OneSpan Inc (OSPN) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen. My name is Stacy and I will be your conference operator today. At this time I would like to welcome everyone to the VASCO Data Security International, Inc. 2006 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

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 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. On the call today with me 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're going to review the results of the fourth quarter and full year 2006. 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.

First, I'd like to address revenue for fourth quarter 2006. It was $25.2 million, an increase of 44% over fourth quarter 2005, and our strongest quarter ever. It was also our 16th consecutive positive quarter in terms of operating income and cash flow, with gross margins of 70% of revenue and a very satisfying operating income of 27.8% of revenue. Revenue for the full year 2006 was $76.1 million, an increase of 39% over full year 2005. Gross margin was 68% of revenue, with operating income of 24.9%.

Our backlog, or firm business, for Q1 of this year as of today is $23.6 million. Backlog is defined as orders already shipped between January 1st, 2007 and today plus firm purchase orders scheduled to ship before March 31, 2006. The results of Q4 2006 and the strong backlog announced today confirm once again that our strategies are working worldwide.

New accounts continued to grow during the fourth quarter. During the quarter we sold an additional 470 new accounts, including 95 new banks and 375 new enterprise security customers. In 2006 we sold 1,553 new accounts, including 233 new banks and 1,320 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 close to 650 banks and over 3,600 enterprise security and e-commerce companies, including corporations, federal, state and local governments, as customers located in over 100 countries around the world. It is clear that we are making significant progress -- business progress in the United States as well. The trend that we experienced in Q2 and Q3 2006 is continuing and even strengthened this past quarter.

In fact, 53 of the 95 new banks in Q4 were signed here in the United States. This success has definitely been fueled by the very strong baking industry directive issued on October 12th, 2005 here in the United States by the FFIEC, an umbrella group of regulators that includes the FDIC. The FFIEC directive has raised the security awareness of U.S. banks dramatically.

We foresee that our growth in the U.S. will accelerate. While many banks are making the right decision by opting for the proven strong authentication solutions of long-standing security companies such as VASCO, others are deciding on a meet-minimum approach due to the stringent deadline.

We believe that these banks will realize in 2007 that the products they've installed do not offer a good user experience and user experience is key for every successful authentication project. In 2008 and '09 we believe that these banks will reconsider and opt for mature proven solutions from established vendors, replacing those installed in 2006 and 2007.

To support our growth in the U.S. we are investing strongly in our market presence. We almost doubled our U.S. staff year-over-year, especially in sales. We tackled large banks via a direct sales. To reach the smaller banks we have established tight and successful business partnerships with leading banking solution providers such as FiServ, FundTech and others. Additionally, 11% of our fourth quarter revenue and 10% of full year 2006 revenue was achieved in the United States, up from 7% for all of 2005.

VASCO is strengthening its leadership position worldwide, including Europe, Asia and Latin America, and in all our key verticals. As you know, VASCO does not only sell to banks. We use the same products that we've developed for the banking markets and other sectors and with great success. We are experiencing continuing success in the enterprise security and e-commerce markets, and are continuously reinforcing our product offerings for that sector.

The recent acquisition of authentication appliances vendor, Able N.V., strengthens our offerings and our position in enterprise security. In addition, we expect that the recently launched 3.0 version of VACMAN Middleware will open the large enterprise market for VASCO, a full option, all-terrain model.

We introduced our all-terrain strategy in the first quarter of 2006 to further penetrate and protect our existing and growing customer base. We expanded our flexible platform, VACMAN Controller, to support a growing array of authentication products. Some of those products, like our Digipass for web and Virtual Digipass, are natively embedded in VACMAN. We are seeing significant interest in Digipass for web.

In fact, the first Digipass for web customers in the U.S. have signed up. Next to Digipass for web we see a growing interest in Digipass for Java Phone, resulting in firm orders where our customers offer their clients a choice between a Digipass put on VASCO's own platforms or a software Digipass for Java Phone.

In Q4 2006, we sold and shipped a record 3.8 million Digipass products, once again demonstrating the effectiveness of our strategies, focus and execution. For the full year 2006 a record amount of 11.1 million Digipass products were sold and shipped. To date, VASCO has sold and shipped approximately 32 million Digipass products. The figures speak for themselves. We are the absolute market leader in authentication.

We expect that our unit sales will continue to accelerate as we develop new markets and identify new audiences for the company's products.In addition, we expect that our newly launched DigipassPlus offerings will bring us additional revenue by adding related technologies, products and services to our core VACMAN and Digipass authentication offerings.

At this time I'd like to introduce Jan Valcke, VASCO's president and chief operating officer. Jan, congratulations to your team on another great quarter.

Thank you, Ken. Ladies and gentlemen, the year 2006 saw the complete transformation of VASCO into the full option all-terrain authentication company. In 2007 we will see VASCO focusing more on software and services. Currently, we are the leading software security company specialized in authentication products. In the future we will be the leading software security company specialized in authentication products and services.

A couple of weeks ago in New York we launched our DigipassPlus product strategy. With DigipassPlus VASCO makes authentication available for multiple use. The renowned VACMAN and Digipass authentication product lines are positions at the center point in the customer's network and application as a service model.

VASCO's product line includes. VACMAN, our core authentication platform combining all technologies on one unique platform. Identikey, VASCO's authentication server combining the VACMAN core authentication platform with full service functionality. aXs Guard, a leading authentication appliance services combining Identikey with a wide variety of internet communication solutions.

Digipass, a suite of over 50 multi-application [e-signature] software products based on the world's most widely spread electronic client platforms; and finally DigipassPlus, multiple use authentication content, positioning VASCO's authentication products at a central point in the networks and applications of several companies at the same time. These companies will buy VASCO activation codes for authentication services.

By sharing the same Digipass/VACMAN infrastructure, authentication will become a very affordable solution per user. VASCO also offers related services under the DigipassPlus label, such as Fraud Detection and Analysis, and the brand-new VASCO [video training]. VASCO has dramatically reinforced its service platform by embedding its software client authentication products, Digipass for web and Virtual Digipass, into its VACMAN controlled service site authentication products.

This means that institutions that have installed VACMAN can immediately protect its customer's asset against phishing, pharming, Man-in-the-Middle attacks and Trojan Horses with best of breed Digipass strong authentication and e-signature technology. If the customer wishes, he can diversify VASCO authentication offerings to different user segments. He can take his pick from a range of over 50 Digipass authentication products, regardless of the client platform on which the Digipass software is installed.

With regard to the markets, we can only state that we are gaining traction worldwide. In Europe, our traditional stronghold for the banking sector, we are even strengthening our leadership, whilst building a robust market position for enterprise security and e-commerce. In the United States, we are growing our number of customers in the banking sector at a terrific speed.

A couple of weeks ago we announced that over 150 U.S. banks are using VASCO authentication products. We are very pleased with that evolution. Asia is doing well, too. Recently we announced a 2 million user deal with Reliance Money in India. Latin America is also evolving positively. Over 50 banks and many [corporates] secure their customer and employees with VASCO software.

We distinguish four vertical markets. The banking sector, our traditional stronghold, where we are still growing quickly. The banking sector brings us high volumes, but lower margins. The enterprise security, our [second] market that has grown into a robust source of revenue. In the enterprise security market, we sell smaller amounts per deal but the margins are much higher, thus compensating for the relatively lower margins in banking.

The e-commerce, both business-to-business and business-to-consumer e-commerce, are becoming even more important for VASCO. And the [government], our revenue in this market is still small but we are ready to take advantage of every market evolution in that sector. VASCO's product and market strategy is simple but effective. First, we developed a product range that suits every bank needs.

Secondly, we take that product range to all the vertical markets beyond banking. And thirdly, we add products and technologies that are needed to suit the specific needs of customers within those verticals. Any future acquisitions have to be seen in that context. The people. VASCO is a fast growing company. To support this growth we need more people.

At this moment, our biggest challenge is to find, to hire and to integrate employees quickly enough to sustain our growth. We are working hard to boost our human resource efforts. In the first place, we do all the traditional actions related to recruiting, including advertising, being present at job fairs, working with recruitment agencies, et cetera, et cetera. We also organize our own actions.

As I already mentioned when I was talking about DigipassPlus, VASCO has developed an online data training. This allow us to train professionals remotely all over the world, every hour of the day. In 126 hours we explain the e-security market in general and VASCO's products and services in detail. We plan to have several thousands of people trained in with our video training before the end of '07.

In addition, we have opened our own VASCO school. For this school we recruit young international people without experience fresh from school. We transform them after a nine-month course into VASCO professionals who are able to represent VASCO in their home market. We started the school at the end of 2006, and the first VASCO school alumni will graduate during the second quarter of '07.

The cash. We are Cliff Bown's terrain here. But I would like to stress the fact that also we are investing important amount in our growth. We are able to stay profitable and even to maximize our profits. This is a very important accomplishment that benefits all our stakeholders.

Finally, I would like to tell you something more about our total cost of ownership of on authentication project. There's a lot more to authentication than only the sales price of the front end of the solution. As we explained in our press release about VASCO's business strategy, VACMAN supports over 50 different client authentication products, including Digipass software that is installed on our own platforms, PDAs, PCs, [the net], smart cards, et cetera, et cetera.

Our business model gives customers the chance to pick the right kind of client authentication device for the right customer or end-user segment. Instead of the purchasing price of the end-user device, total cost of ownership (TCO) is the only right method to calculate the cost of an authentication project. TCO comprises the purchase price of the solution, including backend, front-end and maintenance.

The lifespan of the solution, the cost has to be divided by the number of years this solution is in service. The hidden costs such as back-office costs, calls from end users that have problems getting logged in, et cetera, the implementation of the solution/number of days a solution is off-line because of the implementation, the administration costs, collateral fulfillment.

VASCO scores very well with regards to TCO. Our Digipass hardware client authentication devices have a lifespan of between five to seven years. VACMAN Control is very easy to integrate and to maintain. This means that the application has a limited to no down-time. This ensures the continuity of the customer's business. Back-office costs are extremely low. One of our customer has over three million customers that are secured with Digipass. They receive less than 800 support calls per month for their online banking application.

Collateral fulfillment. VASCO puts its know-how and experience as the market leader at the disposal of its customers. We help them. We put them in contact with their peers in other countries that have more experience with similar problems. That's why we are organizing banking summits in the world's major hubs and why we have launched VASCO's Trust Club, a Digipass secured site on which our worldwide customers can exchange experiences, ideas, threats, solutions.

Looking ahead, we make sure that our customers see [a clear grow pattern] towards all the applications and functionalities, towards the future future -- towards the further future, sorry, hence our full option all-terrain strategy and our current DigipassPlus offerings.

Thank you

Thank you, Jan. At this time I'd like to turn the call over to Cliff Bown, our chief financial officer.

Thank you, Ken, and hello to everyone on the call. Revenues for the fourth quarter and full year ended December 31, 2006 were $25.2 million and $76.1 million respectively, an increase of $7.6 million, or 44%, over the fourth quarter of 2005 and an increase of $21.5 million, or 39%, over the full year ended December 31, 2005.

Compared to 2005 the increase in the fourth -- for the fourth quarter and full year ended December 31st, reflects significant increases from both the banking and the enterprise security markets. Revenues in the fourth quarter of 2006 from the banking and enterprise security markets increased 42% and 56% respectively over the fourth quarter of 2005. Revenues for the full year ended December 31, 2006 from the banking and enterprise security markets increased 39% and 42% respectively over full-year 2005.

The distribution of our revenue in the fourth quarter of 2006 between our two primary markets was 86% from banking and 14% from enterprise security, and compares to 87% from banking and 13% from enterprise security in 2005. For both the full year ended December 31, 2006 and 2005 approximately 85% came from banking and 15% came from enterprise security.

The geographic distribution of our revenue in the fourth quarter and full year 2006 showed the increasing strength of the U.S. market. In the fourth quarter of 2006 approximately 63% of revenue came from Europe, 11% from the U.S. and the remaining 26% came from other countries, which included significant contributions from Asia, India, South America and Australia. For the fourth quarter of 2005, 65% of the revenue was from Europe, 5% was from the U.S. and 30% was from other countries.

The geographic distribution of our revenue for the full year ended December 31st, 2006 was approximately 62% from Europe, 10% from the United States and the remaining 28% from all other countries. For full year ended December 31, 2005, 72% of the revenue was from Europe, 7% from the U.S., 21% from other countries.

As a result of our increasing customer base, we are becoming less dependent on any one customer. For the fourth quarter of 2006, no single customer accounted for more than 10% of our revenue. In addition, revenues from the top ten customers in total were 48% of our revenue in 2006, compared to 70% of our revenues in 2005. For full year 2006, only one customer slightly exceeded 10% of our revenue and revenues from our top ten customers totaled 49% in 2006 as compared to 64% of revenues in 2005.

Gross profit as a percentage of revenue for the fourth quarter of 2006 was 70% compared to 63% in 2005. For the full year ended December 31, 2006, gross profit as a percentage of revenue was approximately 68% compared to 63% for the same period in 2005. The improvement in margins are driven by three components.

First, our software product revenues, which are revenues from VACMAN Controller, software versions of our Digipasses, and other non-manufactured product revenues, have increased as a percentage of our total revenue. Second, we continue to reduce our cost of our manufactured product. And third, our mix of business continues to shift towards our consumer products.

VASCO shipped approximately 3.8 million Digipasses in the fourth quarter of 2006, an increase of 57% over the fourth quarter of 2005. For the full year ended December 31, 2006, VASCO shipped approximately 11.1 million Digipasses, which was an increase of 52% over the units shipped in the full year 2005. As non-hardware product revenues increase, we believe that our old metrics of average selling price and cost per Digipass unit are no longer useful at a consolidated level and we plan to discontinue providing those metrics.

Operating expenses for the fourth quarter of 2006 were $10.6 million, an increase of $3.8 million, or 56%, from the fourth quarter of 2005, and operating expenses for the quarter included $450,000 related to stock-based incentive plans. Operating expenses for the fourth quarter increased by $1.9 million, or 43%, in sales and marketing, $941,000, or 98%, in research and development, $642,000, or 48%, in general and administrative when compared to the fourth quarter 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 costs was primarily related to increased compensation due to increased headcount primarily from our acquisitions of Logico in May of 2006 and Able N.V. in October of 2006. The increases in general and administrative expenses were primarily related to increases in headcount, stock-based incentive program costs, increased insurance costs, and increased professional service costs.

Operating expenses for the full year of 2006 were $32.8 million, an increase of $9.3 million, or 39%, from the comparable period of 2005. Operating expenses for the full year 2006 included $1.6 million related to stock-based incentive plans. The reasons for the increase in the expense for the full year are generally consistent with those previously described or noted for the quarter-over-quarter comparison.

Operating income for the fourth quarter of 2006 with $7 million, an increase of $2.8 million, or 66%, from $4.2 million reported for the fourth quarter of 2005. Operating income for the full year ended December 31, 2006 was $18.9 million, an increase of $8 million, or 73%, from the $11 million reported for the full year ended December 31, 2005.

Operating income as a percent of revenue, or operating margin, was approximately 27.8% for the quarter and 24.9% for the full year ended December 31, 2006. The operating margin was approximately 3.8 percentage points for the quarter and 4.8 percentage points higher for the full year, when compared to the same periods of 2005. The increase in operating margin for the quarter and full year is attributable to the improvement in gross margins as a percentage of revenue.

Income tax expense for the fourth quarter of 2006 was $2 million, an increase of $760,000 from the fourth quarter of 2005. The increase in tax expense is attributable to higher pretax income, partially offset by a lower effective tax rate. The effective tax rate was 28.5% for the fourth quarter of 2006, compared to 30.1% for the fourth quarter of 2005.

Income tax expense for the full year 2006 was $6.1 million, an increase of $2.2 million from the same period in 2005. The increase in tax expense is attributable again to higher pretax income, partially offset by the lower effective tax rate. The effective tax rate was 32.5% for full year 2006, compared to 33.2% for full year 2005.

Earnings before interest, taxes, depreciation and amortization, EBITDA or operating cash flow, if you will, was $7.6 million and $19.8 million for the fourth quarter and full year ended December 31, 2006 respectively. EBITDA in 2006 reflects an improvement of $3.1 million, or 70%, from the fourth quarter of 2005, and an improvement of $7.2 million, or 58%, from full year 2005. The fourth quarter of 2006 reflected the 16th consecutive quarter of positive operating cash flow.

Our work force as of December 31, 2006 was 184 people worldwide with 98 in sales, marketing and customer support, 63 in research and development, and 23 in general and administrative. The average headcount for the full year ended December 31, 2006 increased by approximately 40 persons, or 35%, over the average headcount in 2005.

Finally, I would like to make a few comments on the balance sheet. During the fourth quarter 2006 our net cash balance and our net working capital balance decreased from the prior quarter. During the fourth quarter our net cash balance, which is defined as total cash less [inaudible - audio gap] borrowings, decreased $7.8 million, or 38%, to $12.6 million from $20.4 million at September 30th, 2006.

The decline in net cash reflects both our purchase of Abel N.V. for $5 million euros in cash, and our increased investment in receivables and inventory. During the fourth quarter our net working capital decreased $2 million, or 9%, to $22.1 million from September 30, 2006 and primarily as a result of the acquisition of Able.

Bank borrowings noted on the balance sheet were up $2.2 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 66 days at September 30 of 2006 to 72 days at December 31, 2006.

The increase in DSOs is primarily related to the increase in the percentage of the full quarter's revenue that was recognized in the last month of the quarter. The company continues to have no term debt, and the company has approximately $1.3 million as of December 31, 2006 available for additional borrowings under its line of credit that is secured by its receivables.

Now, I would like to turn a meeting back to Ken.

Thank you, Cliff. First, I would like to comment on order backlog for Q1 2007. As of this date today we have firm orders with shipments scheduled for the first quarter of approximately $23.6 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 84% higher than the $12.8 million backlog going into Q1 2006. In addition, the backlog is 72% higher than the $13.7 million in revenues reported for Q1 2006.

Today, we are providing guidance for full year 2007. Consistent with past practices, we'll only comment on annual numbers, not quarterly numbers. First, we estimate that full year revenue will grow between 35% to 45% in 2007 over 2006. Second, we expect that full-year gross margins will be in the range of 60% to 68% of revenue. Finally, we are projecting that operating income will be in the range of 18% to 25% of revenue on a U.S. GAAP basis.

In summary, we are very pleased with our results for Q4 and full year 2006 and look forward to continued strong performance in 2007. And as always, you can rely on VASCO's people to do their very best.

This concludes our presentations today. We'll 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 reenter the queue after the answers to your initial questions have been given.

Operator?

[OPERATOR INSTRUCTIONS]

Our first question is coming from [Daniel Ives] of [inaudible] Friedman.

Hey, guys, congrats and good quarter. Question on margins. Does 25% operating margins kind of seem like that plateauish area, or do you think margins could kind of gradually get higher as the business continues to scale?

Well, we've given you a range of operating margins that we feel confident about. But as we move further into a software centric business where gross margins are significantly higher than hardware margins, you could surmise that the direction will be north, not south.

Okay. And on the U.S. market, what do you think has kind of been that spark that's really ignited the U.S. growth? And maybe you could kind of talk about that like when you talked to the channel. I mean, what are the things that may have surprised you on the positive side?

Well, what has -- what has really fueled the activity and growth here in the United States, because our strong vertical worldwide is banking, in October of 2005 the FDIC, which is a member of the FFIEC, they announced guidance. They sent a letter to all their banks and savings and loans and they said that we are asking you, we are giving you guidance that you should abandon your fixed password method of securing your online banking.

It's not adequate, it's not safe, it's easily hackable. And so, we're giving you guidance to add a second factor, in other words implement two factor authentications, something you know and something you have. At the time they made the announcement, they were fairly explicit. They talked about something you know and something you have, they gave examples of a USB token, a smart card or a token -- a stand-alone token.

Since then, of course, they have become a little more open in terms of what might be acceptable. So in our comments we talked about a meets-minimum approach. The kinds of approaches I'm talking about there are questions like what's your mothers maiden name, what school did you go to, what's your favorite pet. They have been modestly or moderately accepted, I guess, as plausible improvements to fixed passwords.

But a long story short, it's that guidance issued in October of 2005 that has dramatically increased the activity in banks in the United States. We've seen great success by calling on the banks directly with our own salespeople. We're seeing growing and great success working with our partners like FiServ and FundTech and others who in turn operate as VASCO's representatives to their own captured customer base. So clearly, the improvement in the business in the United States has been driven by the guidance of the FDIC back in October of 2005.

Okay, thanks. Good quarter.

Thank you.

Our next question is coming from Robert Breza from RBC capital markets.

Hi. Good morning, and congratulations on the great margins. One -- [clip] as you look at the margins, can you kind of talk to us on how you think they should trend? I know in your prepared remarks you talked about software becoming a larger percentage. Can you kind of just talk to us maybe on how you're seeing -- and maybe this is partly for Ken, as you look at the outlook, you talked about Digipass for web and the Java Phone.

How should we think about those products gaining traction, obviously influencing the margin? And then maybe as a follow-up, Ken, could you talk a little bit about how Able performed in the quarter? Thanks.

Sure. Well, our expectations, I guess, are reflected pretty much in the guidance that we've given to the market of 60% to 68% of revenue. Granted, that's lower than our 70% so, as always, we generally try to look at things in a conservative manner. But until software is a more predominant part of our revenue stream, it's hard to tell exactly in any given year where we'll end up. So when you look at the 60% to 68% range, the 60% says that software doesn't gain a lot of traction in 2007, whereas the 68% would have a much higher level of traction of that software.

The volatility in that rate will also sort of reflect the size of the deal; as we see more and more banks come on, therefore larger and larger quantities and, as we've stated before, generally our prices are lower for those kinds of deals. So long story short is the pressures on the margins come from the hardware content in the large deal that will have a tendency to push the margins down. The opportunity for better margins come from the increased software content, and for full year 2006 we did see a good move in that direction.

Rob, you also had a question about the contribution that Able made? Is that correct?

Yes.

It's still a bit early for us to be commenting on that and, as you know, we don't normally break out individual business lines. But I can say generally speaking we're very pleased with how fast we've gotten up and running with Able. And at least internally we can see the revenue they're producing and we can actually see the contribution that they're making on an earnings per share basis. It's just something we are just not prepared to talk about in any specifics.

Okay, I'll jump back in the queue. Thanks.

All right. Thank you, very much.

Thank you. Our next question is coming from Amit Dayal from Rodman & Renshaw.

Good morning, guys, and congratulations on the quarter.

Well, thank you.

Thank you.

Just one question to begin with. With the momentum in the U.S. market, positive outlook for the card reader business and strength in Europe and Asia, are you being conservative with your 35% to 45% revenue growth outlook?

Well, I think we traditionally tend to want to be in a position where we are under-promising and over-delivering. We don't have a crystal ball. We do have a lot of business. We can see that from our firm purchase orders. As you know, we can see what revenue we can expect for the whole year. There are unforeseen circumstances that might impact the top line.

And so what we want to do is to give guidance that we feel absolutely confident about and not try to venture beyond that. So are we optimistic about the business? Yes. Are there incremental opportunities that we do not include in our guidance that are possible? Absolutely. But I think most everybody here knows that we don't look at a market, hold our thumb up and say we think we can get X% of that market. That's not the way we do it. So, we do not include incremental opportunities which could have a very positive impact on all those lines, all the guidance lines.

Great. Thanks. And just one follow-up to the previous margin related question. Could you clarify how much of the margin improvements are coming from the [layered] deployment at banks that you've always highlighted, versus the shift in business towards CNA?

In terms of the margin improvement, our shift in business to enterprise security, formerly known as CNA, was marginal. The percentage split between bank and CNA was largely the same last year and this year. So there wasn't much of an impact there. Relative to the layering of the banks, that certainly had an impact on our increased revenues but didn't have any significant impact on the margins because the banking revenue as a total percent was what's constant.

I think, Amit, as you -- in some of our prepared remarks we talked about the growth rate in the banking sector versus the enterprise security and on a full year basis, banks grew 39% year-over-year and enterprise security grew 42%. So I don't think those -- either of those factors had a significant impact on margin because both grew approximately the same and the overall mix at the end of the day was approximately the same.

All right. Thank you.

Thank you. Our next question is coming from Katherine Egbert from Jeffries.

Hi. Thank you. I'm wondering if you could tell us the contribution of the fraud detection product, if it was meaningful in the quarter? And then also, I know your Analyst Day was just a couple of weeks ago, but give us an update on Digipass for web, any kind of new developments there?

Again, Katherine, we don't break out specific numbers. Digipass for web we really started selling in earnest in late third quarter after the summertime, presenting it to our banks, presenting it as an alternative to the hardware Digipass and/or the Java Phone Digipass. And we are making progress. We've signed some deals. It's a product that complements the hardware products and the software products.

It's a part of our DigipassPlus strategy where on one unique platform, VACMAN Controller, we offer our customers many choices. It's not just a single product but over 50 different products and the software products as well. So, I can just say in general that we're pleased with how that product is being accepted in the marketplace, both here in the United States and worldwide.

All right. And then last question, wondering can you give some thoughts on the recent consolidation in the space, particularly [RSA] being taken over by [EMC]. Do you think that's presenting you with any opportunities, particularly domestically?

Well, what we're seeing is-- first of all, RSA is a fierce competitor. And I don't see any -- and, Jan, you can comment on this in just a second. I have not seen or heard that RSA is any less competitive than they have been in the past. I will say that it appears that here in the United States were RSA has had such a strong brand with their name that perhaps the acquisition of RSA by a big storage or information management company like EMC has somewhat blurred that brand.

I know that in terms of distribution companies, distributors, resellers that we're making progress that before we did not make because they were quite happy, the distributors that is, quite happy in just representing the RSA products. Now they're looking at either representing RSA and VASCO or even considering replacing RSA with VASCO.

But worldwide, Jan, why don't you comment on what you're seeing in terms of RSA as a competitor?

Of course, RSA -- now EMC, is our main competitor. They were and they still are our main competitor. A couple of years ago, I should say they announced that they're going to the consumer market. I believe that we have never been so successful in that market ever. As you can see in that banking consumer market, we are growing at a speed of one to two new banks a week.

They're very strong in the enterprise security but with -- like Ken mentioned, due to the fact that first of all they are now EMC and EMC has also some very strong competitors. And we see that we can entering in those distribution markets. Secondly, with the launch a couple of months ago of our VACMAN 3.0, which is a very robust software, we can now tackle, in fact, the software products of RSA.

So, yes, we see them as a main competitor but we believe that today we are very strong in our existing markets and that we will be much, much stronger in the enterprise security markets in the next quarters.

Okay. Thanks, Jan. Congratulations.

Thank you.

Thank you. Our next question is coming from Sean Jackson from Avondale Partners.

Hey, good morning. Again, good quarter.

Thank you.

Talking about the U.S. market again, your comments seem to suggest that really the acceleration in growth in that market is going to come in '08 and '09 and that -- so is it fair to say that throughout '07 it will remain kind of 10% to 11% of revenue or should it be a little higher than that through '07?

Well, I don't have a number in mind other than I think that the U.S. is awake now and it's been jarred awake by this guidance of the FDIC. VASCO's brand is starting to be established here in the United States, not only in the financial community but also in the enterprise. And so yes, I think you can anticipate that the U.S. as a percentage of the worldwide revenue will continue to grow.

Okay. And also just another question on the gross margin side. I know you're not revealing the price point metrics anymore, but are you seeing a little bit of price pressure in that segment and is the decrease in the cost of making the tokens offsetting that?

Well, as far as manufacturing is concerned, you know that we are always trying to find ways to reduce our costs of manufacturing. We think that's very, very important. And we've been successful in doing that every single year.

As far as price pressures are concerned, I don't think that that's really a concern at VASCO. I think our concern was and is to position ourselves to take advantage of audiences that we have not been able to go after. And that's one of the reasons why the software for Java Phone and Digipass for web, alternatives to our physical tokens, is so important. But I think that you'll find that many of the banks worldwide still want a physical device because it's a branding opportunity.

We manufacture these devices in their color with their logo and so they actually like a real physical device that they can put into the hands of the customers. But when you're talking about the low-end consumer, the consumer that doesn't keep very much money in their bank account, their checking account, their savings account, they don't do very many transactions, clearly, those kind of users will not get a VASCO physical token. And they are ideal for our software alternatives.

And so if you look at this as incremental opportunities, that's the way to look at it. I don't see any serious downward pressure on the price per unit, selling price per unit for the physical token, you know the calculator tokens, and those that need a lower price, more flexibility, we have these alternatives, these software alternatives.

And just real quick lastly on the software piece of your business, can you give us a ballpark range of what is the contribution now? I assume it's still less than 10%. Is that fair to say? And then going forward, what are your internal expectations or what's this going to be '07, '08 and beyond? How quickly can it ramp?

I'll let Cliff answer that question.

Well, in terms of where it is today, we're really not prepared to give specific data because we want to start doing it where we can give comparable data for all of the relative periods at a particular point in time. It is more than 10% today. So we've moved from under 10% that we've often talked about in the past to over 10% today.

And where it goes in the future and the prospects or the ability to ramp, we're very optimistic about that. It is really part of our DigipassPlus strategy. We really see that the software content of our offering is becoming more and more important. So certainly, it's our hope, expectation that it will ramp nicely throughout 2007 and beyond.

Okay. Thank you.

Thank you. Our next question is coming from Joe Maxa from Dougherty.

Thank you. Ken, I was just wondering what's the timeframe that you expect to ship this two million tokens for Reliance money?

Joe, as you probably know, we're very respectful and adhere to what our banks ask us to do and it's not unusual for us to make an announcement for a customer, whether it's a bank or financial institution or any kind of customer, where we have already shipped some or all of the order before we're actually able to issue the press release. And so, I think you can assume that the Reliance deal fits into that category that we started shipping last year and --

They've begun active deployment.

And they've begun active deployment. Again, I can't specifically say what percentage but that's typical of the deals we do. By the time we're allowed to announce the deal, some or all of the order has been shipped.

Okay. Yes, I just wanted to get -- I was curious over what's the total length of time of shipping that 2 million would be. Do you think it's over a year, or would it be less than that?

Jan, could you address that?

Well, I hope it will be for many, many years, Joe. You know a deployment is a deployment. It's always depending also of the success of the customer. And like Ken and Cliff mentioned and if you look at their website you see that they are doing -- that they started already to do the deployment.

For those that have seen the VASCO corporate presentation, there's a graphic that I always use and it explains the sustainable repeatable revenue of VASCO's business. It's a general chart but it shows that these rollouts or these deployments typically have a two to four-year life.

And there's a ramp-up in the first year where some large percentage of the total life of the deployment is done. And I would -- I would guess that the Reliance Money deal is similar to that. Exactly how long the deployment will last, I'm not sure. As Jan has just stated, this is the first deployment. We're expecting that this will go on for a number -- a period of time.

Got it. Can you give us an idea what to expect for your revenue linearity throughout '07? Should it be similar to '06?

Yes, I guess so. If you look back over the last several years our revenue has kind of looked like this. We have a strong second quarter and then we have a third quarter that is flat to the second quarter and then we have a strong fourth quarter and the first quarter is kind of flat to the fourth quarter.

That generally is the trend, although anytime anybody asks me this I remind them that we're still a small company, and some larger customers could impact that picture, that history. And so, you can't necessarily rely on that history always taking place just because we are still relatively a small company.

Okay, great. Just quickly, what is your expectation in employee growth in '07 versus '06?

Cliff?

In general, Joe, we would expect it to be comparable to what happened this year. We started the year at approximately 127, 128 employees and then we ended up at the end of the year at the 184 that I mentioned during the call. So, we're still planning on substantial investment in staff and resources to help sustain the growth of the business, as Jan commented.

Okay. Thank you.

Thank you. Our next question is coming from Fred Ziegel from Soleil Securities.

Hi, guys.

Hi, Fred.

How are you?

Good.

So, just one quick one for Cliff. What's the expected tax rate for '07?

Well, we haven't published that and as you know, Fred, we generally don't. But let me talk a little bit about the dynamics of what various analysts may look at. One of those dynamics is as we become more profitable in the U.S. we'll be able to use more of our net operating loss carry-forwards. And as you know from our prior publications, we have over 20 million of those kinds of NOLs carry forward.

So that did benefit us a little bit in 2006. We would expect to have a bigger benefit from that in 2007 and at some point we would even be hopeful that if we can reach a level of profitability in the U.S. and sustain it over a period of time that we can reverse the reserves that we have against that NOL.

As you probably know from reading our financials, we've not taken any tax benefit for that NOL. It's fully reserved. But as we grow in the U.S., as we become more profitable, consistently profitable, we'll work to look at what point we can reverse that reserve. If that happens in 2007, it would reduce the rate substantially but it would be a one-time reduction when we reverse that reserve. But otherwise, you can assume or sort of estimate that the plan would be that the tax rate will continue to work its way down until such time as we have that lump sum reversal.

Does it work its way down from the Q4 number, or was there something in particular in Q4 that kind of skewed it to [downside]?

Well, Q4 was the year-to-date adjustment. Under U.S. Generally Accepted Accounting Principles, each quarter we project what our full-year rate would be and we book that rate on a year-to-date basis for that quarter. So we had made projections for the full year, first quarter, second quarter, third-quarter.

And again, we generally try to be somewhat conservative so when we got to the fourth quarter and actual results were known, we had the cumulative effect of the pickup in that. So I think in my comments, I commented that the fourth quarter rate was 28.5% but the full year rate was 32.5%, if I'm not mistaken.

Right.

: So, I think you could say the 32.5% really was the full-year rate based on everything we did in 2006 and then you would use that as the base as you go forward in 2007.

Okay, great. And one question for Jan. Could you update us on, I guess particularly in places like the UK, where we stand in terms of EMV reader standardization?

Again, Fred, I need to give you the standard answer is first of all, we [as] the authentication company, basically we don't mind what is the choice is of a customer or country. We have so many products today that we can answer on all the needs of the financial institutions and now also more and more beyond the financial institution.

Secondly, some countries are moving slowly to another technology, could be the ID card, could be EMV. Now, on the UK it is moving slowly forward to EMV. But it's not a general trend. As you probably know, the banks have the choice either to go for it or to have their own, let's say, their own choice of technology.

Maybe a follow-on to that, back to Cliff for second. So if, indeed, we did see an upswing in reader revenues, would that -- what would be the implication on that to the gross margin? I assume it would put a little pressure on it?

Yes.

Yes?

Generally the readers are more of a commodity kind of product. It depends on whether it's just being deployed for EMV only, or if it's being deployed in conjunction with a banking application. But generally, there is more competitive pricing pressure in that segment.

Okay. Thanks, guys.

Maybe I can add something there, Fred. As we are not selling any more readers alone, we are really selling the VACMAN as the [code of] indication platform and the banks needs more than just readers.

Okay. Thanks.

Operator, we have time for two more questions from two individuals, one each, please.

Thank you. Our follow-up question is coming from Amit Dayal from Rodman & Renshaw.

Hi, guys. Just one question on the banking summits. How many more are planned for 2007?

Jan, would you address that please?

Yes, sure. While we have different banking summits, we have our international banking such as Zurich and New York and other ones. That international banking summit means that we are organizing them for different countries. We have local banks banking summits typically -- I'm sorry, the international banking summits are typically one and a half, two days. The local banking summits are typically one day, and then we have also road shows that we are doing like half a day, a roundtable and things like that. You can expect that we are organizing at the speed of about two per month.

Great. Thank you.

[inaudible]

Great. Thanks. Just one more question, Ken, if you don't mind. Are the tokens being issued by eBay/PayPal originating from VASCO? Could you confirm that for us, please?

Yes. If you look at the token on PayPal's website, it's clearly a GO3, a VASCO GO3. I would reemphasize, however, that our partner, VeriSign, is the intermediary there. VeriSign is our OEM partner, our reseller partner, and PayPal, Charles Schwab, eBay, Yahoo, they are VeriSign customers. So any specifics, you really need to contact one of those parties.

Great. Thank you so much, Ken.

You're welcome. Operator, one more question.

Sir, there appears we have no questions.

All right, good. Perfect. All right. Well, then, thanks everybody for joining our call today, and thanks to the VASCO people around the world for their hard work, dedication. I'm always very, very proud of you. Thanks, very much, everybody. Bye.

This concludes today's VASCO Data Security conference call. You may now disconnect.