OneSpan Inc (OSPN) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen. My name is Sandra and I will be your conference facilitator today. At this time, I would like to welcome everyone to the VASCO Data Security International Inc. 2005 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Thank you.

It is now my pleasure to turn the floor over to your host, T. Kendall Hunt, Founder, Chairman and CEO. Sir, you may begin your conference.

Thank you, operator. Good morning, everyone; for those listening from Europe, good afternoon, and from Asia good, evening. We have continuing good news to discuss with you today.

My name is Ken Hunt. I'm Chairman, Founder and CEO of VASCO Data Security International Inc. On the call with me today are Jan Valcke, our President and Chief Operating Officer, and Cliff Bown, our EVP and Chief Financial Officer.

Before we begin the conference call, I need to brief all of you on forward-looking statements. Statements made in this conference call that relate to future plans, events or performances are forward-looking statements. Any statement 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.

Today, we are going to review the results for fourth quarter and full year 2005. As always, we will host a question-and-answer session after the conclusion of management's prepared remarks. If possible, I would like to budget one hour total for this conference call. If you can limit your questions to one or two, it would be appreciated.

The results for the fourth quarter confirm once again that our strategies are working worldwide. Even though the fourth quarter is traditionally a strong quarter, we were especially pleased with the strong second half of the quarter, resulting in our seventh consecutive quarterly increase in revenues. The increases in revenues have been combined with increases in operating productivity and margins.

Revenues for the fourth quarter were $17,519,000, up 32% sequentially over third quarter 2005, and an 88% increase over the comparable fourth quarter of 2004. Revenues for full year 2005 versus 2004 were up 83%.

New accounts continued to grow during the fourth quarter. During the quarter, we sold an additional 251 new accounts, including 21 new banks and 230 new corporate network access customers. Almost all of these corporate network access new accounts and many of the new bank customers were generated through our distributor and reseller partners. Program to date, we have signed 45 distributors, who in turn service a network of over 1500 resellers in about 104 countries around the world.

For full year 2005, we sold 821 new accounts, including 89 new banks and 732 new corporate network access accounts. Comparatively for all of 2004, we produced 543 new accounts, including 70 banks and 473 corporate customers. We now have over 440 banks and over 2300 network access accounts, including corporations, federal, state and local governments as customers located in over 100 countries around the world.

VASCO's sustainable, repeatable sales model. For 12 quarters now, I have sung the same song, namely, that VASCO's developed a sustainable, repeatable sales model. Our bank customers launch multiyear projects that are supported by our strong authentication products. These projects are directed towards large corporate and consumer audiences and are rolled out over two to four years. Many of our bank customers secure their orders with firm 12-month purchase orders, giving us great visibility for our future revenue flow.

The 228 total new bank customers we signed in the years 2003, 4 and 5 are now in various stages of their two to four-year rollouts, adding to the sustainable, repeatable revenue flow that we see from other long-standing banking customers, some going back to 1987. This has created a layering or stacking effect and is driving our top-line revenue and guidance.

Full option, all-terrain model; this is VASCO's new strategy. We will still maintain the high-volume, high-quality, low-cost producer strategy that has driven our business so rapidly. However, in order to further penetrate and protect our existing and growing customer base, our plan is to offer a compelling and flexible platform that supports not only our own growing array of strong authentication products, but also those of our partners as well.

This will include not only our traditional Digipass hardware authentication products, but also a discrete selection of alternative authentication products that can be easily deployed to an ever-growing number of users across a broad number of vertical markets and industries. This new and revised strategy will continue to drive our units and revenue. You will hear more about our new product strategy during Jan Valcke's presentation later in this call.

We sold and shipped approximately 2.4 million Digipass units during fourth quarter 2005, once again demonstrating the effectiveness of our strategies, focus and execution. If you look back over the last seven quarters, you would see that the quantity of Digipass units shipped has increased in each successive quarter, with the most significant ramp-up in volume beginning the fourth quarter of 2004.

In Q4 of 2004, we shipped more than 1 million units for the first time in the Company's history. Program to date, approximately 20 million Digipass units have been sold and shipped through year-end 2005, excluding an estimated 2.5 million units sold by AOS prior to our acquisition. We expect that our unit sales will continue to accelerate as we develop new markets and identify new audiences for the Company's products.

Strategically, VASCO will continue to focus on retail and consumer audiences, those individuals that are doing online financial transactions of all types. These could be Internet consumers using an EMV smartcard. These could be B-to-C users of all sorts, including wagering, auction and subscription services. And of course, there will be a growing number of banking customers doing their online banking in a safe and secure environment.

In a growing number of countries around the world, most recently in Hong Kong, governments and associations are demanding that their financial institutions deploy strong two-factor authentication. VASCO will continue to benefit from this trend.

As everyone is aware now, a very strong banking industry directive was issued on October 12th last year here in the United States by the FFIEC, an umbrella group of regulators that includes the FDIC. The FDIC has distributed guidance to all of its supervised banks, commercial and savings and loans. This guidance is not as crystal clear as it is in Hong Kong. In Hong Kong, they're explicit; they require banks to deploy to every customer two-factor authentication, a user name and a physical device, like a security token, a USB stick, a smartcard.

The FDIC guidance is more interpretive. They suggest that every bank perform a security assessment on every application to determine what they think is appropriate. The recent announcement of our new strategy, full-option, all-terrain security, is an acknowledgment that the banking market will adopt a wide range of security solutions. With our broader discrete layers of security, we are prepared to meet the security requirements of the banks at the level they believe is appropriate.

In order to maximize our results in the banking market, we will continue to focus on the largest banks directly with our own sales organization. Around the world, we've found great success working with agents and resellers as partners in countries where we do not have a direct presence. When opportunities present themselves through these partners, we leap into action, immediately deploying VASCO troops to the scene of the action. In other countries, including the United States, we work with partners like Fiserv and their major division, ITI, large IT banking outsources who resell VASCO's products to their existing customers, making it possible for us to reach thousands of small and midsized committee banks and their millions of Internet banking clients.

At this time, I'd like to introduce Jan Valcke, VASCO's President and Chief Operating Officer. Jan, once again, congratulations to you and your team on another great quarter.

Thank you, Ken. Ladies and gentlemen, at the beginning of 2003, VASCO became successful because of its focus on strong authentication. We were good at what we were doing and the market appreciated that. Now three years later, we are the global number one provider of strong authentication products.

On the client side, there are four authentication technologies -- password technologies, including TAN and Scratch List, Q&A session, matrix awards, etc., etc; one-time password technologies, VASCO's stronghold, its successful hardware and software Digipass family; the certification PKI; and finally biometrics. VASCO integrates those four authentication technologies on one and unique platform, the VACMAN Controller.

The VACMAN Controller is the backbone of our success, the core product that the end-user doesn't see. It is an easy to install, easy to maintain server authentication product that supports over 15 algorithms and concepts, all operating systems, and the four client authentication products we have discussed before.

VACMAN Controller is embedded into the security and Internet infrastructures of over 100 solution partners. VACMAN controller is also the core of VASCO's identity server and authentication server product for the enterprise security and also the banking sector.

VASCO has built its leadership position in the dynamic password segment. During 2005, VASCO has reached the impressive amount of 20 million Digipass sold and delivered. In total, VASCO has sold over 7 million Digipass during the year 2005.

Digipass had started back in the early '90s as a product that was only distributed to selected corporate banking customers. It has now become a mass product for retail banking and other sectors. And with over 440 banks using our products, we are well-equipped to capture all our customers' needs in the Digipass sphere. We truly are an authentication Company.

The next step in our success story was to adapt our product strategy to allow us to win those markets out of the reach of the hard- or software Digipass products. Meaning for example, the highly secured USB-protected certificate and PKI applications, but also the password technologies for people who buy [books] a couple of times a year, who want to check their frequent-flier miles and book airplane tickets.

We are not leaving our very successful product strategy; we will stay the authentication Company. However, we add new products to our offerings; that way, we become the full-option, all-terrain authentication company. With full-option, we mean that VASCO's VACMAN Controller can support passwords, one-time password, certification and biometrics. Contrary to some, VASCO does not believe in hype and gives clear target dates for every one of those technologies.

VASCO is already a world leader in the dynamic password and digital (indiscernible) field with its famous Digipass productline. Starting next quarter, VASCO will support alternative password technologies. In Q1, we already won a first bank that will use VACMAN Controller to calculate codes that will be printed on a paper-based TAN list. Later this year, VASCO will add certificate PKI client products for the clients.

The announcement of our [proud] partnership with the company [Utran] from Italy was the first action in that field. Dependent upon market conditions, demand and the necessary development of technological infrastructure, VASCO will also be active in the biometric sphere. VASCO doesn't believe in biometrics as a stand-alone, online authentication technology, but as an add-on for the current two-factor authentication standards, making the leap to three-factor authentication.

VASCO's R&D resources are fully focusing on all four above-mentioned technologies. All-terrain. All-terrain stands for the sectors, the professions using VASCO's Digipass and VACMAN products. All VASCO's Digipass products are developed to meet and surpass the banking sector's stringent security criteria. In a later phase, these banking level security products are introduced in other sectors.

Currently, VASCO's products are used in between 50 and 100 vertical applications, including online brokerage, the government, e-gaming, automotive, sports, the airline industry, travel, manufacturing industry, and of course, banking. By [recalling] the full-option, all-terrain authentication company, VASCO gives a strong signal to its customers, prospects and partners. They can rest assured that VASCO will be able to offer them best-of-breed authentication products now and in the future.

Customers will also be able to choose the authentication solutions that are best suited for them, their customers, their budget and their market. VASCO will offer a la carte authentication from fast food to haute cuisine.

To [capture] our customers' needs, we need a (indiscernible) service network. Therefore, VASCO has accelerated its hiring program. At the end of Q3, VASCO had over 110 employees; on December 31st, we had 128 people working for us. I think that we have proven this quarter that we can grow without endangering our profitability. Thank you.

Thank you, Jan. At this time, I would like to turn the call over to Cliff Bown, our Chief Financial Officer. Cliff?

Thank you, Ken, and welcome to everybody on the call. As noted earlier by Ken, revenues for the fourth quarter and full year of 2005 were 17.5 million and 54.6 million, respectively, an increase of 8.2 million or 88% over the fourth quarter of 2004 and an increase of 24.7 million or 83% over full year 2004.

Revenues for the quarter and the full year included 1.2 million and 4.5 million, respectively, net of purchase accounting adjustments from AOS-Hagenuk, which was acquired in February of 2005. Revenues for AOS before purchase accounting adjustments for the quarter and full year were 1.2 million and 5.0 million respectively. Excluding the revenue from AOS, our revenue grew 76% over the fourth quarter and 67% over full year 2004.

Revenue for the fourth quarter of 2005, as mentioned by Ken, was 32% higher than the third quarter of 2005, if you include AOS revenue, and it was also 35% higher than the third quarter of 2005, if you exclude AOS revenue.

Compared to 2004 the increase in revenue for the fourth quarter and full year reflected significant increases from both the banking and the corporate network access markets. Revenues in the fourth quarter of 2005 from banking and corporate network access increased 101% and 34%, respectively. Revenues for the full year 2005 from the banking and corporate network access market increased 95% and 32% respectively.

The distribution of our revenue in the fourth quarter of 2005 between our two primary markets was approximately 87% from the banking and 13% from the corporate network access market. In the fourth quarter of 2004, approximately 82% came from banking and 18% from corporate network.

The geographic distribution of our revenue for the fourth quarter of 2005 was approximately 65% from Europe, 5% from the United States, 13% from Asia and the remaining 17% from other countries. It should be noted that the revenue from each of these primary geographic areas, Europe, the United States and Asia, increased in the fourth quarter of 2005 as compared to the fourth quarter of 2004. For the fourth quarter of 2004, 89% of the revenue was from Europe, 7% was from the U.S. and 4% was from other countries.

The geographic distribution of our revenue for the full year 2005 was approximately 72% from Europe, 7% from the U.S., 12% from Asia and the remaining 9% from other countries. For the full year 2004, by comparison, 81% of the revenue was from Europe, 10% from the U.S., 2% from Asia and 7% from other countries. As was the case in the fourth quarter, revenue from each of our primary geographic areas increased for the full year of 2005 as compared to the full year 2004.

Gross profit as a percentage of revenue for both fourth quarter and full year 2005 was approximately 63%, and compares to 65% and 69% for the fourth quarter and full year 2004, respectively. The decline in gross profit as a percent of revenue in 2005 compared to 2004 in both the quarter and full year was primarily related to the lower average sales price, partially offset by lower average cost of product produced. The lower average sales price reflects the increase in the size of the deployments of our customers.

As has often been noted previously, our strategy of being the high-volume, high-quality, low-cost producer has positioned the Company to compete effectively for the larger deployments of tokens, especially in the consumer market, and has resulted in significant increases in the number of tokens sold in each of the last four quarters.

VASCO shipped approximately 2.4 million tokens in the fourth quarter of 2005, which was 127% greater than the fourth quarter of 2004. For the full year 2005, VASCO shipped approximately 7.3 million tokens, which was 159% greater than for the full year 2004.

The average selling price per token, including related software, was approximately $7.22 for the fourth quarter of 2005 and $7.44 for the full year 2005. In 2004, the average selling price per token, including related software, was approximately $8.70 for the fourth quarter of 2004 and $10.54 for the full year 2004.

As you will hear in a moment, the decline in average sales price and related gross margin have been more than offset by a decline in operating expenses as a percent of revenue, all of which has resulted in an increase in operating profits, both on absolute dollars as well as in percentage of revenue.

Operating expenses for the fourth quarter of 2005 were 6.8 million, an increase of 2.3 million or 50% over the fourth quarter of 2004, and operating expenses for the quarter included 539,000 related to AOS, of which 54,000 was related to the amortization of intangibles arising from that acquisition. Excluding the AOS expenses, operating expenses for the quarter increased 39% over the fourth quarter of 2004.

Operating expenses for the full year 2005 were 23.5 million, an increase of 8.3 million or 55% from full year 2004. Operating expenses included 2.3 million related to AOS, of which 367,000 were related to the amortization of the intangibles arising from the acquisition. Excluding the AOS expenses, operating expenses for the full year increased 40% over full year 2004.

In addition to the expenses related to AOS, operating expenses increased in each of the three major categories -- Sales and Marketing, Research and Development, and General and Administrative, when compared to the fourth quarter and full year in 2004. The majority of the increases in expenses was in the Sales and Marketing area, and were related to the Company's increased investment in sales staff and marketing programs.

It should be noted that while overall operating expenses increased, operating expenses as a percentage of revenue declined. For the fourth quarter of 2005, operating expenses as a percentage of revenue were 39%, an improvement of 9.8 percentage points from 48.8% reported for the fourth quarter of 2004. For the full year 2005, operating expenses as a percentage of revenue were 43%, an improvement of 7.7 percentage points from the 50.7% reported for the same period in 2004.

As Ken has often mentioned in the past, we believe that the decline in operating expenses as a percentage of revenue reflects the leverage or opportunity for improved operating productivity that is in the Company's business model. By working through the distributor and reseller network and also as a result of selling larger quantities related to consumer applications, the Company is able to support higher levels of revenue without commensurate increases in its expense base.

Operating income for the fourth quarter of 2005 was 4,208,000, an increase of $2,715,000, or 182%, from the $1,493,000 reported in the fourth quarter of 2004. Operating income for the full year of 2005 was $10,953,000, an increase of $5,401,000, or 97%, from the $5,552,000 reported for the full year 2004.

Operating income as a percentage of revenue, or operating margin, was approximately 24% for the quarter and 20% for the full year in 2005, and is 8 percentage points and 1.5 percentage points higher, respectively, than the same periods in 2004. The increase in operating margin is attributable to the reduction in operating expenses as a percentage of the revenue, partially offset by the decline in gross margins.

As we look forward and as has been mentioned in previous calls, we plan to invest a portion of our increased operating profit in discretionary programs that will increase our sales and marketing capability and, over time, are expected to generate incremental revenues from new geographic regions or to increase our penetration in existing markets.

Other Income and Expense was expense of $7,000 for the fourth quarter of 2005 compared to expense of 538,000 for the same period in 2004. For the full year 2005, Other Income and Expense was income of $506,000 compared to expense of $539,000 for full year 2004. The increase in Other Income in Expense is primarily due to differences in exchange, gains and losses that resulted from the combination of our increasing U.S. dollar net asset position and the change in the exchange rate between the euro and the U.S. dollar. As you may recall, in May of 2005, the Company initiated a program to hedge the income statement exposure to transaction gains or losses resulting from the changes in currency rates.

The Company reported income tax expense of $1,276,000 and $3,827,000 for the fourth quarter and full year 2005, respectively. In 2004, the Company reported income tax expense of $471,000 and $1,880,000 for the fourth quarter and full year, respectively.

The effective tax rate was 30% for the fourth quarter and 33% for the full year 2005. The effective tax rate for fourth quarter and full year 2004 was 48% and 37%, respectively. The rates reflect the Company's earnings by tax jurisdiction, and the lower rates in 2005 reflect an increase in earnings in countries in which the Company has net operating loss carryforwards that have been fully reserved for book purposes in prior periods.

Earnings before interest, taxes, depreciation and amortization, EBITDA or operating cash flow, if you will, from continuing operations was $4.5 million and $12.5 million for the fourth quarter and full year 2005, respectively. EBITDA in 2005 reflects an improvement of 3.3 million or 276% from the fourth quarter of 2004, and an improvement of 6.8 million or 118% for the full year of 2004. The fourth quarter of 2005 reflected the 12th consecutive quarter of positive operating cash flow.

The makeup of our workforce as of December 31st, 2005, was 128 people worldwide, with 80 people in sales, marketing and customer support, 31 people in research and development, and 17 people in general and administrative categories. The average headcount for full year 2005 increased by 32 persons, or 40%, over the average full-year headcount in 2004.

I would now like to make a few comments on the balance sheet. Our net cash balance and working capital balances increased from the prior quarter as a result of the Company's strong operating performance. During the fourth quarter, our net cash balance, which is total cash less bank borrowings, increased $4.7 million or 51%, to $14 million from 9.3 million at September 30th, 2005. Our working capital increased $3.5 million or 27% to 16.3 million from $12.8 million at September 30th of 2005.

Bank borrowings noted on the balance sheet of 3.2 million were borrowed under our line of credit and relate solely to our hedging program. There was no impact on working capital from the hedging program, as the additional cash was offset by short-term debt.

During the quarter, our Days Sales Outstanding and Accounts Receivable increased from 59 days at September 30th, 2005, to 63 days at the end of the fourth quarter. The increase in Days Sales Outstanding is primarily related to the increased volume and revenue recorded in the last month of the quarter, and was not yet due at the end of the year.

The Company continues to have no term debt and the Company has approximately $300,000 as of December 31st, 2005, for additional borrowings under its line of credit, as secured by its receivables.

Now I would like to turn the meeting back to Ken.

Thank you, Cliff. First, I would like to comment on order backlog for Q1 2006. As of this date, we have firm orders with shipments scheduled for the first quarter of approximately $12.8 million. Any new orders received before quarter's end and shipped during the quarter would be additive to this number. This backlog shows the strength of our order flow, as it is 20% higher than the backlog going into Q1 2005. In addition, the backlog is actually 12% higher than the $11.4 million in revenues reported for Q1 2005.

Today, we are providing guidance for full year 2006. As in the past, we only comment on annual numbers, not quarterly numbers. We estimate that our full-year revenue will grow between 35 and 45% in 2006 over 2005. We expect that full-year gross margins will be in the range of 58 to 63% of revenue. Finally, we are projecting that operating income will be in the range of 13 to 18% of revenue on a U.S. GAAP basis. Excluding amortization costs and the non-cash costs associated with the Company's equity and long-term incentive compensation plans, we expect that operating income will be between 15 and 20% on a pro forma basis.

In summary, we are very pleased with what we've accomplished in 2005. As in the past, we will not 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.

At this time, that concludes our presentations today and we will now open the call for questions. As I mentioned earlier, as a courtesy to others on the call, I would appreciate it if you would limit your questions to an initial question plus a follow-up. If you have additional questions, please re-enter the queue after the answers to your initial question have been given. Operator?

(OPERATOR INSTRUCTIONS) [Derrick Dunne] of StreetAccount. Derrick has removed himself from queue. Jeff Englander of America's Growth Capital.

Can you talk a little bit -- the guidance range in terms of revenues and on the gross margin line is a little bit lower than you have been using historically the last couple of years. Can you talk about what you see going on there and why maybe some of the -- I guess I'd call it caution going into the year?

Certainly. You know from past discussions, anybody that has ever talked to me, you know that we tend to be on the conservative side. We try to underpromise and over deliver. As a reminder, last year we increased our guidance in a special conference call in December of 2004. We had had two successive years a little bit over 30% growth and we came out with guidance in that December meeting of 35 to 45%. In February, at the next earnings call, we increased that to 55 to 65%.

And then as we got further into the year, had a better, firm feeling for the year -- I think it was in August -- July, after the second quarter, we increased it to the 65 to 75%. So I think just generally speaking, that is our style, that's the way we like to do it, and we don't give estimates or guidance based upon hope and a prayer. We want to feel very confident that when we give guidance, we reserve the right sometime in the future if we deem it appropriate to revise our guidance again.

Can you talk about whether -- if there is anything specific you are seeing out there that may lead you to be a little bit more conservative? And also, if you can address the impact of risk-based authentication systems, you know, [OATH] VeriSign just acquired MapCentric -- that they may be having on the market and the sales cycle.

Affecting the guidance that we've just given on the revenue line, we're giving that guidance against a fairly higher revenue for the quarter and revenue for the year. I don't think there is anything in particular other than us looking at our backlog, looking at our opportunity, and being the conservative company that we've been in the past.

One last question. Can you talk about some of the things you may be doing, particularly in this country, in terms of channel management, in terms of some of the hiring you may have done to broaden out and become more efficient in the channel?

Absolutely. Jan, would you handle that question please?

Yes. As you probably know, we have different markets. If you're talking about the banking market, we continue also in the U.S. with our very successful banking summits, where we are putting prospects and customers together so that bankers can talk between them about how they are doing deployment market, Internet banking and so on and so one. So we will certainly continue to do that in the banking area.

If you see in the CNA market, you see already that in the CNA market, due to the fact that we have launched new software -- new software, we've launched that in the fourth quarter -- that are accepting or that can be used by more users by licensed -- and that is typically for big countries like in the U.S. -- you see already in the increase of the number of accounts that we are making in CNA.

So we are continuing to do what we did before, just step-by-step, and I think we know what we are doing.

Can you talk about what you may be doing -- go ahead. I'll get back in the queue. Thank you, Ken and Jan.

Jonathan Ruykhaver from Raymond James & Associates.

Can you give a little bit more color on activity in North America? Do you have pilots currently in place? Do you sense tokens will be a solution that banks use to meet the FFIEC requirement? Do you really think it's going to be challenge question software alternatives that get more of the attention over time in North America?

Yes, I think it's going to be across the board, to be honest with you. Our research and the feedback we've heard from banks we call on here, I think that they're diligent about meeting the guidance of the FDIC. And you should understand what the FDIC is saying, in our interpretation, and they actually had an official at the banking summit in New York several weeks ago.

They're basically saying, look, banks go out and do a needs assessment on all your applications, and you make a determination about what level of security you need application-by-application. Do your pilots, start something. And I think as long as the banks are showing good-faith effort in trying to meet the guidance, that they will get a kitchen pass into 2007.

We are seeing a lot of activity, we are seeing a lot of pilots, we're seeing more calls into us by far than ever before, we're seeing a lot more reception. One of the reasons we came out with this broader solution was we acknowledge that not every bank is going to deploy tokens across all their customer bases; that's not going to happen. So it's going to be a discrete choice of different types of security and we're going to be a player there.

Right. But you do see evidence based on pilot activity that tokens will get deployed in North America?

Jan, I didn't answer that question properly, I guess. Maybe you can give a little more color.

First of all, you need to understand our offering -- we are a authentication company; we are combining four authentication technologies. And we are not a token company. We are really an authentication company, and tokens is only one of our offerings.

Like Ken mentioned, we have so many solutions, we have -- if you look at our client side, we have over -- almost 40 products, Digipass, different products. Some of them are hardware tokens, some of them are Digipass hardware products, smartcards, and also more and more software devices. So we believe, and I'm very convinced, that all the experience that we have, that we are really ready to answer on the U.S. market.

And whatever the bank wants to do with deployment, we have already the products. And even better, we have already customers of it. So we are really well-prepared for that North American market.

So just to, I guess, conclude. You do sense that you've got the portfolio that will address those issues and probably start to get deployments in place later this year, and not really expect any meaningful revenues till '07, it sounds -- from North America.

That is a lot of question in one sentence? But generally speaking, it yes.

Just one quick question. Can you comment at all on the partnership with ITI, the division of Fiserv. Have you seen any activity for that channel to date?

We have the different partners, we have the solution partners for our banking software, and we have integrated VACMAN Controller, we have integrators. We have also authentication service companies, like the credit card companies and like VeriSign, and more and more now we have also metric partner companies -- we have them already in Europe and Asia and also in the U.S.

There is a lot of activity going on, because these partners are serving hundreds, thousands of banks. And yes, we see a lot of activity with network quality, banking network partners, not only in the U.S.

But you do see activity with Fiserv, specifically?

Yes (multiple speakers).

Andre (indiscernible), [Synergy] Investments.

Thank you. Congratulations on a strong quarter. Maybe I can just follow up on the prior question and maybe you could just elaborate. As far as Fiserv and VeriSign are concerned, what are your expectations on the revenue from the channel in this fiscal year?

That is not something we break out, Andre.

Okay, then maybe (indiscernible) -- do you expect to see revenue in the second half of this year?

Yes.

And then you are introducing some of the more software solutions in your product footprint. Can you talk about gross margin implications on some of the newer solutions that you are introducing?

I think we expect over the longer run those software solutions to have much higher gross margins, and therefore to improve the average gross margin that we report. However, in 2006, as reflected by the guidance, we don't know that those will be a dominant factor in the numbers; hence, the decline in the guidance from 63% actual today to the 58 to 63% going forward.

When we look at that gross margin number and the outlook for 2006, we still see large demand for large deployments of our traditional tokens. And over time, I think you'll see the software solutions blended more in the mix and the gross margin rate level off, if not slightly increase.

Michael Tieu of Brean Murray, Carret.

Good morning. Just want to follow up on the FFIEC regulations. You mentioned that were a lot of activities, but maybe you could be a little more specific. Did you win any new contracts in the U.S. due to the FFIEC regulations? And if you did, were these competitive deals?

Jan, can you answer that question? We've certainly closed some deals since the original October announcement, but those deals were probably in play before the announcement. I can't personally think of any that since the announcement we've won because of that announcement. But Jan, would you answer that?

Yes, well, if you're talking again on the banking market here, the banking market we are making about and achieving a little bit more now than two banks every week -- this is worldwide -- new customers or new banking customers that we are receiving. Some, and more and more, are coming from the U.S.

Okay. Apparently the U.S. makes up about 5% of your revenue -- actually, that is the number in Q4. Do you expect that number to expand significantly in 2006?

I would say the answer to that is yes. The United States in my history -- North America in my business history has always had a fairly large percentage of worldwide sales. The percentage that we enjoy right now is fairly small. Certainly, we expect that number to grow.

Lastly on R&D, you are expected to roll out some new products this year. And yet currently, your R&D expenses compared to some of your competitors are predominantly low. Do you expect that number to go up significantly, Cliff? Perhaps you can help us with that in terms of our modeling for 2006.

Well, I think the absolute spending in R&D will certainly go up. As Jan has mentioned, we're broadening our portfolio to many other types of authentication methodologies. So you will see that number increase, both through internal investing as well as a potential buy strategy. Ken and Jan have talked historically about make versus buy, and when it comes to the technologies, we employ both actively. When we acquired AOS-Hagenuk, that was basically a technology buy, and we increased our R&D staff by over 40% this last year. The actual headcount increase in R&D was 49% during this last year.

So we are investing, but we're investing in a very focused area. As it relates to percentage of revenue, I really don't have a target percent. As we've talked in the past, our operating margins are targeted to be in the 15 to 20% range on a pro forma basis, but there will be periods when our revenues grow faster than our ability to efficiently spend. And that was the case in the fourth quarter where we had a marked increase in headcount -- Jan mentioned we went from 110 to 128 -- yet our revenues grew so much faster that we ended up with a 24% operating margin.

So in terms of absolute dollars, I think you can see or anticipate that we will continue to increase our spending there reasonably aggressively in R&D. The growth there will be second only probably to sales and marketing. But we have no specific targets in mind as a percentage of revenue.

Thank you.

J. Hingorani of Thompson, Davis & Company.

Congratulations, great results. Cliff, can you just go over the market segment information again -- banking, CNA?

Yes, the banking for the quarter was 87%, and for the full year 86%. CNA, obviously, is the rest at 13% for the quarter and 14% for the full year. But both segments grew at a substantial rate. As I mentioned in my comments, the banking market grew in the 90 to 100% plus range; the CNA market grow in the 30% plus range.

Then, Ken, you talked about the banks that came on in 2002 through 2004, are in years two through four of their rollout. That creates a layering or stacking effect.

Right.

And kind of marrying that with the sustainable, repeatable model, can we talk about -- just give us some color on banks that may have come on in 2002, 2003, how they went from maybe programs that were one application or an expanded?

Historically, we even have a pyramid in our updated corporate presentation. Historically, you're going back 15 years, we would go into a bank and we would service just their corporate accounts. We would build a product in the bank's color and with their logo, and they would deploy that to their corporate accounts. And then the next project -- that would be project number one, that would be for corporate banking, cash management, wire transfers, those kind of applications.

And once we were in the bank and they got that first application up and running, we would go to an entirely different department, the retail or consumer department, and we would work with the EVP of consumer banking and we would start deploying there. As we continued to become more aggressive with our pricing, we encouraged the banks to continue to deploy more and more and deeper and deeper into those audiences.

So again, historically, we would start with the corporate clients and then we would move to the retail clients. In many instances over the last year when we've gone into a bank, the very first application is the retail or consumer site; and then secondly, the corporate side. So that has been a big shift and one of the reasons why our volumes have been going up so rapidly.

We expect to see that continue. Again, let me remind you we have a roughly 440 banks as clients, there are over 50,000 banks in the world. We've barely penetrated the banks and the audiences we already have. So we expect to see more and more growth on the consumer side.

And also seeing how -- you know, you're seeing more and more growth in Asia -- given that EMV is now being implemented there starting the first quarter of this year -- correct?

Yes.

Somebody commented about U.S. and North American growth. That as and when you have standards implemented and we've certainly got the directive -- but will we see a lot more growth in Asia this year, for example, a lot more relative growth?

Jan?

I think basically what we are doing in fact is we are making our programs up in, let's say, November and from all regions. Basically, what we are doing is we have a business plan by country and by market segment. That means is based on those business plans that we are doing all the hiring programs and so on and so on.

So we see -- first of all, what we see is growth everywhere in the world, again. The second thing is you need you understand what Digipass is. I know that a lot of people are seeing a Digipass as a token, a one-time password, a reader. But it's much more than that. Digipass is really a concept that has tens of different applications, such a lot of different applications for electronic and digital signing. It can be used in e-government applications, working with ID cards.

So basically, it is -- and therefore we have also 40 different form factors and a lot of them are in software. To answer very straightforward your question, I think first of all that all regions will grow. I will not say that all regions will grow as fast in retail banking. But all regions will grow fast in authentication. Some will do it in EMV; some will do it with ID cards. And some will do it just with software platforms, and their hardware devices will be integrated afterwards, not from the beginning.

But basically, we don't mind. We don't mind because we as an authentication company, we have so many solutions today that we can offer to a lot of applications. So the right answer is growing in all regions in authentication.

So the 2.4 million number that you reported, we shouldn't necessarily only relate that to tokens?

I think you can relate that to hardware, Digipasses seen as tokens. But again, what we are offering on the market is much more than tokens.

Okay, great. I'll step back in queue and follow up with you guys off-line. Thank you again. Congratulations.

Alan Weinfeld, Kaufman Brothers.

(indiscernible) on the quarter. I just was interested in how -- you have the backlog and that's pretty certain. Then you go out and ship in the quarter customers that come on. But what happened in December it looks like was that you had a backlog, I believe, a 14 million type number. But then you booked and shipped, I think, a real large number of about 3 to $3.5 million of revenues. Is that correct?

It was 4.8.

4.8. So that was a very large number. Was that in your plan to do that or did something special happen in the quarter that you booked and shipped that much revenue?

We're quite fortunate in the fact that we have the experience we do with the manufacturers that we've been using for quite some time. And what we have been able to do is to shorten the leadtime for manufacturing these custom tokens. Our key strategy, of course, is to have the right number of processors, because that is at the heart, the engine for the token devices.

And as long as we have the processors, the turnaround on building the casings, the little models, the form factors, assembling, testing and shipping has been reduced to a very short period. And that is why we are able to do 4.8 incrementally from the earnings call.

So do you see that happening again in this March quarter or do you just have to see how the business comes along?

We just have to see how the business comes along. But I think the important thing is if the demand is there, we're able to accommodate the buyer. I'm very happy you pointed that out. We're very proud and pleased with that aspect of the fourth quarter. It shows that we not only have strong demand, but we have the ability to respond quickly as well.

Thank you.

Horacio Zambrano, Wedbush-Morgan Securities.

Congratulations. I guess just following up with that question that was just asked on the 4.8 upside from when you gave guidance, it seems like the CNA, the Corporate Network Access, had 230 customers this quarter, up from sort of a flat 167, 168 level for most of the year and that helped drive that.

What should we expect sort of in '06 from here? It looks like Q4 is generally seasonally strong for CNA. But do you think there is a whole new baseline -- is this momentum that sustains itself, the channel is now getting more traction here, or is this purely seasonal effect on CNA?

No, I think it's a general statement that the resellers that we've signed and trained over the last three years are getting better at what they do as it relates to our partnership. Obviously, when you go to the trouble of signing up 45 distributors and 1500 resellers, you have to do something with them. And that is train them, make sure they understand what the value proposition is when they're out selling strong authentication to their customers. So we do that at the training level.

We are also starting to hire channel managers whose only job is to work with the channel, continually training them, going to their seminars, going to their shows and helping them be productive. Generally speaking, I expect the channel to become more productive and, in fact, to grow in raw numbers.

With regards to the EMV market, in the past, you've said that '06 would start to show meaningful contribution to your growth. Can you give us some color on EMV in Europe and how strong that market should be in '06 versus '07? And then in Asia, with the standard sort of being put in place as of this quarter, do you expect that is more of a credit card and point-of-sale rollout versus real readers being sold into that market?

Jan, without talking about specific revenues, would you answer that question?

Okay. What we see first of all in the EMV market, the first implementation of EMV is always what is called POS applications; that is those terminals that you see in [bus] stations, restaurants, [shelter] and so on, because EMV basically is the standard for commerce applications.

The nice thing of EMV is that to do EMV, you need a smartcard. And due to the fact that you have a smartcard and due to the fact that the smartcards today have enough memory, enough pole processing, you can also put an authentication protocol on it. And with the authentication protocol and, for instance, a Digipass EVM reader, called the 800 series here at VASCO, you can use it to secure online banking applications.

Having said that, that means that the EMV authentication protocol applications are basically country-oriented. So if there is one bank or one organization starting in a country, they do it mostly with several banks. How does that work? Basically that works as follows -- one other organization, banking organization or organization owned by banks, they put a standard -- there is always a little bit of chauvinism (indiscernible) by country -- every EMV cap authentication protocol is a bit different by country. And that is the bank's choice, to see they follow that direction or they go on their own.

So it's very much country-oriented. Which countries do you see? We see the Benelux, which stands for Belgium, Netherlands and Luxembourg; we see some movement in Central and Eastern Europe and some movement in Asia.

Okay. Just last question. At the analysts' day, I took away that you might offer in Q2 a challenge-and-respond sort of password type authentication. Last week, you announced a partnership with PassMark. I am just wondering how those two play into each other -- is PassMark sort of a short-term type partnership to address password authentication in the U.S.? How does that sort of play in with your plans to offer your own internally-developed challenge-response technology?

Horacio, we went to be the brand for these types of authentication, whether it is with banks or it's for Internet consumer B-to-C, B-to-B. It's a huge, huge market. There are many different solutions out there. If one of the other solutions are already in an account, whether that's an enterprise account or a bank account, we'd like them to be able to look to us for strong token authentication. So if they have a solution that even layers or is exactly like ours, we'd still like the ability for them to look to us for strong token authentication.

So I think just generally speaking, the business is so large, the industry is growing so fast that our strategy is to partner with as many legitimate partners as we can to offer our strong solutions.

But you still have plans to develop your own [fast] challenge response type technology?

Absolutely.

Okay, thank you.

Absolutely.

Great, thanks.

Joe Maxa of Dougherty & Company.

Question I have is regarding the backlog you've given, 12.8 million for Q1 currently. That compares to 10.7 million at that was a year ago, which ended up being about 93% of total revenue for the quarter. The previous year, granted, you didn't have a big retail presence, but it was about 86% of the revenue. Should we be assuming somewhere in that same ballpark for Q1?

I think, Joe, that Ken probably addressed that a little bit earlier with Alan's call. For the fourth quarter of last year we saw a lot more in-quarter -- orders and shipments that were fulfilled in the same quarter. We don't know exactly what the order flow will be. So the data points that you reference are all correct, where in fact the difference between backlog and the actual for the quarter weren't that great in the first quarter.

But much like we saw a change in the trend last year -- and we didn't know at that point if it was a trend. The fourth quarter of last year for the first time we shipped one million at tokens. We went from 660,000 to 1 million in the fourth quarter of last year. This year, we had the first big bump in a difference between backlog and final quarter. So again, we only have one data point, and the data point doesn't make a trend. So we're going to have to wait and see what the order flow is.

Right, okay. Cliff, also, what are you expecting the tax rate to be this coming year?

We're obviously planning for the rate to continue to decline as we drive more and more business in the countries where we have NOLs. At this point, I think will wait for the first-quarter actual results, because that will be the first time that we sit down and look at the full year and do our estimate of the tax rate.

We do have some tax plant that are unfolding. We do have our estimates right now. But I'd prefer not to get into that on this call. I think it would be more appropriate for the call after first-quarter actual results.

Okay. Last thing. Ken, does your guidance include any expected token sales from the eBay PayPal consumer push?

No, I'd say generally speaking in those kinds of opportunities, we look at them mainly as incremental opportunities, where we don't have direct control. We like to sit back and we will be pleased if we get a substantial amount of revenues.

So no, I would say that our guidance is really oriented to our core business -- business that we can control directly. But we are very opportunistic and we are very optimistic about the partnerships that we do sign. But we mostly look at them as incremental to what we are communicating to the market.

Great. Thanks, Ken.

Operator, can we just have a couple more questions, please?

Thank you. Fred Ziegel of Soleil Brokerage.

Just a quick question for Cliff first. Gross margins historically are influenced by mix between banks and corporate network access, and then within the banking side of it, the larger versus the newer banks. So in terms of the gross margin guidance for '06, it would appear as if we should be expecting an increasing percentage of the business coming from your large installed banking. Is that the way to read that gross margin?

Yes, I would anticipate that more and more of our business comes from the very large deployments. When you look at our customer base, what has happened is our Top 10 customers continue to change. This year -- or last year, Top 10 was about 60% of our total revenue; this year, Top 10 will be about 64%.

But what we see coming on are some of that layering affect. For example, of that Top 10, one of them started with us in 2003; three of them started with us in 2004; one of them started with us in 2005. The rest are all that sustainable, repeatable that Ken talks about, because those were customers that have been with us a long time.

But what we also see is the revenue from those top-tier guys are much higher than they were in the previous year. So a person that had 10% of the revenue in 2004 had to do 3 million plus in business, and we had three of those. This year, with 54 million in revenue, they will have to do more than 5 million in business with us to be in that Top 10, and this year we had two.

So we are seeing larger deployments around the world, and our gross margin forecast reflects the fact that we believe that's going to continue.

Okay. I guess a question for Ken or Jan. With all that's been going on recently -- and I guess probably one of the big themes at the RSA conference was around authentication. When you look at the competitive rankings, have players, in your mind, shifted one way or the other?

Jan, why don't you answer that question?

I'm sorry -- I didn't understand --

His question was the competitive landscape and has competition shifted to new players?

Let me think about that question. I'm sorry -- I didn't get 100% the question.

I think what Fred is asking, there seems to be some new companies, new players that we've never heard of before. So the old traditional -- I won't name them -- I won't name that traditional players, but there have been some new names that have popped up on the screen with new innovative solutions that are password technologies.

Yes, okay. Now I understand the question. Again, first of all, you need to understand very well the Digipass and the VACMAN Controller concept to understand that we have a very competitive advantage as a Company because we have so many customers. And an authentication product is more than just a device; it needs to be integrated, it needs to be deployed, it needs to be marketed.

And like always, you see newer companies coming into the market, and it's only afterwards to see if they're going to stay or not. But again, I'm not worried about that.

Last question. The banks, if I contrast the U.S. to I guess banks outside the U.S., would you say that the banks outside the U.S. are less likely to adopt a new technology from a startup company and more likely to stick with the traditional vendors and the U.S. maybe the other way around?

First of all, I don't see a difference between the mentality of North American banks and other banks. It is always the same thing. In the beginning, they are putting teams together, they need to learn what a real deployment is. First of all, they need to learn what their customers are, because a lot of those banks, they don't know (indiscernible) very well. They need to know how those customers are working. And that takes some time.

And that is what is happening now in the U.S. -- teams that are putting together -- there putting RFPs together or RFIs together; they're doing some testing, some piloting, they go on the left and on the right. And yet one day they're going to need to make a decision for what technology they are going. And that is happening in the rest of the world, yes.

After we see what is going to be the result; again I'm very, very confident, I know who it is working, it's in every country the same way it is working. And I believe we are very well-equipped, we have very good strong products that has proven qualities to conquer that North American market.

Are you seeing any interest in the Digipass 100?

If you see the product, it is of course a product that is a very sexy, that is very attractive, you see that product. So the answer is certainly yes. Will it be for big deployments or for part of the customers we see what will be the reaction. But it's [more] probably the Digipass 100. Again, the Digipass 100 is only one of our almost 40 Digipass products. If you want a black-white answer, it is really yes.

Thanks.

One less questioner, please, operator.

Chris Hovis of Morgan Keegan.

Congrats on the quarter. Most of my questions have been answered. I do want to just try to explore the partnership opportunities you mentioned with regard to software or other alternative authentication devices. Can you help us understand the revenue opportunity for VASCO in an instance where perhaps PassMark and VASCO are deployed?

The arrangement can be across the board. It could be an OEM agreement, like we have with VeriSign, where we manufacture the Digipass GO3 in their color and with their logo and we implement the OATH algorithm for them. They buy the product, they integrate it into their own platform and they sell it through their channel.

In other situations where we've embedded our technology into another hardware platform, we receive a royalty for every unit that is shipped. In some cases, it is simply a strategic partnership where if the customer wants to add Digipass tokens to our partner's software platform that does some security to the lower level users in a different way, we are brought in as a partner and we make the direct sale. So it is really across the board, depending upon the partner and the agreement.

Is, let's say, a software-only authentication such as PassMark, where they are already deployed, you would get revenue from the tokens you are selling as well as the software that you sell VACMAN Controller. Is there any incremental fee to support existing PassMark customers with the VACMAN controller?

I think he's asking if there is a maintenance fee or something as PassMark sells our product into the (multiple speakers).

I don't know. Again, I have to give you the general -- I don't know the exact agreement we have with PassMark and I wouldn't answer it anyway. I would just say we work a deal that makes sense and that is worth our doing.

Cliff, one other quick question on tax rate. I know you want to hold off till Q1 before giving a definitive answer. As we're looking into '06, is it fair to assume that the tax rate would be closer to Q4's number?

I would anticipate that, yes. One of the issues that we need to look at thoroughly is the amount of tax benefits that we've not recognized for book purposes. We had significant NOLs in the U.S. and other places around the world that are fully reserved. At some point, we will cross the line as to when those reserves are no longer needed. Under the accounting literature, you may recall that you have to have a reasonably certain outlook on the future to be able to recognize those as current benefits.

There may come a point -- I'm not saying it will be in 2006 -- but there may come a point when in fact most of that needs to come back to the books. At the present time, all of those NOLs are still fully reserved so all of it we picked up in 2005 were the benefits directly related to the countries where we did have profits. And as we look at 2006, we're going to have to review that fairly carefully.

And share count guidance for '06 -- thoughts there?

We've got about 36.2 million shares outstanding today. We've got 139,000 more outstanding as of the end of 12/31, and about 2.2 million option shares that were outstanding on that date. Those would be the primary numbers that would go into the share count going, forward subject to if there were other acquisitions or other activities to be done along those lines where we wanted to use our stock.

Great. I'll follow up with any other questions. Thanks.

With that, I'd like to conclude the call. I'd like to thank everybody for their attention and for joining us today. And to all the VASCO people around the world, thanks very much for your hard work in executing our plan. Good day.

Thank you. This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.