OneSpan Inc (OSPN) 2003 Q4 法說會逐字稿

Good morning and welcome to the VASCO Data Securities International fourth quarter and full year 2003 earnings conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions following the presentation. I would now like to turn the floor over to Tony Schor, from Investor Awareness. Sir, the floor is yours.

Thank you, operator and thank you everyone for participating in today's VASCO Data Security International's fourth quarter and full year 2003 earnings conference call. My name is Tony Schor, I'm president of Investor Awareness, Inc. We're a full-service investor relations agency that provides strategic investor relations counsel for VASCO Data Security. Should anyone like to request additional information on VASCO or be included on Vasco's e-mail list, please contact Investor Awareness, 847-945-2222. Ken Hunt, the chairman, founder, and CEO of VASCO Data Security International will first discuss the company's recent developments. Mr. Hunt will then introduce Jan Valcke, President and COO, who will give an update of VASCO's day-to-day operations. We will then hear directly from Cliff Bown, CFO who, will discuss fourth quarter numbers. At the end of the presentation we will open the call up to questions and answers. In the meantime I've been asked to read the following forward-looking statements.

Statements made in this conference call that relate to future plans, events, performances are forward-looking statements. Any statements containing words such as believes, anticipates, plans, expects, and similar words is forward-looking; and these statements involve risks and uncertainties and are based on current expectations. Consequently actual results could differ materially from the expectations expressed in these forward-looking statements. I direct your attention to the company's filings with the Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard. I'd like to now introduce Mr. Ken Hunt, Chairman and CEO, of VASCO Data Security.

Thank you, Tony. Good morning everyone. For those listening in from Europe, good afternoon, and Asia, good evening. I'd like to take this opportunity to thank -- hello? Hi, it's Ken Hunt. Sorry for the interruption. Technology sometimes is difficult. I trust that everybody received my good morning greetings. I'd like to go ahead and proceed. I'd like to take this opportunity to thank all of you for participating in today's call.

Today we'd like to review fourth quarter and full year 2003, and give you some expectations for first quarter 2004. We will also comment on the company's expectations presented in a range of percentages for revenue growth, gross margin, and operating income for 2004. You know, I look back on 2003 with satisfaction and pride. When I was asked by VASCO's board to return as CEO in late November of 2002, I was frustrated that we had not been able to achieve profitability. I was frustrated that we were burning cash and, in fact, it appeared that we would soon run out of cash. Our people were also frustrated. They welcomed a leadership change and were anxious to work hard to contribute to VASCO's success. I am very proud of all of VASCO's people. No one gave up. No one thought we could not succeed. A key promotion in late November of 2002, was the appointment of Jan Valcke to president and chief operating officer. Under Jan's leadership the company further lowered it's operating costs, increased it's revenue production, introduced new products, added a significant number of new accounts, and achieved positive operating income. And positive EBITDA, or operating cash flow in all of the quarters of 2003.

Looking back over 2003, we achieved a lot. I'm not just referring to our financial performance. In 2003, we completed the sale of VACMAN Enterprise, a unit no longer core to VASCO's business. We reached agreement with Ubisom to repurchase it's $15 million preferred stock investment in VASCO for $4 million in cash and $2 million VASCO common shares. We completed a $8 million capital raise through a private placement, managed by investment bankers Wedbush Morgan and Gilford Securities. We repaid Dexu Bank its $3.4 million term loan plus interest. We launched Digipass Pack for Microsoft Outlook web access, and Lotus Domino; covering over 80% of all web mail access. We introduced Digipass GO 3, our entry level one button token, the most easy to use and cost-effective one-time password device on the market. We sold and shipped 2.4 million Digipass tokens for a total of 10.4 million Digipasses to date. We also signed 10 new distributor agreements, bringing the total number of VASCO distributors to 29; and we settled the Active Card lawsuit.

Businesswise, we had a solid fourth quarter. Our revenues were $6,196,000, up 83% over fourth quarter 2002; and we had net income from continuing operations of $235,000. Revenues for the full year 2003 were $22,866,000, 32% higher than full year 2002. We also had net income from continuing operations for full year 2003 of $761,000. Very importantly, we continued to control costs, reporting a 15% decrease over the same 12-month period last year, including the costs associated with the aggressive defense of the company's position relative to the Active Card patent lawsuit. We continue to grow our customer base by selling new accounts both directly through our own sales force, but particularly important, through our growing distributor and reseller channel. In the fourth quarter we sold an additional 130 new accounts, including 23 new banks and 107 new corporate network access customers. Approximately 90% of these corporate network access new accounts were generated through our distributor and reseller partners. We are very pleased with the development of our distributor channel. For full year 2003, we sold a total of 572 new accounts of which 69 were banks, 502 were corporate network access customers, and one E-commerce customer. We now have approximately 262 banks as customers, approximately 1,145 network access accounts including corporations, federal, state, local governments, 15 in e-commerce and one in e-government located in over 60 countries around the world.

The distributor reseller channel is a continued focus of our business development staff. The reseller channel is extremely important to VASCO because it broadens and stabilizes our customer base, and allows us to leverage our sales through established productive sales and support organizations. We have communicated the positive impact of this channel by reporting significant new accounts produced through this channel over the past full year. Program to date we've signed 29 distributors who in turn service over 1,000 resellers. Additionally, we've trained and certified over 1,250 professionals from these organizations to sell and support VASCO's products.

Let's talk a bit about our strategy. Our strategy has been, and continues to be, to identify and develop markets whose customers will generate a sustainable and repeatable revenue stream to VASCO. These are organizations that have large audiences including employees, customers, partners, suppliers, or other associated parties. As revenue is created from these VASCO customers, the cost of supporting the production of these revenues is expected to decrease as a percentage of those revenues. One such market is VASCO's strongest vertical market, banking and finance. We typically sign a bank, assist them in a pilot application, then roll them out their application to thousands or even millions of users over multiple months or years. A second growth market for VASCO is corporate network access, which we also sometimes refer to as CNA. Working through the growing reseller and solutions partner networks that I mentioned before, VASCO is able to reach hundreds of thousands of end customers. We support and train our resellers professionals who, in turn, train others in their respective firms.

These resellers sell VASCO's Digipass Pack solutions to longstanding customers and new accounts. They sell to small and medium accounts that VASCO could not feasibly reach directly. They sell first in small pilots, and then follow on with add-on sales. As VASCO selects, signs, then trains and supports these resellers; our cost for supporting these revenues is also expected to decrease as a percentage of those revenues. More broadly speaking, our target markets are the applications and the users who currently authenticate themselves with a static or fixed password. Industry reports identify over half a billion users worldwide who rely on fixed passwords. This number is expected to more than double by the end of 2004 to over a billion. VASCO, a market leader in identity authentication, has sold and delivered over 10.4 million Digipasses by the end of last year, 2003; and we've just scratched the surface of this enormous market. Additionally, with over 50,000 banks in the world, and our penetration of approximately 262 banks as customers, we have a significant untapped opportunity in the banking and finance market. At this time I'd like to introduce Jan Valcke, VASCO's President and Chief Operating Officer. Jan and his team are doing a great job executing our business plan. I know all of you want to hear more from Jan. Jan.

Thank you, Ken. The year 2003 was a very special year for VASCO. Even a historical year. Three issues made it challenging year on the business level. The first issue was the fact that a lot of operational issues had to be solved during the year 2003. Solving these problems absorbed a lot of the management team's energy and bandwidth. The second issue was the worldwide economic crisis, and the third issue was the low door price. Despite all those difficulties, VASCO succeeded in being profitable the full year 2003. VASCO has worked hard to win it's place in the midst of the leading and flourishing companies in it's sector. We can clearly state that the focus on authentication works. Authentication is our core business, and we are extremely good at it. We achieved profitability, and the 572 new customers we won during 2003 proved that claim. VASCO shows a clear dedication to R&D.

During 2003 we launched over 50 new products such as Digipasscode 3, Digipass 260, 560, 580, and the Digipass Authentication Server. In addition, VASCO has invested in the maturity of it's existing products, for example, by adding the new algorithm to the Digipass products. This is all I will say about 2003. It was a good year, but it is the past; 2004 is our current focus. In 2004 we will go forward in optimizing VASCO's internal and external structure, procedures and costs. This does not only mean we will solely concentrate on cost cutting. VASCO will invest to grow in specific areas where we are convinced that we can gain substantial market share and become even more profitable. The opening of our North American sales and support headquarters in Boston is a first important step. For a company like VASCO, it is important to have a physical presence in the northeast of the United States. We have a large number of customers and prospects on the East Coast, and it is of utmost importance to continue our expansion, and provide our customers and partners with the highest level of support. I am convinced that our Boston office will prove to be successful.

I'm also convinced that VASCO will prove to be successful in 2004. We have state of the art products, the right market vision, and above all, great people. Thank you very much, and I'm looking forward to speaking to you again in three months time.

Thank you, Jan. At this time I'd like to turn the call over to Cliff Bown, VASCO's Chief Financial Officer.

Thank you, Ken. Before we review the results in detail, I'd like to remind everyone that with the sale of the VACMAN Enterprise business unit in the third quarter, all activity related to it including it's results of operations, the gain on the sale of the unit, and the costs associated with the sale of the unit, have been reported as discontinued operations. As a result, prior periods have been restated and the amount reported as revenues, gross profits, and operating expenses include only those items relating to continuing operations. As many of you have seen in our press release, revenues from continuing operations were $6.2 million for the quarter, and $22.9 million for the full year ended December 31st, 2003. As Ken mentioned, the revenues for the quarter were $2.8 million, or 83% higher than the fourth quarter 2002. The increase in revenue reflected significant increases from both the banking and corporate network access markets. Revenues for the full year ended December 31st, 2003 were $5.5 million, or 32% higher than the same period of last year. This increase is also attributable to growth in both markets. Revenues for the full year ended December 31st, 2003, from banking segment increased approximately 22% over 2002, and revenues from corporate network access market increased by more than 75% compared to prior year.

As suggested by the differences in the year-over-year growth rates the mix of our revenues between our target markets, banking and corporate network access, continues to change. In 2003, approximately 75% of the revenues for the fourth quarter and full year came from the banking segment, with the remaining 25% coming from corporate network access. In 2002, approximately 82% of the revenues were from banking with the remaining 18% from corporate network access. We believe that the higher growth rate in revenues for corporate network access markets reflects the growth in our distributors, resellers, and solution partners. The geographic distribution of our revenues has not changed significantly over the last year. For the full year 2003, 84% of our revenues were from Europe, 7% from the United States, and 9% from other countries, primarily Asia Pacific and Australia. In 2002, 84% of our revenues were from Europe with 8% from the U.S., and 7% from other countries. The gross margin rate for the fourth quarter 2003 was 63.2% compared with 63.9% in 2002, and the rate for the full year ended December 31st, 2003 was 60.6% compared to 58.8% for full year 2002.

The margin rates in the fourth quarter 2003 and 2002 were generally comparable with the benefit from a stronger Euro being offset by the change in mix of the revenues within the banking segment. The improvement in gross margin for the full year 2003, as compared to full-year 2002, was primarily related to two factors. The increase in the corporate network access revenues as a percentage of total revenue; which as previously noted, increased from 18% in 2002 to 25% in 2003, and the stronger Euro. Operating expenses for the fourth quarter 2003 were $3.5 million, a reduction of $627,000, or 15%, from the fourth quarter 2002. Operating expenses for the full year ended December 31st, 2003 were $12.7 million, a reduction of $2.2 million, or 15% from the full year 2002. Reductions in expense in the fourth quarter were primarily related to adjustments to restructuring reserves recorded in the fourth quarter of 2002 of $320,000, and a reduction in general administrative expenses of approximately $425,000. Reductions in general and administrative were achieved in a broad group of expenses including, but not limited to, services purchased from outside parties, rent, bad debt, travel, and telephone, which were partially offset by increased legal expenses; in large part attributable to the defense of the company's patents associated with the Active Card litigation.

Reductions in expense for the full year were due in large part to the issues previously noted for the fourth quarter, but also reflected reductions in sales and marketing expenses; as well as in research and development expenses. The reduction in sales and marketing expenses was primarily attributed to reduced spending on trade shows, advertising, and travel. The reductions in R&D expenses reflected the benefit from consolidating a number of our research facilities in 2002, and reduced spending for third-party services. Reductions in both the fourth quarter and full-year 2002 were partially offset by an increase in the value of the Euro compared to the U.S. dollar. As noted in previous conference calls, with approximately 60% of our operating expenses in Euros, the strengthening of the euro compared to the U.S. dollar adversely affects operating expenses. For the fourth quarter and full year 2003 the euro, compared to the U.S. dollar, was approximately 20% stronger than the same periods of 2002. As noted in previous calls, we attempt to balance our currency exposure and expenses by denominating a portion of our sales in euros. Operating expenses in the fourth quarter of 2003 included a nominal amount of non-cash compensation expense including depreciation and amortization expenses of $244,000. For the full year ended December 31st, 200 3, operating expenses included $41,000 of non-cash compensation expense and $1.1 million of depreciation and amortization expense.

For the fourth quarter 2003 the company reported an income tax benefit of $92,000. The benefit reflects the impact of finalizing the 2002 tax return for Europe, and updating the tax provision for actual full year 2003 results. For the full year 2003 the company recorded income tax expense of $397,000. The expense reflects the strong performance of the Belgium operating subsidiary, and the use of all of it's net operating loss carry forwards. Tax expense for the full year 2002 was $140,000. There was no tax expense reported for the fourth quarter of 2002. Earnings before interest, taxes, depreciation, and amortization, EBITDA, or operating cash flow, if you will, from continuing operations was $348,000 for fourth quarter 2003, an improvement of $1.95 million from the fourth quarter of 2002. For the full year ended December 31st, EBITDA from continuing operations was $2.3 million, an improvement of $5.8 million for the comparable period in 2002. Excluding non-cash compensation the makeup of our expenses for the quarter were: sales and marketing of $2.4 million, R&D expenses of $200,000, and general and administrative expenses of $900,000. Amounts reported for sales and marketing and R&D reflect a reclassification of approximately $420,000 of expense from R&D to sales and marketing. The reclassification of expense was made to report the activities of our Australian operations on a basis consistent with other subsidiaries.

The makeup of our expenses for the full-year ended December 31st, 2003, excluding non-cash compensation, were sales and marketing expenses of $7 million, R&D expenses of $2.3 million, and G&A expenses of $3.4 million. The current makeup of our sales -- of our workforce is 73 people worldwide with 46 in sales and marketing, 16 in research and development, and 11 in general and administrative.

I would now like to make a few comments on the balance sheet. I'm sure that as you have followed us through the year, you have noticed a substantial improvement in the balance sheet. As a result of our strong operating performance, which includes the four consecutive quarters of profitability and positive operating cash flows, and transactions closed in the third quarter; such as the $8 million equity financing and the repurchase of the series C preferred stock from Ubisom, we have strengthened the balance sheet substantially in 2003. The balance sheet at December 31st, 2003 reflects higher cash balances, the company had $4.8 million of cash at December 31st, 2003; an increase of $2.2 million from the $2.6 million at December 31st, 2002. You'll also note lower day sales outstanding in receivables. We have decreased our day sales outstanding from 73 days as December 31st, 2002, to 37 days at the end of 2003. You'll see the balance sheet has no debt. All term debt has been repaid. You will also note increased working capital. Working capital increased from -- increased approximately $5.8 million from a deficit of $600,000 at the end of 2002 to a surplus of $5.2 million at the end of 2003. The corresponding current ratio has improved from a deficit of 0.93 to positive 2.18.

Finally you'll notice increase in stockholders equity. Stockholders equity increased $6.1 million, over 200% from 2.8 million at December 31st, 2002 to $8.9 million at end of 2003. The company continues to maintain it's line of credit for up to 2 million euros that is secured by it's receivables, and there were no borrowings against that line as of December 31st, 2003. Finally, I would also like to comment on the statement in our press release related to revising our third quarter results and filing an amendment to the third quarter 10-Q. The underlying issue relates to the beneficial conversion option included in our series D convertible preferred stock. Under EITF, which stands for Emerging Issues Task Force, announcement 98-5, which was accounting for convertible securities with beneficial conversion features; we were required to compute the fair value of the beneficial conversion option and report the value of the option as a deemed dividend. In the 10-Q currently on file, in accordance with the EITF, we computed the value of the conversion option, we disclosed it's fair value in the footnotes and we reflected the dividend in the stockholders equity section of the balance sheet. We did not, however, report the amount of the deemed dividend on the face of the income statement, or include the dividend in the calculation of earnings per common share.

As noted in the press release, the amount of the deemed dividend was $3.7 million, and the third quarter 10-Q will be amended to reflect the deemed dividend as a reduction in earnings per common share for the quarter and nine months ended September 30th, 2003. The adjustment will reduce earnings per share as previously reported by 12 cents per share. Now it is important to note that the deemed dividend is a non-cash charge. It did not, and it will not affect, the operating results reported by the company. The correction being made is simply to conform the company's reporting to comply fully with EITF 98-5. I'd like to turn the call back to Ken.

Thank you, Cliff. We would now like to comment on first quarter and full year 2004. With a successful 2003 behind us, we are very optimistic about first quarter, and full year 2004. Our programs and actions that we've described in previous conference calls, and earlier in these comments, are producing the results that we had planned for and expected. We currently have firm orders with shipments scheduled for the first quarter of approximately $5.2 million. Any new orders received before quarter's end and shipped during the quarter would be additive to this number. As far as guidance is concerned, the company further expects to achieve full-year revenue growth of 15 to 25% in 2004, as compared to 2003. We also expect to achieve gross margins in the 50 to 60% range and operating income in the 4 to 10% range. Our DSOs have improved from 73 days at the end of 2002 to 37 days most recently. Going forward we expect our DSOs to range from approximately 45 to 55 days. As far as quarterly guidance is concerned, we do not feel it is yet appropriate.

Our business is becoming more predictable over the horizon of 12 months, but remains somewhat uneven due to the impact of some very large orders and general seasonality, including holidays or vacations, in the third quarter of each year. As a result, we expect that the growth in some quarters will be lower than the full year ranges that I just mentioned, while others will exceed that range. Should our expectations change for the full year we will advise you and in a timely manner. In summary, we are pleased with what we accomplished in 2003. We will not, however, rest on our laurels and be satisfied with past performance as a measurement of our future achievements. You can rely on VASCO's people to do their very best, always. This concludes our presentation today, and we'll now open the call for questions. Operator.

Thank you. The floor is now open for questions. If you have a question, please press the numbers 1 followed by 4 on your touch-tone phone. Please hold while I poll for questions. Our first question is coming from Fred Siegel with Brean Murray.

Hi, Ken.

Hello, Fred.

How are you?

Good.

Talk about the North American market from a couple of perspectives. First, is the bigger opportunity banks -- banks or corporate? That's one part. What sort of staffing and distribution kinds of things are you going to be putting in place to attack that? And finally, when do you think we start to see, as we have in Europe for awhile, when do you start to see some of the banks thinking about some fairly large deployments for consumer applications as opposed to internal?

Fred, thank you. I think I'll let Jan Valcke talk about -- or answer those questions.

Thank you, Ken. I'm sorry, the line is quite bad today. And I hope I will answer the question correctly. I believe your first question was what about the market in U.S. Is that right?

Well, if your mix of business today is roughly three-quarters with banks and a quarter with corporations, as you look at the U.S. market, is that ratio sort of how the opportunities fall out as you look at it, or is it more of a corporate opportunity in the U.S.?

First of all, historically, the banking market has always been much more popular, or the E-banking market has always been much more popular in Europe than in the U.S. The second market where E-banking has been more popular is in Asia, where you see now a growth in banks offering that service. Banks in the U.S., the trend for the banks in the U.S. is rather to offer strong user authentication products in the first place for the corporate banking. That is in every country the same way it happens, first corporate banking, secondly retail banking. So we are at the stage today that in the U.S. more and more banks are thinking or making offers to their customers for proposing some user products, for their corporate customers.

Second market where we haven't talked a lot about it but where it's a lot more popular in the U.S. than in the rest of the world is the business to business market. What is that business? It's companies who are selling their products over the Internet but to a close user group. As an example, Gold Star, an American real-estate company, is offering news, information over the Internet; and for having access to that, to that information, you need to pay a fee, subscriber fee, and, therefore, you receive a Digipass. That is a tremendous market. I can assure you of that. And that is probably the most fast growing market for our business.

Corporate networking access, we didn't start -- we only started about now 18 months to three years ago, in that market, so are quite new in that market. The first step was having a name recognition in that market. We are now at the second step, and we are doing a lot more in the U.S. than in the rest of the world. The second step, is direct marketing to the large customers. How do we to have see that market? We have a brand name there called Digipass Pack, and Digipass Pack is a software with Digipasses that are compatible with the largest market vendors and the networking, like Checkpoint, like Cisco, like Novell, et cetera, et cetera. Over 20 of those. We have partnerships with over 20 of those corporate networking vendors.

So, the first step, again corporate networking, was to have a ground layer with some distributors, secondly our partnerships, and more and more we are now moving forward. Direct marketing to show to the bigger customers that we have products that are easy to use and easy to implement. As an example, I can tell you that we have a very successful technological and marketing partnership with Novell in U.S.; and due to that, that we have won several deals and more and more bigger deals in the U.S. the last year.

Are the product requirements different for the corporate network access application versus the bank, and is the corporate customer more or less or about the same in terms of price sensitivity?

The corporate networking customers are, of course, buying those products for their employees. So let's say that packaging callers, identification of the products with their brand name is less important in that field, like in the banking. Banks are buying products to sell it, to give it away to their customers, and their brand names are extremely important. That is the first difference. The second difference is that in a bank, you've talked very easily of the deployment of 10,000 to 100,000 Digipasses. That means those Digipasses goes in the hands of customers and basically the banks -- what the banks like there is having products that are very easy to explain, a high level of security but also a low cost of ownership.

So as a conclusion we can say the products in the banks are quite the same as in the corporate networking access, but the way you do the deployments, the way you present it, is completely different. Banks are much more sensitive about pricing because basically the banks -- the customers of the banks needs to pay it. Even if they give it away free of charge, somewhere it's calculated in a budget. For the corporate networking access market, price is less sensitive. It's rather the deployment, or the integration into the existing infrastructure they have that is more important, and I believe there we have a very--that we score very high in that market now with an easy to install software called VACMAN middleware for radios and for web, and basically we sell it with the name Digipass Pack. Does that answer your question?

Yes it does, thank you.

I might add just one thing, Fred you know this, but for the rest of the audience, when Jan was talking about the brand, or identity, VASCO for years has been working in a very special partnership with its banking customers, and it actually custom-manufactures the Digipasses that it sells to those banks who in turn give to their customers. We manufacture those in the bank's specific color and with their logo. So it allows them to -- extend their brand right out to the hands of their corporate and retail customers. Next question, operator.

Ed, your line is live.

Good morning, guys. Congratulations. The question on the CNA, what's the average number of seats you're selling on those deals right now?

The average deal size, the number of units?

Yeah.

Jan?

Well, we start with Digipass Pack, which is basically software, and we start with ten Digipasses. So a customer, through the distributor resellers channel can acquire a Digipass Pack and Digipasses. Now, how does that happen? Depend on the size of the company, a company will buy 10, 50, 100 Digipasses, mostly to test them, to give them to some preferential employees; and it's only afterwards, and that can take months afterwards, that we will receive additional orders for other employees of the company. So basically they start with one department, I just give an example, let's say the sales people in a company, when they can work with it or when they are satisfied -- when there is a satisfaction towards that department, they will go to another department, and then another department. So it can start with 10, basically most of the time it starts with 50, and then afterwards we are getting additional orders.

In fact, over time with some of our international corporate customers it can be in the tens of thousands.

That's right.

Okay. So my next question is, during the quarter, how much business did you see from existing customers?

The question was during the quarter how much did we see in terms of business from existing customers.

In terms of the specific numbers, we track the new customers but given the size of the number of them we don't do a precise calculation of existing versus new. But the general calculation that we have done suggest that of the $6 million in total revenue, $6.2, a little over a million was from that new customer group. So I would estimate 75 to 80% is coming from existing customers and the rest from new in the quarter.

Okay. Great. And one question on the balance sheet. I see that deferred revenue has been dropping off. Is that because of the sale of the VACMAN and the structure of the sales there, or can you give me some more color on that?

Sure. The issue with deferred revenue is two-fold. One, VACMAN Enterprise in the earlier periods was an issue, but to the extent we've sold that, that's been removed completely from those numbers. So what you see now are a combination of two things: Ongoing maintenance for the various VACMAN interface products that Jan mentioned, such as the middle ware and the like, but more importantly the deposits on future orders under the just in time delivery program. And what would you see if you looked back over the past year, that goes in peaks and valleys. Under the just in time delivery program, we have tried to get 12 month POs from a number of our larger strategic customers; so that we can plan our shipments, manage the cost of our production, and get it to them just as they need to deploy them. With those orders we've been taking deposits of approximately 30%.

Now, as you look at the data last year, our number in deferred revenue is slightly lower than last year; but as you look at the first quarter of 2003 we had a significant increase, which is when a lot of those cash deposits for full year POs hit, and as the quarter progressed, we're shipping against those POs and deferred revenue came down. I would expect a similar kind of trend this year. We are continuing the just in time program, it has been well accepted, more and more of our customers are comfortable with the deposit requirement so we expect that number to grow in the future quarters.

Thanks, guys.

Our next question is coming from Larry Delake with Delake Financial.

Good morning, gentlemen. Excellent call. My question to you is, how is your product superior to some of the competition that is out there? What do you think is going to make people choose you instead of the others?

Well, I'll start this answer, and allow -- or ask Jan to add anything he would like. I think in terms of comparing 'our product line, which is pretty focused, it's pretty centric on strong authentication. We have a big family of products under the brand name Digipass. We have hardware versions, and we also have software versions. At the simplest end of the product line our products do what our primary competitor, RSA does, which is to generate a one-time password. And that's where their's stops, in terms of functionality. When we ship our products, inside each one of those product is a wide array of functions that can be enabled, or initiated at the time that the device is programmed. And so we decide, depending upon the customer, which of the functions need to be initialized.

Some additional functions that can be made available to a client are more than one identity in the device. So you could have a customer or a user that has one identity for banking, retail banking as an example, and another separate identity for stock brokerage. There's also the ability for higher levels of banking or finance transactions, like a wire transfer, to actually create a signature that represents the wire transfer that you're sending. To make sure that the wire transfer is done accurately, number one, and number two that the sender later on could not repudiate or deny that he initiated that transaction. We also have the ability in one or two models for our Asian market to initialize different languages to prompt the users in the Digipass. So you could have English in one market and you could have Chinese in another market, as an example. So in terms of the Digipass line itself, it's unsurpassed; it's not touchable.

The controllers, also we offer some extremely good solutions; where as many of our competitors have a full-blown -- they call it a aaa server, that stands for authentication, authorization, and administration. We do have such a server, but that requires the customer to maintain duplicate databases of users. Many of our customers, particularly the large banks, like a slimmer or thinner server. And we have something called the VACMAN controller, where we're able to plug our strong authentication directly into their native application; and as Jan had mentioned before we have something called VACMAN radius middleware, that we combine our Digipasses into a Digipass Pack and sell through our distribution channel. And so our focus has been in developing and producing and delivering products that meet the needs of our clients.

So in terms of a comparison, there really is no comparison. We are so far ahead of competition, it's ridiculous. We need to do a better job, of course, selling those benefits and making greater inroads in the market, and that's what we're focused on doing. Jan, would you like to add anything?

Yes, thank you, Ken. I believe, first of all, the biggest difference with our competitors are that VASCO is a purely authentication company. We have over 20 products in authentication, and we believe that we have with that, what we call our Digipass factory product suite, the most products to offer to all kinds of applications. We can offer security products for applications with a low transaction value and a low frequency of usage to applications with a high transaction value, and with a high frequency of usage. To give an example, our factory product fits as well for someone who wants to buy a book over E-bay once a year to a CFO who needs to transfer every hour $100 million. That's a whole product line. We believe that we are the only company in that market to have such a big suite of products. Our competitors are various, but they're only in some market segments competitors. And maybe they have other products that we don't have, but at least we have the widest range of products in authentication.

A second big difference, I believe, is that we are the company who is coming from the banking field, the banking security, and banks are very, very key, in security applications. We spend a lot of energy to deploy that market and also product. And again we are offering all those products also more and more to other market segments like the corporate networking access, like business to business; and quite soon with the standardization of the EMV platform in 2005, also in e-commerce. So it's like Ken was saying, we are fishing in a market that is probably for 95% open. We have our market vision, it's working. Authentication works. We are growing, and I believe that we are on that field far ahead to our competitors.

Next question, operator. Thanks to that previous question.

Our next question is coming from Garrett Becker with Tradition Azeal.

Hi, guys. I jumped on a little late so I apologize if you've gone over some of this already. Just wondering going forward looking at what your growth might come from, I know you spent a lot of time building out the channel so far. Where are you with that, and how much of your growth at this point is further build-outs of the channel? Or is it just a matter of now accelerating the revenue from existing channel partners?

Well, we have -- Garrett, thanks for joining us. We have a good solid base of banks. We just announced earlier we've got 262 banks total. Most of those banks have a repeatable revenue stream, ordering almost every quarter new units from us. So we'll continue to service the needs of those current customers, and we'll continue to add new banks whenever we can and add them to the repeatable revenue base. The smaller banks, of course, as we add them, will produce smaller unit sales and higher gross margins. Much the same as the corporate network access channel that we've talked about selling through. Many, many of the new accounts, 572 in 2003, involve the distribution channel, the reseller, selling to their customers; initially, as Jan said before, in small department sales, like the sales department, then adding on over time.

So we're focused on growing the business in banking and finance, which is our strong vertical market. We're doing that both directly and we're doing it through partners in countries where we find it advantageous to work with partners that know the local customs, have networks of contacts, and that sort of thing. We'll continue to add new resellers because of the leverage we get from that channel; and our job, once we sign a reseller, is to support them, train them, and go to their seminars, go to their shows and help them be productive. But in both of those channels, both the banking channel and the CNA, or reseller channel, we get a lot of leverage, because once we get a bank going, we basically have to support them from the point of view of taking their orders and making sure that we support their deployments.

On the corporate network access side it's basically the same thing. Once we sign up a reseller and train their people, those people go back and train others at the reseller, once they get their first sale, they know how to do it; and they simply come back to us for shipping of the orders and helping them in some of the shows that they go to. So our focus will be both those markets, the vertical market and the reseller channel market in terms of new accounts, of course, the new accounts will continue to come from the CNA market, the reseller channel.

Great. Just wondering on the competitive landscape maybe if we can go back to that a little bit, have you seen -- are you seeing anybody more or less, particularly in this quarter; and maybe are you competing more successfully against any one particular competitor out there?

I'll take a shot at it then let Jan add to it. As Jan said a few minutes ago the market is maybe 10% penetrated, he used 90% opportunity. So that means an awful lot of transactions happen where there's no competition. RSA, or the others, will get orders and we won't know about it. We'll get orders, and they don't know about it. So the market is extremely big, and so none of us are evangelists. We're simply trying to take the orders as the market begins to take more active measures in terms of security for their private data. So I'd say that in terms of competition, you know who the large one is. It's RSA, and they're the Kleenex of the business. When most people think about a strong identity product, they immediately say secure ID, and I kind of go along with that, because at least I know that the audience understands the business we're in. I think that as people learn more and more about VASCO's solutions and how strong they are, that we'll have more and more opportunities to compete, and once we have the opportunity to compete, we can be very competitive. Jan.

Yes, thank you, Ken. I would like to add a couple of things there. It is true that certainly in the U. S., RSA is the number one in the corporate networking access market. So again, VASCO is not only in that market, it is also in other markets. And in a lot is countries today, I can assure you that in a lot of countries today VASCO is seen as the number one in authentication. And authentication is broader, is a lot broader market that only the corporate networking access market. We have spoken about E-banking but again, business to business and later on this year and certainly next year, E-commerce will be a lot -- or much stronger business than today.

That means that as a strategy, and even not a black and white strategy, but in the countries where we are very strong today, in banking, we are also getting stronger and stronger in corporate networking access due to the fact that the customers of those banks are normally also working in corporate and identify our products with high level of security. So step by step we go forward and we are gaining a lot more market share in that distribution, or in that corporate networking access market. For the U.S. again we are doing a lot more direct marketing than we were doing in the past. As you can understand, for VASCO it was important to have first the foundation, that layer that gives us our repeating business, I believe we have done that in 2003. Also with the strength of our office in Boston, we can go now with new people that we've hired during the last year, we can grow much more stronger fighting for deals and we do a lot more direct marketing in business to business and e-banking, and we believe that that is the right strategy for the U.S., for the rest of the world.

Thanks, guys. And congratulation on a good quarter.

Thank you.

Our next question is coming from George Johnson with Stifel Nicolaus.

Good morning. I think the Active Card settlement was pretty significant, in my opinion, but what financial impact did the settlement have in 2003?

Your question really has to do with what our expenses were associated with the legal and others in 2003 and what it might have positively impacted our bottom line?

Exactly.

I'll let Cliff Bown handle that.

The reason Ken circled back with that clarification, George, is because the settlement with Active Card itself is confidential. So we can't disclose the specific terms of that, but the amount of the settlement was nominal. However, the amount of money that we spent defending the litigation was significant. During the year, the overall cost of defending the litigation was just under $600,000, and in the fourth quarter the expense was just under $200,000. So in terms of what we would consider to be a nonrecurring charge or expense, it was significant. The settlement itself was not a big dollar kind of item, because it basically concluded that we didn't infringe on the patent, that we were on the right track along the way. So I don't know if that answer the question but if not, circle back.

That's fine. Perfect. Thanks, guys. Congratulation on a good quarter.

Thanks, George.

Your next question is coming from Dennis Denoble.

Hi, Ken, Jan. I want to congratulate all of you for your hard work and for a great 2003. I want to stay on the question of competition for a minute. I've got a couple different questions. Ken, you mentioned that the product line of Digipass is unsurpassed. Are there any gaps in the product line?

Are there any gaps?

That you'll be working on.

Yeah, Jan, you might answer that. You see what the requirements are communicated by our prospects and customers. That's where we -- that's where we learn of the product requirements and the features and functions that are needed in the marketplace, and that's what guides us in terms of research and development expenditures. Jan.

Yes, thank you. First of all, what we are doing in the market is we have what is called a key account management. Key account management means that we go on a regular base to 20% of our largest customers. So if you hear that we have more than 250 banking customers that means that we do key account management in the banking at more than 50 banks. We are -- what is key account management? It's not only sales, but it's also product management that is regular contact with our customers, sometimes also R&D. So that we get the needed information of, the big question, is what to develop.

We believe that the banking or is probably the best market to have that information. Not that we are not listening to other market segments, but banks are always ahead for such things. So that is the way we do our product vision. Yes, there are gaps, and -- in our product line, and we are working on it, and we will come out soon with that information. It's a little bit sensitive to competition because it's going to be quite unique products, a combination of different technologies, new application products which is probably the trend, or not probably, is the trend in the market. But I believe it's a little bit too early to say it here to a public audience.

Okay. Another question I have concerning market penetration. How do you stack VASCO up with your competition, in terms of market penetration? It was mentioned that many people in Europe consider VASCO number one, in the United States it was mentioned that 7% of your revenues come from the United States. How do you stack up with the competition in terms of market penetration separately for the U.S. and then the rest of the world?

Jan, you can handle that, too.

First of all, I did not mention Europe. I mentioned outside U.S., meaning that it's not only in Europe; but also in some Asian countries, or pacific countries, that companies believe to be number one in authentication, that VASCO is number one in authentication. Now, if you look more in detail to our product range, and if we look in the U.S., you will see that; first of all, VASCO in the corporate networking access market is -- the strategy is to be an addon to a lot of the largest vendors in the network. What does that mean? That means that if a company wants to buy a total solution in security, if they want to have a total solution in security they will probably go to another vendor than VASCO, because VASCO as a product company goes through another way of doing business. I'll give an example.

Again, a company want to have this total solution. Probably they will go to companies like Netegrity, RSA, whatever. If the company wants to have strong user authentication for one or more applications, not total solutions, they will probably go or they will probably be better served by a company like VASCO, and VASCO is very aggressive in that market. So on competition-wise we deal on another way than our competitors; we are addon, we look for the quantities and I believe, again, that is the best fit for VASCO.

An example of that is our strong partnership with Novell.

That's right.

Novell has -- with VASCO we've integrated our solution natively into the Novell networking and security offering. And so whenever Novell, either with their own sales people or with some of their resellers, have a need or introduce the idea of strong authentication; we're a natural partner in that Novell client. Another example is a strong partnership we have with a wire transfer and financial transactions company called Pulitzer & Haney. Pulitzer & Haney calls on banks and helps to automate, with their software, those kinds of financial transactions; and they regularly introduce us into those accounts as their preferred vendor of strong authentication. So that's really what Jan is talking about. We leverage our relationships with other companies that are out in the market providing software solutions.

I can add something to that also. We are not seen by those international big corporate networking vendors as a competitor, due to the fact that we stick in our business of authentication, and that we don't go further on that. So we are always seen as a good partner for them.

So in other words, comparing market penetration with your competition is trying to compare apples with oranges, because they're not exactly the same product.

It's not exactly the same products, and it's certainly not exactly the same way of strategy that we are doing.

I understand. I understand. Thank you. One other quick question. Concerning your competitors financial health and financial growth. How do you figure you stack up with your competitors worldwide, in terms of the direction the companies are going?

Well, certainly, I think, if you look at the dot-com era; and certainly the some of the companies in our direct sector, I liken it to a CEO driving off the Cliff at 100 miles an hour thinking he's always going to be able to save the company. We realize we had to do something dramatic about 14 month ago, and we did it. There are some companies out there that have achieved profitability, as VASCO has, there are some that still have not achieved profitability; and haven't taken the extreme measures that are required and that hard look inside them to do what is necessary to achieve profitability. So we're more concerned, Dennis, about executing our plan, than the health of our competitors.

When we make a sale, we don't talk about the financial resources of our competitors, some of them do; but we focus on our solution, we focus on our strong ability in the banking and finance area, our strong ability to help in very, very large deployments. So personally, I'd like to see every competitor in the business profitable. I think when you have one company or two companies or three companies that are not doing well, it does not help our industry in general. I think profitable companies that compete fairly is very healthy.

Sure. They're spreading the gospel.

Sure, that's right.

Gentlemen, thank you very much for this conference. Thank you very much for 2003, and I hope I can say thank you very much for 2004 a year from now.

Well, thanks for joining us.

Okay.

Our next question is coming from Ron Silverton with JMP Capital.

What was your name again?

Ron Silverton, you line is live.

Thank you, operator. A little bit light on your side. Ron?

If you are there your line is live at this time.

I want to retract that question. Sorry.

Our next question is coming from Tom Tyson with Hartwood Capital.

This is actually Doug Moore, I'm partners with Tom. Doug Moore with Heartwood Capital. The question I have, what is the market growth? I'm just a little surprised that you're projecting 15 to 25%. I thought the market was growing at least that fast, actually faster. Could you address that?

Yeah. I will try to do that, Doug. The market growth figure seems to be a moving target. And unless somebody on the call has a better resource than I have had, the numbers seem to move all over the place. IDC seems to be one organization that forecast growth in our business, and, you know, I've seen anything from 20 to 30%. Others, Yankee Group, and I can't cite exactly, but generally speaking I've seen numbers all over the place; I've seen 8%, 10%, 15%, the highest I've seen is 30%. But -- so I guess my answer is I would love to have better data to compare to, but I just can't find it.

Thank you. Next question. Concentration of your customer base. Your top three or five customers, what percent of the total are they?

Well, we measure the top ten fairly routinely, Doug, and the top ten last year were in the mid 60% range. This year the top ten are going to be approximately 70% of our business. Now, those top ten and who's in the top ten varies from year to year. It's not consistently the same customer. As Ken mentioned, we have what we call repeatable revenue, and what often happens is a customer will have major installations in one year, then have smaller maintenance kinds of things the next year, then come back in subsequent years. So we measure a top ten, we report a top ten, according to the SEC requirements trying to give investors a feel for what percentage they are, but the mix within that ten changes.

Thank you. The last question I have is regarding lead times. I would have been -- I would think that as this authentication business gets underway and more banks are doing it and so forth, I would think lead times for you guys to get a good sale should be getting shorter. Am I correct or can you address that, please?

Jan, why don't you address that, also address the nature of how we get our orders from channel.

Can you -- I've heard the word through lead time?

Yeah, his question was, what are we experiencing in terms of lead time, that being the first time that we call on a customer to when we get a signed contract and start shipping? He's saying because of the visibility of security, particularly in banking and more activity occurs in banking, that he expects that our lead times will become shorter.

Okay.

Would you comment.

First of all, let's give a definition of lead time. What we are doing is every day we are prospecting on the market. We don't sell security as such. We only go more aggressively to a prospect if that prospect has already taken a decision that he wants to use strong authentication products, whatever that may be for him. So at that moment, let's say starts lead time for us. So again, we are not prospecting the market and saying, hey, Mr. Prospect, if you don't use our products, will you go bankrupt. No, we leave that to the market of the consultants and all those big consultancy groups. We are acting as soon as that decision or that there is already a decision to go for such technology. From that moment, there are different scenarios possible.

The first scenario is in the banks is that they will go for testing, and basically the lead time could be as short as three months, to one year; until they have taken the decision with what vendor they will work. Again, it's not only -- it can be also what technology they will use so. Three months to one year. After that they will buy a -- let's say a small amount of Digipasses for testing, they're going to buy the software, or they're working with a partner that has already integrated the software; and depending, they're working with one of our partners who has already integrated software. or if they want to do it themselves it will take another, let's say, one month to three months to do the testing. Then he will go in production with employees. A couple of thousand employees who are, at the same customers of the bank, and they will test it through those employees who act as customers; and that will take another six weeks to two months, and after that, they will go in full production. And then we are depending on the success of the marketing machines, where we have our formal and informal VASCO group; because where there is something very typical in banks is, that there is no competition outside the territory.

A bank in the Netherlands doesn't see American basics as competitors, and it's ready to share that experience. We call that our VASCO club, our marketing people are doing with a lot of actions, let's say putting people together so experience can be shared. That is -- gives a shorter lead time, but what is more important, in fact, is that as we are depending on the success of their marketing campaigns; by sharing that information, our new customers will have more customers using electronic banking products and due to that we will sell more Digipasses. In the corporate networking access market it's a short lead time. If they have taken the decision it goes up maybe to a couple of weeks to choose the vendor, typically 50 to 100 Digipasses to one department of the company. Let's say the sales department, after that they're adding departments, then it becomes a business for us. Does that answer your question, sir?

Yes, thank you.

I might add one more thing. In the elaborate description that Jan gave about the way we court banks and they roll out their applications, he's described a very strong barrier to entry for any other companies getting into this business. It's a longer-term kind of committment. You have to have the reputation, you have to be able to demonstration that you know how to do massive deployments and to make those deployments work. You have to have experience, you have the club that Jan mentioned. Which are the other VASCO banking customers that are satisfied, more than satisfied with their relationship with VASCO, that help the new bank be successful in their deployments. So I didn't want that to go unemphasized, that that is a very strong portion of our strengths, particularly in banking.

Thank you.

Thank you.

We have a follow-up question from Ed Cheng.

Ed Cheng, okay.

A lot of your competitors are playing in this government market, in the U. S. especially with the common access card, and the transportation worker, identity credentials? Do you guys see a similar market happening in Europe and since you are strong in Europe would that possibly be something you could get into?

Actually, maybe not known well in the market, VASCO's been in the smart card business for well over a year. Due to a requirement by one of our largest banking customers, they wanted their five to six million debit card holders; which were carrying around in their pockets the European version of a U.S. debit card, a debit card in the U.S. has a magnetic stripe on the back. In Europe it has a chip, an electronic chip or computer chip on it's face, and those customers use those cards on a day-to-day basis to buy things at the store, buy things at the restaurant; and this large customer wanted us to build a device that would -- could be used so that same card could be plugged into this portable smart card reader, it's called a Digipass 800, to generate a one-time password for strong authentication for telephone banking, and Internet banking and brokerage. And so because of that we've been involved in smart cards for well over a year. We were a party to Europay, MasterCard and Visa's announcement. It will be two years this coming March, that they made the announcement in Hanover Germany of a new replacement standard for smart cards.

It's called EMV, Europay, MasterCard, and Visa. So going all the way back then, we were one of the earliest certified companies to support that EMV standard. About six weeks ago, we announced with MasterCard and Barclay Card in the U. K. the very first pilot for EMV in actual use. MasterCard at the time announced that they had signed up about 8,000 Internet vendors that would accept the EMV, kind of smart card. Barclay Card is buying the smart card readers, the Digipass 800 from VASCO, to give to their customers, so we believe we'll be a major player in the EMV smart card part of the business. As far as the common access card, at this time we have no plans to participate in any of those bids with the DoD. Jan, is there anything you would like to add?

Yes. How do we see the market and what is the trend in the market? The trend in the market is to go multi-application, that is for sure. That means that if you are talking about smart cards, that means that smart cards will more and more have multi-applications. So if you're talking like about the DoD, and you see -- you see it in the rest of the world, you will see that governments will issue, let's say, identity cards for their population; but those identity cards will be smart cards, will be probably of a pki technology, and but they will be used for multi-applications. Ken mentioned already about the EMV standard, where we also have already a long-term relationship with MasterCard, Visa, and Europay; EMV, Europay, MasterCard, Visa. And again our product vision is very easy.

We want our Digipass to be compatible with the existing platforms. Once those platforms are in the market, they will not be replaced. As such, these products will need to be compatible with those markets and I believe that we have there the right product vision. So, yes, we are working in government. Yes, we have already millions of Digipasses who are working in field with existing -- and I emphasize it, existing, smart cards. Means that we don't need to change them, and we believe that we have the right product vision in that market.

Would we see a government sale sometime in 2004?

No, you will not see a government or -- you will not see, let's say, honestly, the sales you're going to see in 2004 -- if there are sales in the government you need to see them as pilot tests; as mentioned in Ken's expose, we have already a government that are using Digipasses, national ID cards, smart cards, but the trend, in fact, that those national ID cards will be issued in the next years.

Okay. And --.

But -- sorry. But there's also -- they are not only national ID cards in the market that are using smart card technology, Ken mentioned already before EMV who has announced that--a lot of countries has announced to be ready for 2005 for EMV. Meaning that the traditional bank card will be a smart card, and by using a Digipass you can do Internet security, whatever, business to business, e-commerce. So the trend is again that smart cards will be multi-application that is for sure, and our product vision is to have the products working with as much as possible existing smart cards applications, let's say.

Jan, have you heard, though, of any European government sort of getting into a program with their Department of Defense for some kind of a common access card like the U.S. is doing?

It's more than what the U. S. is doing, it's for the whole population. Lots of governments will issue national ID cards, and ID cards in a lot of countries are an obligation to have it. It's not only a driver's license, you need to have a national ID card with you. It's going to be on a smart card, and it's going to be for the total population. So it's more than just the population of a minister of defense. It's going to be the whole population. I'm saying the trend is certainly multi-application, the trend is not having a smart card for one group of people. The trend is really to have some smart cards that everyone will have in his wallet and that by adding applications like an intelligent Digipasses or other smart cards, that is for me, and I'm sure that will be the trend in the future that governments, banks, and insurance companies will react on.

Thank you.

Once again, that's 1 followed by 4 for any questions you may have at this time. I am not showing any further questions at this time.

All right. Well, in that event, I'll -- I'd like to thank everybody for participating, and I'd like to personally thank everybody for their support and faith in VASCO. We're very pleased with what we did in 2003. We're very optimistic for 2004, and we'll look forward to our next earnings conference call in approximately 90 days. Thanks very much. Bye.

Thank you.

This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.