OneSpan Inc (OSPN) 2006 Q2 法說會逐字稿

Good morning. My name is Eduardo and I'll be your conference facilitator today. At this time I would like to welcome everyone to the VASCO Data Security's Q2 2006 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]

It is now my pleasure to turn the floor over to your host, Kendall Hunt, Chairman, Founder, and CEO of VASCO Data Security International Inc. Sir, you may begin your conference.

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

My name is Ken Hunt and I'm the 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 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're going to review the results for second quarter 2006. As always, we will host a question and answer session after the conclusion of managements' 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.

First I'd like to address revenue for second quarter 2006. It was $18.5 million, an increase of 50% over second quarter 2005 and our strongest quarter ever, even surpassing our extraordinary fourth quarter of 2005.

It was also our fourteenth consecutive positive quarter in terms of operating income and cash flow.

New accounts continued to grow during the second quarter. During the quarter we sold an additional 361 new accounts including 46 new banks, an absolute Company record, and 315 new enterprise security customers.

Year to date we've sold 702 new accounts, including 80 new banks and 622 new enterprise security customers.

Comparatively, for all of 2005 we produced 821 new accounts, including 89 banks and 732 enterprise security customers.

We now have over 500 banks and almost 3,000 enterprise security customers including corporations, federal, state, and local governments as customers located in over 100 countries around the world.

Most importantly, we are making significant progress here in the United States. In fact, 15 of the 46 new banks in Q2 were signed here in the U.S. This success has definitely been fueled by the very strong banking industry directive issued on October 12 last year here in the United States by the FFIEC, an umbrella group of regulators that includes the FDIC.

VASCO's sustainable, repeatable sales model, all of you should know this one by now. I've been consistent with this message for 14 quarters. Namely that VASCO has developed a sustainable, repeatable sales model mainly driven by our strong vertical market, banking, and finance.

Our bank customers launch multi-year projects that are supported by our strong authentication products. These projects are directed towards large corporate and consumer audiences and are rolled out over 2 to 4 years.

Additionally, we continue to add new banks every quarter that contribute an ever-drawing number of new projects. This has created the layering or stacking effect that I often speak about and is driving our top line revenue and guidance.

Full option, all terrain model, we introduced our full option, all terrain strategy in the first quarter of 2006 to further penetrate and protect our existing and growing customer base. We will build on our strategy of being the high volume, high quality, low cost producer by expanding our flexible platform to support a growing array of authentication products.

Some of those products like our Digipass for Web, which we announced in the first quarter, will allow customers to implement a strong authentication solution as a compliment to or as an alternative to deploying hardware authentication devices.

Our platform, which allows any of our forms of authentication to be used simultaneously, will allow customers to deploy an appropriate, cost effective method of authentication for each user of their application by selecting the appropriate Digipass product including Digipass for Web.

We believe that Digipass for Web will provide a seamless, non-invasive way to authenticate users that goes well beyond today's fraud detection products. With the addition of Digipass for Web, VASCO will be able to serve and authenticate every audience that needs strong authentication from people buying a book online once a year to CFOs of companies transacting millions of dollars on a daily basis.

We will also be looking to acquire companies that can expand our authentication product offerings and product development capabilities.

We sold and shipped a record 2.7 million Digipass units during Q2 2006. Once again demonstrating the effectiveness of our strategy's focus and execution. Program to date, approximately 28 million Digipass units have been sold and shipped including the units sold by AOS Hagenuk 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.

I believe that VASCO as a Company is gaining a reputation for its focus and discipline.

We focus on markets where we have a differentiated and unique platform. We don't spend money lavishly but focus on profitability for our shareholders. We don't acquire companies recklessly but use a disciplined, well-developed process that assures a fair price and an optimal and profitable outcome.

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

Thank you, Ken.

Ladies and gentlemen, our successful second quarter proves once again that our strategy works. By focusing on authentication, we make sure that customers and prospects understand what we are doing.

This is a huge advantage compared with competitors for whom authentication is just a sideshow.

As always, I will discuss the 4 elements of the Company - the market, the products, the people, and the money.

The market, our global success proves our market strategy. In every one of our geographical targets, VASCO has won market share. Facts don't lie. This shows that our VACMAN controller strategy is working.

I just want to quote some of the most resounding customer wins and successes.

The first one, Banco Bradesco in Brazil is the first bank in the world that has announced to protect its customers assets with both hard and software Digipass products. We see a growing interest in our software products, whereas our hardware product range is becoming more successful every quarter, in the second quarter VASCO sold and delivered a record amount of Digipass, a spectacular 2.7 million units.

Number 2, VASCO won 15 new banks in the United States during the second quarter for corporate banking. Two of these new customers are the recently announced Citibank and Old National.

All 50 banks have implemented VACMAN controller or VACMAN middle ware. VASCO's strategy is to focus on the corporate banking market first. Once a bank has deployed a first batch of Digipass and has integrated VACMAN control, it is technically ready for larger deployments in all applications including retail banking.

VASCO expects the first strong authentication products for retail banking in the United States to happen in 2007. The Company believes that Digipass for Web will be an important tool to reach that goal.

Number 3, VASCO organized successful banking services in Turkey and Moscow. In total we received over 200 representatives of leading banks.

Successes with Garanti Bank and Bank Asya in Turkey have shown that VASCO's position in the important Turkish market is getting stronger rapidly.

In addition to the geographic markets, VASCO distinguishes so called vertical markets. Of those the financial market and the enterprise security markets are currently the most important.

Emerging markets are the B-to-B e-commerce, B-to-C e-commerce, and e-government.

The financial market, VASCO's traditional stronghold, grows quickly with the addition of 46 new banks in the second quarter, of which 15 for the United States.

Although growth in the U.S. is a cause for optimism, in order to gain even more momentum, we stepped up the organization of new banking summits and round tables in the U.S. On August 22 we will tackle the central region by means of roundtable in Columbus, Ohio.

In total, over 500 financial institutions, of which 50 in the U.S. protect their customers with VASCO's Digipass. We can safely state that Digipass is used for retail banking on every continent except Antarctica.

The enterprise security market, formally known as CNA, is growing quickly. In the second quarter we won 315 new customers in this field.

VASCO's total number of enterprise security customers is close to the 3,000 mark. Both e-government and e-commerce are emerging.

In Belgium, for example, we have seen the first cases of local police forces using our eID reader technology based on the Digipass 820 platform.

The products, VASCO's continuing efforts to broaden its product line pay off. Our customers and prospects see us as a full option, all terrain authentication company, being able to offer on account authentication.

Around VACMAN control authentication platform, banks and other organizations can truly choose which client authentication they want to use for which type of customer. VASCO is much more than hardware authentication vendor. More and more banks show interest in mixing hard and software Digipass authentication.

The before mentioned Bradesco case is a nice example of this approach.

The second quarter of 2006 saw very important evolutions in the product sphere. VASCO developed and launched Digipass for Web, the software web based Digipass that will be an important asset, especially in the e-commerce and the U.S. retail banking market.

The launch of Digipass Easy Pack was a prelude of the creation of a suite of products especially aimed at the enterprise security market.

You will see a lot more of this kind of products in the near future.

As always, VASCO uses a make or buy strategy for new products and new technologies. The recent acquisition of the Austrian smart card specialist Logico fits perfectly in that strategy. Logico had the lock of range of password management and PTI enabling technology and products.

They sell those products to enterprises in, amongst others, the healthcare, government, and industrial sectors. The existing Logico products are a big reinforcement of VASCO's product range for enterprise security.

The combination of VASCO's existing offerings and Logico's password management tools creates great synergies that will become apparent in the short term, certainly when used in conjunction with VASCO's VACMAN control and identity server.

I would like to conclude the product chapter by referring to last quarter's conference call. During that call we explained VASCO's solutions for the different types of fraud schemes that are currently used on the Internet by organized crime.

Man in the middle and Trojans are highly sophisticated forms of attacks that can be completely neutralized by using VASCO's proven e-signature technology. E-signature, a transaction signing, is a functionality that is embedded into VASCO's Digipass since the first half of the 90s of last century.

Because information about the transaction is a part of the signature calculation so the transaction cannot be hijacked and sent to a different account by a man in the middle or a Trojan.

We are more than willing to discuss the Digipass functionality later on.

A large number of banks have used Digipass signatures for many years. This gives VASCO an enormous competitive advantage in times when attacks yet even more sophisticated.

For your information the e-signature functionality is included in Digipass for Web.

The people, VASCO's staff is growing steadily. At the end of the second quarter we had over 150 employees worldwide. Hiring took place globally and we gained a lot of R&D resources with the acquisition of Logico.

Logico or VASCO Austria will act as VASCO's smart card technology R&D center. The integration is going smoothly and we have high expectations about the added value of Logico to our products and solution range.

The cash, I will not tell you too much about our cash situation because Cliff Bown, our CFO will do that. What I can tell you is that VASCO is growing quickly and that we can finance our own growth with the money that we earn every quarter and that's for both organic growth and acquisitions.

We will keep focusing on both growth and profitability in the future while keeping costs under control. Thank you.

Thank you, Jan.

At this time I'd like to turn the call over to Cliff Bown, our Chief Financial Officer. Cliff?

Thank you, Ken and hello to everyone on the call.

Revenues for the second quarter and 6 months ended June 30, 2006 were $18.5 million and $32.2 million respectively, an increase of $6.2 million or 50% over the second quarter of 2005. And an increase of $8.4 million or 35% over the 6 months ended June 30 of 2005.

On a sequential basis revenue for the second quarter of 2006 was 35% higher than the first quarter of 2006.

Compared to 2005, the increase in revenue for the second quarter and 6 months ended June 30 reflected significant increases from both the banking and the enterprise security markets. Revenues in the second quarter of 2006 from the banking and enterprise security markets increased 52% and 40% respectively.

Revenues for the 6 months ended June 30 of 2006 from the banking and enterprise security markets increased 34% and 43% respectively.

The distribution of our revenue in the second quarter of 2006 between our 2 primary markets was comparable to the distribution in the second quarter of 2005.

In 2006 approximately 87% of our revenues came from banking while 13% came from enterprise security. In the second quarter of 2005 approximately 86% came from banking and 14% from enterprise security.

The geographic distribution of our revenue in the second quarter of 2006, however, was significantly different than in 2005. In the second quarter of 2006 approximately 62% came from Europe, 14% from the United States, 5% from Asia, and the remaining 20% from other countries.

For the second quarter of 2005 79% of the revenue was from Europe, 6% was from the United States, 12% from Asia, and 2% was from other countries.

It should be noted that with the exception of Asia, our total revenue from each of our primary geographic areas increased in the second quarter of 2006 as compared to the second quarter of 2005.

The geographic distribution of the revenue for the 6 months ended June 30, 2006 was approximately 65% from Europe, 11% from the U.S., 7% from Asia, and the remaining 18% from other countries.

For the 6 months ended June 30 of 2005, 83% of the revenues was Europe, 6% from the U.S., 7% from Asia, and 3% was from other countries.

On a year to date basis revenues from all of our primary geographic areas increased as compared to the 6 months ended June 30 of 2005.

Gross profit as a percentage of revenue was relatively comparable in 2006 and 2005. Gross profit as a percentage of revenue for the second quarter of 2006 was 64% compared to 65% in 2005. For the 6 months ended June 30 of 2006 gross profit as a percentage of revenue was approximately 66% compared to 64% for the same period in 2005.

In general, both the quarter and 6 months ended June 30 the percentage decline in average sales price was offset by the percentage decline in average cost of product produced.

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 with our larger deployment of Digipasses, especially in the consumer market. And has resulted in significant increase in the number of Digipasses sold.

VASCO shipped approximately 2.7 million Digipasses in the second quarter of 2006, which is 71% greater than the second quarter of 2005.

For the 6 months ended June 30 of 2006, VASCO shipped approximately 4.4 million Digipasses, which was 45% greater than for the first 6 months of, 6 months ended June 30 of 2005.

The average selling price per Digipass, including related software, was approximately $6.86 for the second quarter of 2006 and $7.24 for the 6 months ended June 30 of 2006.

In 2005 the average selling price per Digipass, including related software, was approximately $7.85 for the second quarter and $7.73 for the 6 months ended June 30.

Operating expenses for the second quarter of 2006 were $7.8 million, an increase of $2 million or 35% from the second quarter of 2005. Operating expenses for the quarter included $430,000 related to stock-based compensation or incentive plans.

Operating expenses for the second quarter increased by $931,000 or 26% in sales and marketing, $332,000 or 37% in research and development, and $903,000 or 82% in general and administrative when compared to the second quarter of 2005.

The majority of the increase in sales and marketing area were related to the Company's increased investment in sales staff and marketing programs. The increase in research and development was primarily related to increased compensation due to increased headcount.

The increases in general and administrative categories were primarily related to the increases in the Company's provision for uncollectable accounts, stock based incentive program costs, increased compensation, insurance costs, and professional service costs.

Operating expenses for the first 6 months of 2006 were $14.3 million, an increase of $3.3 million or 30% from the comparable period in 2005. Operating expenses for the 6 months of 2006 included $712,000 related to stock based incentive plans.

The reasons for the increase in expense for the 6-month period are generally the same as previously noted for the quarter-over-quarter comparison.

Operating income for the second quarter of 2006 was $4.1 million, an increase of $1.8 million or 79% from the $2.3 million reported for the second quarter of 2005. Operating income for the 6 months ended June 30 was $7 million, an increase of $2.8 million or 66% from the $4.2 million reported for the 6 months ended June 30 of 2005.

Operating income as a percent of revenue or operating margin was approximately 22% for the quarter and the 6 months ended June 30 of 2006 and is approximately 4 percentage points higher than the same periods of 2005.

The increase in operating margin for the quarter is primarily attributed to the reduction in operating expenses as a percentage of revenue. The increase in the operating margin for the 6 months ended June 30 is attributable in equal parts to the improvement in gross margin rate and to the reduction in operating expenses as a percent of revenue.

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

Now I'd like to make a few comments on non-operating income and expense.

In the second quarter of 2006 Secured Services, Inc. repaid their installment note in full. As a result, we recorded $189,000 of income related to the recovery of impairment charges recorded in the first quarter of 2006.

For the 6 months ended June 30, 2006 we have reported an impairment charge of $600,000, which reflects a full reserve against the investment the Company had in Secured Services preferred stock.

Other income and expense primarily consist of exchange gains and losses on transactions denominated in currencies other than the reporting entities current currency and subsidies received from foreign governments related to our export businesses in those countries. There were no significant changes in other income and expense for the quarter.

For the 6-month period, the decrease in other income and expense is primarily due to a reduction in transactions gains in 2006 as compared to 2005.

Income tax expense for the second quarter of 2006 was $1.4 million, an increase of approximately $500,000 from the second quarter of 2005. The increase in tax expenses attributable to higher pre-tax income partially offset by a lower effective tax rate.

The effective tax rate was 32% for the second quarter of 2006 compared to 35% for the second quarter of 2005.

Income tax expense for the first 6 months of 2006 was $2.4 million, an increase of approximately $750,000 from the same period in 2005.

The increase in tax expense reflects the tax on increased earnings and an increase in the effective tax rate.

The effective tax rate for the first 6 months of 2006 was 36% compared to 35% for the first 6 months of 2005. The tax rate for the first 6 months of 2006 is higher than the expected tax rate for the full year as it does not include a benefit for the impairment charge.

The normalized effective tax rate for full-year 2006 is currently 33% and compares to 35% for 2005. The effective tax rate for both periods reflects the Company's estimate of its full-year tax rate at the end of each respective period.

The rate reported for 2006 is lower than the rate for 2005 as the Company's expectation of earnings in countries in which the Company has a loss tax-loss carry forward are higher in 2006 than they were at the end of 2005.

Earnings before interest, taxes, depreciation, and amortization, EBITDA or operating cash flow if you will from continuing operations was $4.6 million and $6.9 million for the second quarter and 6 months ended June 30 of 2006 respectively.

EBITDA for 2006 reflects an improvement of $1.9 million or 68% from the second quarter of 2005 and an improvement of $1.8 million or 34% for the 6 months ended June 30 of 2005.

Second quarter of 2006 reflected the fourteenth consecutive quarter of positive operating cash flow.

The make up of our workforce as of June 30, 2006 was 150 people worldwide with 85 in sales, marketing, and customer support; 46 in research and development; and 19 in general and administrative. The average headcount for the 6 months ended June 30, 2006 increased by approximately 31 persons or 30% over the average 6 months ended June 30 in 2005.

Finally I would like to make a few comments on the balance sheet. Our net cash balance and working capital balance decreased from prior quarter as a result of the Company's purchase of Logico Smart Card Solutions and the increased investments in other components of working capital, primarily accounts receivable.

During the second quarter our net cash balance, total cash less the bank borrowings, decreased $1.5 million or 10% to $13 million from $14.5 million at March 31 of 2006.

Our working capital increased $1.4 million or 7% to $20 million from $18.7 million at March 31 of 2006.

Bank borrowings noted on the balance sheet of $3.1 million were borrowed under the 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 76 days at March 31 of 2006 to 81 days at the end of the second quarter. The increase in DSO is primarily related to the increased volume of revenue reported in the last month of the quarter and was not yet due at the end of the quarter.

The Company continues to have no term debt. And we have approximately $400,000 as of June 30, 2006 available for additional borrowings under this line of credit that's secured by its receivables.

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

Thank you, Cliff.

First I'd like to comment on order backlog for Q3 2006. As of this date, we have firm orders with shipments scheduled for the third quarter of approximately $16.1 million.

Any new orders received before quarter's end and shipped during the quarter would be added to this number.

This backlog shows the strength of our order flow, as it is 39% higher than the backlog going into Q3 2005. In addition, the backlog is 21% higher than the $13.3 million in revenues reported for Q3 2005.

Today we are updating guidance for full-year 2006. As in the past, we only comment on annual numbers, not quarterly numbers. First, we maintain our estimate that full-year revenue will grow between 35 and 45% in 2006 over 2005.

Second, we expect that full-year gross margins will be in the range of 60% to 65% of revenue up from our previous estimate of 58 to 63%.

Finally, we are projecting that operating income will be in the range of 15 to 20% of revenue on a U.S. GAAP basis, up from our previous estimate of 13 to 18%.

Excluding amortization costs in the non-cash costs associated with the Company's equity and long-term incentive compensation plans, we expect that operating income will be between 18 and 23% on a Pro Forma basis, up from the previous guidance of 15 to 20%.

In summary, we are very pleased with our results for Q2 2006 and look forward to a strong performance for the remainder of 2006.

And as always you can rely on VASCO's people to do their very best.

This 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'd limit your questions to an initial question plus a follow-up.

If you do have additional questions, please re-enter the queue after the answers to your initial questions have been given.

Eduardo?

Thank you.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Daniel Ives with Friedman, Billings, and Ramsey. Please go ahead.

Hey, guys. Good quarter.

Hi, Daniel. Thank you.

Good.

Can you kind of speak geographically and maybe focus on the U.S.? I mean I know traditionally with FFIEC you've kind of been lukewarm on that in regards of how it doesn't really have too much teeth.

But it seems like you guys had a good quarter in the U.S. Is there a change in that in regards to the catalyst maybe a little nearer than you thought happening in '06?

Well, we are seeing business being done. A lot of the deals we're doing are not full term; they're not full-grown. But they're a start.

But you can see from the contribution that the U.S. made 14% of overall revenue for the quarter. That business is, I would call it beginning to get robust.

Okay, and can you just comment not average on the actual acquisition or price, things like that. But in regards to EMC buying RSA, how does that really affect the landscape from your perspective? I mean does that create an opportunity for you?

I'm sure you guys have followed it close. I'm just trying to understand how VASCO views that. Thanks.

Sure. Well, as far as that transaction is concerned, I was pleased with the valuation number one because it was a very high valuation. And number 2 I think that their joining with EMC probably muddies the water a little bit in that they are no longer a pure play security company.

VASCO on the other hand is indeed a pure play, strong authentication security company as Jan Valcke mentioned in his comments earlier.

The buyer, the prospect doesn't have to think very hard to understand what it is we do. We're very precise. We're very focused.

Operator, next question?

Our next question is coming from Ranjini Chandirakanthan of Think Equity. Please go ahead.

Hi. Good morning and congratulations on a great quarter.

Thanks, Ranjini.

Quick question on the 46 new bank customers, especially the ones in the U.S. You had mentioned that they are in - they have VACMAN controller installed. How long before they get to a run rate that's recognizable in the financials? Is it already there?

Or should we be looking a couple of quarters out?

Well, if you hearken back to the presentation that I make, typically these rollouts these application rollouts take 2 to 4 years. And in that first year probably something on the order of 30 to 40% of all the units are shipped in that first year.

The real message here for these 15 banks and then the total of 50 banks plus in the United States is as again Jan mentioned we've installed VACMAN controller. That's our middle ware product that allows us to support all of our authentication products and solutions.

The first application in all these banks seems to be corporate banking. We go in. We make the installation. We get that up and running. And then we move on to the other departments.

It's the way Jan Valcke and his people have been successful over the history of our business.

There have been some exceptions over the last year or 2 where we go into a bank and start with a retail or consumer application. But traditionally that's the way we do it.

We start with the corporate banking application. We get our VACMAN controller installed. Once that's up and running, our sales people go over to the different department, the consumer department, and make a sale there.

So this is our strategy and it works well Historically. It's going to work well in the United States.

Great. And just as a follow-up to that, given your reiteration of revenue guidance and backlog, which seems to be flat quarter-over-quarter, should we read that the fourth quarter will again be the big quarter for the year?

Well historically our 2 strong quarters have been the second quarter and the fourth quarter. So I can anticipate that the fourth quarter will be a strong one, yes.

Thank you.

Thank you. Our next question is coming from Brad Lehl of Jefferies & Co. Please go ahead.

Hi, guys. Nice quarter.

Thank you, Brad.

I just a couple of quick things here, Ken.

I'm just wondering if you can give us an update on, you talked a little bit about Digipass for Web. If you can give us any feedback from the field, how much traction you're seeing and just any broad commentary on Digipass for Web thus far?

Sure. I know just the guy to answer that question. That's Jan Valcke.

Okay, Ken. Thank you.

So, as mentioned in the first quarter, we were at the moment we were developing the Digipass for Web. And in the second quarter, at the end of the second quarter, this product has been finished.

And the nice thing on the Digipass for Web, it is a part of our VACMAN controller strategy. That means that a bank, an e-commercial, because we're talking a lot about banks. But more and more we're getting also customers outside the banks, the bigger corporations for business-to-business, for the business-to-consumer.

But once they have that VACMAN controller and they use it for instance like in banks in U.S. for corporate banking, you may not forget that they are ready to use also this Digipass for Web for retail banking or retail e-commerce.

So by winning every bank, every big shop we believe that in the future shorter or middle terms we will do more and more business with those customers for other applications than just the application they bought for it.

So the right answer on that is today is yes there are now 500 banks that are already technically ready that can deploy this Digipass for Web. Besides these 500 banks there are about 3,000 corporate who are ready to do the same thing.

So we expect a lot of business for that product.

Okay, great. And then Ken on your guidance, the gross margin. I'm just wondering the slightly higher percentage there. Is that mainly you're expecting growth there on the Digipass for Web and some of the software product? Is it a stable ASP? Can you just give us some color as to what's going into that?

Cliff will address that question.

Yes, Brad, what we've seen is that while our average selling price has continued to come down, the size of the shipments and size of the orders continues to grow. Average selling price continues to come down.

The economies that we've achieved in manufacturing costs as a percentage have been comparable to the declines in price.

So I think that is a bigger factor than the software content.

But as we go forward, software certainly will play a bigger role. It will drive average selling price down but the margins on that will be much higher. And as you know our corporate network access business is 85% plus margins. It will be similar to that.

So looking forward it'll have more of an impact than I think what you've seen in our year to date results.

Okay, thanks guys.

Thank you. Our next question is coming from Andre Glukhov of Brean Murray. Please go ahead.

Yes, thank you. Congratulations on the good quarter.

Let's maybe first of all to follow-up on the previous question on the backlogs, since the backlog is flat sequentially here, do you think that since we're headed into a seasonally weak quarter for your Q3 that the upside, sort of running into backlog difference. Can it be below the current quarter level or what do you think is going to transpire?

Well we don't give quarterly guidance, Andre, so there's no direct answer to that.

All I could really do would be to refer you back to our backlog history and the difference between what backlog has been and what the final quarter results have been. You'll see a lot of variation in that analysis. But I think that's the best information that's available publicly to give you a feel for what Q3 might be.

So basically you think, basically you're saying it might be consistent with historical patterns?

I can't say that it will be because one of the things that's happening within VASCO is our channel is getting stronger and our product offering to the channel is getting stronger. Therefore what we now refer to as enterprise security, which we used to call it corporate network access, is getting stronger.

And when we talk about backlog, the backlog generally is what we've incurred as revenues to datein both enterprise security and banks. But it's primarily banks firm orders through the rest of the quarter as we don't have much visibility into the corporate network access side.

So as we look forward with the strengthening of the enterprise security segment and the sales going into that, it will create some variation with our historical patterns. But right now the historical patterns is all that you could look at in terms of trying to get a fix on it.

One other comment, if you look back over the last several years, 4 or 5 years ago the third quarter was always our weakest quarter because of the holidays in Europe and because Europe was producing most of our revenues.

Over the last couple of years, the third quarter was flat to up a bit over the second quarter. Don't read anything into that other than I'm just giving you some history. I think you should rely on what Cliff just said.

All right, thanks.

And then Ken, on a separate note, you did comment that you guys expect on consumer rollouts in the United States in 2007. Can we interpret that you guys are ready in some beta tests with some of the U.S. banks? Or can you give a little more color there?

Jan, would you like to address that?

Well I can only say what I have mentioned before is that today 50 banks in the U.S. have integrated the VACMAN controller for corporate banking applications.

But that technically they are ready to use that for retail banking and also other applications.

Thank you.

For competitive reasons I cannot answer more than that.

All right, thank you.

Thank you. Our next question is coming from Horacio Zambrano of Wedbush Morgan Securities. Please go ahead.

Thank you. Good morning and congratulations, guys.

Thanks, Horacio.

Can you tell me where the enterprise strength is coming from geographically, if it's in Europe mostly or the U.S.?

I'll let Cliff address that.

On an absolute basis, certainly Europe is where the majority of dollars are. But in terms of the growth quarter-over-quarter we're seeing growth in all of the areas.

So is that breakdown geographically the same on the enterprise side as it is on the consumer side?

The breakdown the same on the?

As a percentage, are the percentages comparable?

No, no. The percentages wouldn't be comparable across all our regions. So you can't take the number and spread the enterprise security revenues by region equally. And we don't disclose the details of the breakdown between banks and enterprise securities by geographic area.

I don't think we would go there over time. I think it's best if we stay at that macro level and talk in terms of aggregate growth.

Okay. And then last question on DSOs it went up about 5 days. Are you happy with that? Or what's going on? Can you give us some color there?

Yes, it's a phenomenon of doing a lot of business in the last month of the quarter. We had a very strong June and many of those revenues are not even in the current receivables.

So that's just a reflection of a very strong end to the quarter. So no, we're not concerned with that at all.

Thank you.

Thank you. Our next question is coming from Joe Maxa of Dougherty & Company. Please go ahead.

Thanks. The old performance in June, was that primarily the CNA business? Or did you see some early shipments on the retail banking as well?

Say again, Joe. I didn't understand your question.

So you had some - you had a better than expected June quarter or June month, I'm sorry. Did that performance ...

We didn't say that. We didn't say that, Joe.

Okay, you had a very strong last month from what I just heard, a strong viewing.

That's true. We had a very strong last month of the quarter.

And the upside from where we were modeling based on historical trends of backlog that was all performed. I'm just wondering if that came from additional banking shipments or CNA related?

In terms of the models that are out there in the analysts' community, we haven't commented specifically on those. I think overall our revenues were slightly grater than what the consensus revenue was.

But I do think that the variability that we see between what we have in backlog going into the period and what that quarter may be, largely comes from enterprise security shipments.

The underlying answer to the question is we're seeing strong growth in both segments. The growth in enterprise security in the first quarter was 46% over the first quarter of 2005. Second quarter we grew 40% over the second quarter of 2005.

Banking on the other hand, and in part the first quarter was impacted because we had the pull forward revenue into 2005. But banking revenue in the first quarter was up 15% and in the second quarter it was up 52%.

So as you try to understand why our performance was slightly different than what models might have been, I don't know that there's an easy answer to it. And it'd probably be a different answer for each analyst's model.

Okay. Let me take a stab at that U.S. retail opportunity you're talking about in 2007, the first one.

Are you expecting that to be Token related? Or did I hear something about more software?

We expect it to be both. The Digipass for Web is our software equivalent of a hardware Digipass that resides on a person's PC. As Jan was saying all the 500 banks we have where Digipass, excuse me, VACMAN controller, our platform is installed. They're all candidates for Digipass for Web where a hardware Digipass is not justified.

So you're thinking it would be the Digipass for Web or the Token versus something along the lines of your Identikey server that's going to be coming out?

Well, I think it'll be across the board. The customer, the bank will make the decisions whether they use the hardware Digipass or a Digipass for Web software product. The Identikey server is simply another platform that's more robust and more like an authentication server.

Yes, we're very optimistic about the software version of Digipass, which we call Digipass for Web. It not only does one-time passwords, but it also does the electronic signature that defeats man in the middle and Trojan attacks.

We think that's going to be a very popular product.

Okay, great. Just one last thing, when is the Identikey server expected to be available now?

Jan, would you address that please?

Yes, well what I can tell you about that? I think on this time we will announce it.

What I can tell you is that if you look at banks that mainly the larger banks are using, are integrating VACMAN controller. I think that will continue and that the Identikey server will go to the smaller and medium banks.

We expect to do an announcement later on this year on the Identikey server.

Thank you.

Thank you. Our next question is coming from Amit Dayal of Rodman & Renshaw. Please go ahead.

Thanks, guys, a great quarter, Ken and the rest of the team.

Thanks, Amit.

Most of my questions have been answered. But I was kind of looking for any odd bits you have on the EMV side.

Sure. Jan, would you address EMV, where we stand with that?

I know what update you're looking for. What I can tell you is that EMV as a technology quite country oriented. And that some countries went already EMV like in the Netherlands, like in Belgium, and that some other countries will follow.

It will be mainly in Europe. It'll be in business.

Amit, I might remind you that last year we did a significant amount of our revenue that was EMV card reader related. And we expect ongoing revenues from that part of our business.

Great. Thank you guys.

You're welcome.

Thank you. Our next question is coming from Fred Ziegel of Soleil Securities. Please go ahead.

Hi, guys.

Hi, Fred.

I just wanted to make sure I heard Cliff right. Did you say the banking slash enterprise mix was 80, 20?

No. For the quarter banks were 87% ...

87, okay.

... enterprise was 13; year to date banking's 85, enterprise was 15.

Okay. In terms of the new gross margin range, and I know we just talked about within the banking side maybe a greater mix of software base going forward. Are we also anticipating a shift in banking versus enterprise back toward enterprise?

Well that's a good question. We continue to grow our distribution channel, which is key to the answer to that question. And we're optimistic about the role and the participation or contribution that the enterprise security revenue plays.

But I don't know that I could address that in any great clarity going forward.

We're optimistic about it. We're doing everything we can to add additional resellers, particularly larger distributors and particularly here in the United States. And we're optimistic about the role that the channel will play in our ongoing success.

I think Fred if you look historically the mix hasn't varied by huge amounts. 2004 was 80, 20; 2005 was 86, 14; this year we're 85, 15. So we haven't seen any huge change over time. Both have been growing at a very robust pace, both enterprise security and banks.

And I think inherent in your question is whether or not one is going to grow faster than the other going forward. And we see sizable opportunities in both.

Okay. So most of the gross margin change is really related to hardware versus software as opposed to banks versus enterprise?

Yes. I think it's the good job Jan and his team have done in terms of engineering our product to reduce the cost, negotiating with manufacturing so that in fact our cost reductions can keep pace with the price reductions.

And anyway I guess that's all we'll say on that.

Go ahead.

No, no. That's about all we can say. We have nothing that would tell us that the mix is going to be any different than it has been historically as Cliff just said.

The upside on the gross margin could be because of a higher mix of the channel because that's where we have the very high gross margins because they're small sales.

Right. Right. Can you give us some sense in the U.S. what is it predominantly? I assume it's predominantly banks. But is it virtually all banks that are driving the revenue number?

This I think is a little bit into the sensitive area because we don't want to get into CNA versus bank by market. But no, it's being driven by both.

By both? Okay.

I think we have growth in both.

And then there's always the obligatory question. VeriSign on their call talked about perhaps some activity with Schwab and eBay in the back half of this year. Would you care to comment on that?

Yes, we're seeing some orders from them. About all we can say.

Okay. Thank you.

You're welcome.

Thank you. Our next question is coming from Brett Waldman of Kaufman Brothers. Please go ahead.

Hi, guys. Congratulations on the quarter.

Thanks very much.

In regards to your Logico acquisition, I was wondering if you're seeing any greater interest in smart cards than you have over the last few years?

Yes. Well generally speaking we have seen more interest in smart cards. We've seen more interest in public key infrastructure, or PKI. And that's one of the reasons that we started looking around for a make versus buy kind of opportunity.

We have the option of either hiring and creating our own in-house R&D group. Or we were fortunate, however, in finding Logico, a small firm in Austria that has the expertise we were looking for.

So indeed over the last year or so we've seen increased interest in this area. And that's why we made the move to acquire Logico and their R&D staff.

Okay, great. And is this mostly in-house, Ken, government? Or are you seeing to see other verticals starting to see more interest in it too?

Jan, why don't you address that? It's government. It's healthcare. And generally speaking I think that the channel that we sell through have been asking for this kind of solution for their broad customer base.

Okay.

If you look at what we have sold in the expose is that the Logico business was primarily healthcare, government, and industrial. By adding the technology of Logico on VASCO's platforms and by adding the existing Logico software in the VASCO channels we see it's much more broader than only those markets.

Great. Thank you.

Thank you. Our next question is coming from Chris Hovis of Morgan Keegan. Please go ahead.

Nice quarter, guys. Most of my questions have been addressed, just a couple of housekeeping items.

Was there any revenue recognized from Logico in the quarter?

It was nominal.

Nominal, okay.

And if we were to look at the U.S. market in particular but enterprise strength across the board, is that being driven by some type of change you're seeing in the end user demand environment such as new use cases for strong authentication? Or is it just primarily due to starting to execute on the channel strategy that you put in place?

Well I think our - we've been focusing on the U.S. market for a while. And we have hired more channel managers to work with our channel partners in the United States. We worked hard on calling on the top banks directly here in the United States.

We signed up partners like Fiserv that have kind of a captured audience of 3,000 or so banking customers, community and savings and loans that we sell through.

So it's a combination of all those things. Plus, generally speaking and certainly in the banking area because of the FDIC guidance and generally speaking in the enterprise security, small and medium businesses, people are more aware of the issue of strong authentication.

So it's a combination of all those factors.

Okay, great. Thank you.

You're welcome, Chris.

Gentlemen at this time we don't appear to have any further questions.

All right. We've concluded this in an hour. I'd like to thank everybody for their attendance and the good questions. And once again I want to thank all the VASCO people around the world for their hard work, their dedication, and excellent production during the second quarter of 2006.

Good day, everybody.

This concludes today's VASCO Data Security Q2 2006 earnings conference call. You may now disconnect. And have a wonderful day.