 2018
Notes to Consolidated Financial Statements
(2) The following consolidated financial statement schedule of the company is included on page F-42 of this Form 10-K:
Schedule II – Valuation and Qualifying Accounts
All other financial statement schedules are omitted because such schedules are not required or the information required has been presented in the aforementioned consolidated financial statements.
(3) The following exhibits are filed with this Form 10-K or incorporated by reference as set forth at the end of the list of exhibits:
ExhibitNumber Description
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ExhibitNumber Description
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ExhibitNumber Description
14.2 OneSpan Inc. Code of Conduct and Ethics.
21 Subsidiaries of Registrant.
23 Consent of KPMG LLP.
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
OneSpan Inc. will furnish any of the above exhibits to stockholders upon written request addressed to the Secretary at the address given on the cover page of this Form 10-K.
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OneSpan Inc.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Financial Statements
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets as of December 31, 2020 and 2019 F-4
Notes to Consolidated Financial Statements F-10
Financial Statement Schedule
The following consolidated financial statement schedule is included herein:
Schedule II – Valuation and Qualifying Accounts F-42
All other financial statement schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
OneSpan Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of OneSpan Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedule II (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Changes in Accounting Principle
As discussed in Notes 2 and 11 to the consolidated financial statements, the Company has changed its method of accounting for credit losses on financial instruments as of January 1, 2020 due to the adoption of Accounting Standards Update (ASU) No. 2016-13, Measurement of Credit Losses on Financial Instruments, and as discussed in Notes 2 and 12 to the consolidated financial statements, the Company changed its method of accounting for leases as of January 1, 2019 due to the adoption of Accounting Standards Codification (ASC) Topic 842, Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
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Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Revenue from contracts containing software licenses with terms and conditions that are unique to individual contracts
As discussed in Notes 2 and 6 to the consolidated financial statements, the Company enters into contracts to deliver a combination of hardware devices, software licenses, subscriptions, maintenance and support and, in some situations, professional services. The Company evaluates the nature of the goods and services promised in these arrangements to identify the distinct performance obligations. Certain arrangements contain terms and conditions that are unique to the individual contracts and may vary with regard to the number and type of promises included. The Company recognized total revenue of $215.7 million for the year ended December 31, 2020.
We identified the evaluation of revenue from contracts containing software licenses with terms and conditions that are unique to individual contracts as a critical audit matter. Specifically, auditor judgment was required to evaluate the Company's identification of performance obligations in such contracts, including for contracts with new customers or contracts that were amended with existing customers.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s revenue recognition process. This included controls relating to the identification of performance obligations and evaluation of unique terms and conditions present in individual contracts. We tested a selection of contracts, including contracts with new customers or contracts that were amended with existing customers, by obtaining and reading the underlying contract and accounting analysis to evaluate the Company’s identification performance obligations. Specifically, we evaluated the completeness and accuracy of the Company’s identification of terms and conditions that were unique to the selected contracts and the Company’s determination of the impact of those terms and conditions on revenue recognition.
/s/ KPMG LLP
We have served as the Company’s auditor since 1996.
Chicago, Illinois
February 25, 2021
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OneSpan Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
ASSETS
Current assets
Operating lease right-of-use assets 11,356 10,580
Intangible assets, net of accumulated amortization 27,196 36,209
Deferred income taxes 7,030 7,863
Contract assets - non-current 1,877 3,355
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Short-term income taxes payable 2,618 7,410
Long-term income taxes payable 6,095 6,958
Stockholders' equity
Accumulated other comprehensive loss (10,220) (13,295)
Total liabilities and stockholders' equity $ 375,203 $ 382,542
See accompanying notes to consolidated financial statements.
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OneSpan Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the years ended December 31,
Revenue
Cost of goods sold
Operating costs
Amortization / impairment of intangible assets 9,122 9,470 9,852
Net income (loss) per share
Weighted average common shares outstanding
See accompanying notes to consolidated financial statements.
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OneSpan Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
For the years ended December 31,
Other comprehensive loss
Cumulative translation adjustment, net of tax 4,534 1,543 (5,516)
Pension adjustment, net of tax (1,459) (1,551) 797
See accompanying notes to consolidated financial statements.
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OneSpan Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
Accumulated
Additional Other Total
Net income (loss) — — — — — 3,044 — 3,044
Restricted stock awards 139 — — — 3,973 — — 3,973
Tax payments for stock issuances — — — — (970) — — (970)
Pension adjustment, net of tax — — — — — — 797 797
Net income (loss) — — — — — 7,864 — 7,864
Restricted stock awards — — — — 3,368 — — 3,368
Tax payments for stock issuances (18) — — — (569) — — (569)
Pension adjustment, net of tax — — — — — — (1,551) (1,551)
Net income (loss) — — — — — (5,455) — (5,455)
Restricted stock awards 242 — — — 4,740 — — 4,740
Tax payments for stock issuances (96) — — — (2,030) — — (2,030)
Pension adjustment, net of tax — — — — — — (1,459) (1,459)
See accompanying notes to consolidated financial statements.
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OneSpan Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years ended December 31,
Cash flows from operating activities:
Net income (loss) from operations $ (5,455) $ 7,864 $ 3,044
Loss on disposal of assets 118 69 (49)
Changes in operating assets and liabilities:
Cash flows from investing activities:
Additions to property and equipment (3,101) (7,453) (3,685)
Net cash provided by (used in) investing activities (4,664) (9,893) 194
Cash flows from financing activities:
Repurchase of common stock (5,030) — —
Tax payments for restricted stock issuances (2,030) (569) (970)
Net cash used in financing activities (7,060) (569) (970)
Effect of exchange rate changes on cash 914 (208) (1,556)
Supplemental cash flow disclosures:
Cash paid for interest $ — $ — $ —
See accompanying notes to consolidated financial statements.
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Restricted cash included in other non-current assets 847 847 847