OneSpan Inc (OSPN) 2007 Q3 法說會逐字稿

Good morning, my name is Janine, and I will be your conference operator for today. At this time, I would like to welcome everyone to the VASCO Data Security International, Inc., Third Quarter 2007 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, T. Kendall Hunt, 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. 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 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 may differ materially from the expectations expressed in these forward-looking statements. I direct your attention to the Company's filings with the U.S. Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard.

Today we are going to review the results of the third quarter of 2007. 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 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 third quarter 2007. Revenues were $30 million, an increase of 60% over third quarter 2006 and once again a very strong quarter. It was also our 19th consecutive positive quarter in terms of operating income and cash flow. Our gross profit for the quarter was 67% of revenue and our operating income was 27.5% of revenue.

Our backlog or firm business for Q4, as of today, is $33.4 million. Backlog is defined as orders already shipped between October 1st, 2007, and today. Plus, firm purchase orders scheduled to ship before December 31st, 2007.

The results of Q3 2007 and the strong backlog announced today confirm once again that our strategies are working worldwide. Few, if any, companies in our peer group are growing as quickly as VASCO.

As you know, the subprime mortgage loan crisis has been a very visible topic over the past few months. I wish to be very clear about this, VASCO's business has not been affected by the economic loan problems created by the subprime loan crisis in the United States. Our products are used in the United States banking industry primarily for business and soon retail banking applications.

With VASCO's products, financial institutions reduce their infrastructure costs, generate incremental fee revenues from financial transactions completed over the Internet, stay competitive and increase their customers' trust in the Internet.

New accounts sold continued at a very high level. During the quarter, we sold an additional 608 new accounts, including 106 new banks and 502 new enterprise security customers. This compares to the third quarter a year ago in which we sold 381 new accounts, including 58 banks and 323 enterprise security customers.

We now have close to 6,000 customers, including approximately 950 banks, in more than 100 countries. In addition to banking, our enterprise security companies include corporations, federal state and local governments.

Since the first quarter of 2003, VASCO has experienced steady, controlled growth and continued growing profitability. Over the past couple of years, this growth has occurred worldwide, from the Americas to EMEA to Asia. This has resulted in a worldwide market leadership position for VASCO.

We expect that our worldwide growth will continue, with strong contributions from all geographic areas. To support our strategic growth, we are investing in a network of offices worldwide. As you probably know, we have recently opened offices in Tokyo, Japan, and Sao Paulo, Brazil. We are investing in those regions because we believe that we can generate significant business in both the banking and enterprise markets.

Finally, I'd like to comment about the origin of our revenue. Many of you have heard me chant about VASCO's sustainable, repeatable sales model. This sales model, mainly responsible for our continued strong and profitable growth, is still in place.

However, and more importantly, we see that VASCO is moving towards an even more recurrent sales model. Growth in our non-hardware revenue is keeping pace with our overall growth as it has represented approximately 14% of our revenue in each quarter of this year.

VASCO's non-hardware revenue includes client authentication software, maintenance, support and subscriptions in the Digipass Plus field. In addition, our strategy of increased focus on software is generating higher levels of deferred revenue that will be recognized over the life of the contracts. We expect that the recurring revenue that comes from these new contracts will become a more significant part of our revenues in future periods.

The growth in non-hardware revenue is one of the main reasons VASCO is able to maintain its relatively high gross margins. Only a couple of years ago, VASCO's margin was, according to some, a reason for concern. We are proud to demonstrate that this Company and this management is able to invest in fast growth while staying very profitable. This is due to the solid structure of the Company, our execution and our ability to adapt the Company's market approach to a quickly evolving environment.

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

Thank you, Ken. Ladies and gentlemen, the third quarter of 2007 was remarkable in several ways. In the markets, we have seen that the rise in criminal activities on the Internet. As a result there has been a growing interest about our technologies and products. Specifically in banking, our e-signature technology has become the key asset in many competitive deals.

We foresee that in many banks and e-commerce companies will upgrade their current strong authentication protection from one-time password devices to e-signature devices or software.

This is good news for VASCO. We have offered the e-signature technology since the '90s and have built a vast amount of know-how, experience, products and customers in the field. In the entire application security field, we are experiencing more traction in applications other than banking due to the growth in criminal attacks. With application security, we mean every application where an enterprise or an institution could use VASCO's products to more strongly authenticate its customers.

An application security project is very similar to a banking project. VASCO secures the entry to an application and makes sure that the user can do a secure transfer of content over the Internet. We expect that these kinds of applications will become a large source of revenue for VASCO.

In enterprise security, we took some giant leaps forward in the third quarter. The rollout of our new generation of Digipass Packs became a true success. It pleases us that the channel is very excited about Digipass Pack, the first step of small and medium enterprises, or SMEs, towards secured network login and remote access.

During the third quarter, we signed a strategic distribution deal with Azlan-Tech Data, one of the largest distributors in the world, and with other channel partners. We are fully armed to win the battle of the SMEs.

In e-government, we took our offerings to a high level with the launch of our eID prototype. Geographically, we see strong opportunities for application security in all regions. We think that in a number of regions, including U.S., the introduction of the e-signature functionality will start to happen in the foreseeable future.

As you know, we have a three-step strategy in place to win business in a network country. We focus on the banks. They spread the word about VASCO and our Digipass products. Number two, after the first deals with the country banks, we hire local staff. Once they are involved, we open an office and finally we use our local office to go after the enterprise security market.

With regard to the products, we see an evolution towards higher added-value products. Our vision and strategy is working. VASCO sells more software and will continue to invest in those kind of products. The rise in software sales is expected to result in higher gross margins. Our gradual evolution to the Digipass Plus outsourced service model allows us to build up a layer of deferred revenue that will make our performance more predictable over time and that will allow the Company to focus even more on its long-term evolution.

As you know, VASCO is not the kind of company that exists on hype. We know our goals, we focus on our strategies and we are successful that way. We keep investing in our VACMAN core authentication platform. We keep adding new functionalities at a very high rate. Our VACMAN controllers enjoy the high esteem in the market.

We've maintained our strategy of making our VACMAN middleware compatible with the products of our solution partners in the enterprise security market. VACMAN middleware is the heart of our Digipass Packs. We have Digipass Packs for remote access, for network security and for the combination of both. Our Digipass Packs are brought to the market via our two-tier network of distributors and resellers.

The Packs are for us the perfect door opener to bring strong authentication into the systems of the SMEs.

When we are talking about the next asset of the Company, the people, we have to stress the fact that our existing staff is doing great in a quickly evolving market and that employees of the Company have experienced a long-term explosive growth.

I want to congratulate them for their splendid work. We keep reinforcing our workforce in order to support our worldwide growth. At the end of the third quarter, VASCO had over 220 employees.

Cliff Bown will explain everything about our financial position. This puts us in the right position to look for suitable acquisitions and to say yes when a growth opportunity comes our way at a reasonable price. Thank you.

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

Thanks, Ken, and welcome to everyone on the call. As noted earlier by Ken, revenues for the third quarter of 2007 were $30 million, an increase of $11.3 million, or 60%, over the third quarter of 2006. For the first nine months, revenues were $88.8 million, an increase of 75% over the comparable period in 2006. Revenues for the first nine months also exceed our revenues for the full year 2006 by $12.7 million, or 17%.

The increase in revenue for the third quarter and first nine months reflected significant increases from both the banking and enterprise security markets. Revenues in the third quarter of 2007 from the banking and enterprise security market increased 49% and 130%, respectively.

For the first nine months of 2007, revenues from the banking and enterprise security markets increased 72% and 86%, respectively.

It should also be noted that the comparison of revenues was positively impacted by the weaker U.S. dollar in 2007. We estimate that revenues in the third quarter and first nine months of 2007 were approximately $1.7 million and $3.9 million higher, respectively, than they would have been had the exchange rates in 2007 been the same as in 2006.

The distribution of our revenue in the third quarter of 2007 between our two primary markets was approximately 80% from banking and 20% from enterprise security. This compares to 86% from banking and 14% from enterprise security in Q3 of 2006.

For the first nine months of 2007, 84% of our revenues was from banking and 16% was from enterprise security and this compares to 85% from banking and 15% from enterprise security for the first nine months of 2006.

The geographic distribution of our revenue in the third quarter was approximately 66% from Europe, 8% from the United States, 16% from Asia, and the remaining 10% was from other countries.

For the third quarter of 2006, 58% was from Europe, 6% from the United States, 9% from Asia, and 27% was from the other countries. It should be noted that revenue from each of the primary geographic areas increased in the third quarter of 2007 as compared to the third quarter of 2006.

For the first nine months of 2007, the geographic distribution of the revenue was 64% Europe, 9% the United States, 16% Asia, and 11% from other countries. For the first nine months of '06, the geographic distribution was 62% from Europe, 9% from the U.S., 8% from Asia and 21% from other countries.

Gross profit as a percentage of revenue for the third quarter of 2007 was approximately 66.6%, which compares to 68.3% for the third quarter of 2006. And for the first nine months gross profit as a percentage of revenue was 65.5% in 2007, compared to 67% in 2006.

The decrease in gross profit as a percentage of revenue for both the third quarter and first nine months of 2007 as compared to 2006 primarily reflects an increase in the card readers sold, both in absolute dollars and as a percentage of total sales and a decrease in the selling price of the readers which results from larger quantities being sold and competitive pricing pressures.

The decline in gross margin from these two factors was partially offset by an increase in the percentage of the business coming from the enterprise security market, an increase in the percentage of business coming from non-hardware products, a reduction in the average per-unit cost of the products sold and the strengthening of the Euro compared to the U.S. dollar.

Our non-hardware revenues were 14% of total revenue in the third quarter and first nine months of 2007 and compares to 8% of revenue in the third quarter of 2006, and 11% of total revenue for the first nine months of 2006.

Operating expenses for the third quarter of 2007 were $11.7 million, an increase of $3.9 million, or 50%, for the third quarter 2006, and operating expenses for the first nine months of 2007 were $33.6 million, an increase of $11.5 million, or 52% from the same period in 2006.

Operating expenses for the third quarter and first nine months of 2007 included $564,000 and $1.469 million, respectively, related to stock-based incentive plans. Stock-based incentive plan expenses in the third quarter and first nine months of 2006 were $455,000 and $1.167 million, respectively. It should also be noted that the comparison of operating expenses from 2007 to 2006 was negatively impacted by the weaker U.S. dollar in 2007.

We estimate that expenses were $587,000, or 7.5% higher for the quarter, and $1.9 million, or 8.6% higher for the first nine months, than they would have been had the exchange rates in 2007 been the same as in 2006.

For the third quarter, operating expenses increased by $1.7 million or 37% in sales and marketing, $1.1 million, or 77% in research and development, and $1 million, or 64% in general and administrative when compared to the third quarter of 2006. The majority of the increase in the sales and marketing area were related to the Company's increased investment in sales staff, increased purchased services, and higher depreciation costs, primarily related to the cost of training films developed in 2006.

The increase in research and development was primarily attributable to increased compensation expenses, in part resulting from the acquisition of Logico and Able in the second and fourth quarters of 2006, respectively.

The increase in general and administrative expense primarily reflects increased compensation expenses and professional services. For the first nine months of 2007, operating expenses increased $6 million, or 46%, in sales and marketing; $2.9 million, or 81% in research and development; and $2.1 million, or 41%, in general and administrative when compared to the same period in 2006. The reasons for the increase in expense in the first nine months are generally the same as for the third quarter.

Operating income for the third quarter was $8.3 million, an increase of $3.3 million, or 66%, from the $5 million reported for the third quarter of 2006. For the first nine months, operating income was $24.6 million in 2007, an increase of $12.6 million, or 105% from the $12 million reported in 2006.

Operating income as a percentage of revenue or operating margin was 27.5% for the third quarter and 27.7% for the first nine months of 2007. In 2006, our operating margins were at 26.6% for the quarter and 23.5% for the first nine months.

The increase in operating margin is attributable to improved efficiency, as reflected by a decline in operating expenses as a percentage of revenue, primarily in the sales and marketing line item for Q3 and in the sales and marketing and general and administrative line items for year-to-date Q3.

The Company reported income tax expense of $2.3 million for the third quarter and $6.9 million for the first nine months of 2007. The effective tax rate for both periods was 28%. For 2006, the Company reported $1.7 million of expense for the third quarter and $4 million for the first nine months. The effective tax rate reported for the third quarter of '06 was 33.5%. For the nine-month period ended September 30th of '06, the effective tax rate was 34.9%, which included the impact of the charge for impairments in our investment in secured services.

The effective tax rate, excluding the impact of the impairment charge, was 33.2% for the first nine months of '06. The effective tax rate for both periods reflects our estimate of the full-year tax rate at the end of each respective period. The rate reported in '07 is lower than the rate reported in '06, as our estimate of the full-year tax rate in 2007 reflects increased earnings in Switzerland, which are taxed at a lower statutory rate, and increased earnings in the United States, which will be offset by the use of tax loss carry forwards.

Earnings before interest, taxes, depreciation, EBITDA, or operating cash flow, if you will, was $8.7 million for the quarter and $26.5 million for the first nine months of '07. EBITDA was $3.4 million, or 64% higher in the third quarter, and $14.3 million, or 117% higher than the first nine months of '06.

The makeup of our workforce at September 30th, 2007, was 222 people worldwide, with 124 in sales, marketing and customer support, 70 in research and development, and 28 in general and administrative. The average headcount for the third quarter was 60 persons, or 39% higher, than the average headcount for the third quarter of 2006. The average headcount for the first nine months of 2007 was 61 persons, or 43% higher, than the average headcount for the same period of 2006.

The strength of our operating performance is also reflected in our balance sheet. Our net cash and working capital balances both increased from the prior quarter and prior year end. As of September 30th of 2007, our net cash balance, which is defined as total cash plus bank borrowings, was $36.7 million, an increase of $10.7 million, or 41%, from $26 million at June 30th of 2007, and an increase of $24.1 million, or 192%, from $12.6 million at December 31st of 2006.

As of September 30th, 2007, our working capital balance was $46.6 million, an increase of $8.8 million, or 23%, from $37.8 million at June 30th of 2007 and an increase of $24.5 million, or 111%, from $22.1 million at December 31st of 2006.

Bank borrowings noted on the balance sheet at September 30th, 2007, of $3.3 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 additional cash was offset by short-term debt. During the quarter, our days sales outstanding and accounts receivable decreased to 55 days as of September 30th of 2007 from 67 days at March 30th of 2007 and from 72 days at December 31st of 2006. The decrease in DSO was primarily related to the timing of when the sales were made in the quarter.

Now, at this time, I would like to turn the meeting back to Ken. Thank you.

Thank you, Cliff. First, I'd like to comment again on order backlog for Q4 2007. As of this date, we have firm orders with shipments scheduled for the fourth quarter of approximately $33.4 million.

Any new orders received before quarter's end and shipped before the quarter would be additive to this number. This backlog shows the strength of our order flow, as it is 55% higher than the backlog going into Q4 of 2006. In addition, the backlog is 33% higher than the $25.2 million in revenues reported for Q4 2006.

Today, we are also reaffirming guidance for our full year 2007. As in the past, we only comment on annual numbers, not quarterly numbers. First, we are reaffirming our guidance that our full-year revenue will grow from 55% to 65% over full-year 2006. Second, we are reaffirming our guidance that full-year gross margins will be in the range of 60% to 68% of revenue. And, finally, we are reaffirming our guidance that full-year 2007 operating income will be in the range of 23% to 30% of revenue.

In summary, we are very pleased with our results for third quarter and first nine months of 2007 and look forward to a strong performance for the remainder of the year. 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 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 with Friedman Ramsey.

Thanks. I have a few questions. First, did you see any pushouts in the quarter in terms of deals that you were expecting to close that maybe went into 4Q or '08?

We did not.

And for 2008, is there any way you can maybe try to give us some sense as to what type of growth you'd expect on the top line, just as that's getting closer and maybe a better gauge of your business into next year?

Well, we're not giving guidance at this time for 2008. We will do that in the earnings conference call that will occur sometime in the middle of February of next year. I have answered that question many times when people have approached me and asked that question. What I've said is I feel comfortable that we can grow at 30%-plus at the top line over the next couple of years.

Okay, thanks.

Sure, Dan.

Thank you. Our next question is coming from Jonathan Ruykhaver with ThinkEquity Partners. Jonathan, you may go ahead.

Yes, hi, Ken.

Hi, Jon.

It looks like revenues were somewhat light relative to the backlog entering the September quarter. Were there any issues as it relates to fulfilling?

No, there weren't. As I mentioned in the press release and in my comments, you're seeing VASCO evolve into more recurring revenues and sometimes that means that when we book a software deal, instead of booking all the revenue in the current quarter, it's amortized over multiple years. So you'll also see that our deferred revenue grew by about $1.2 million quarter-to-quarter, and that's reflective of our strategy to generate more and more non-hardware-related revenue. And, again, non-hardware-related revenue would be software. It would be maintenance, it would be support and it would be subscription revenue.

Okay, so those deals will get booked as subscription deals and deferred over a period of time.

Cliff has something to say.

Jonathan, I'm not sure what you're looking at in terms of weakness in terms of incremental sales over the backlog. As we've commented in previous calls, our business is seasonal and traditionally the third quarter is one of the weaker quarters.

So if you were to compare back the spread between backlog and actual results this quarter, that difference is about $2.9 million. Last year, that difference was $2.6 million. The year before, it was $1.7 million. The year before that it was $1.8 million. So in my mind and the data that I look at, the growth over the backlog was stronger than in previous periods and is a demonstration of the increasing strength of our channel.,

Right. I think on an absolute basis you're right. I was just looking at it on a percentage basis. My final question is, can you talk abut the implication to effective tax rate given your move to Zurich?

Well, you use the implication in terms of this full-year rate being at 28% versus the 33% in the prior year. As that operation becomes more fully integrated, we would anticipate that the rate will continue to work its way down. It will have a positive effect.

That move, however, will be somewhat mitigated by the fact that the Swiss company has to buy the intellectual property from the other countries in which VASCO owns the intellectual property. So for the next four or five years, there will be buy-ins, which will have the effect of increasing the tax rate. But that will be offset by the fact that more of the earnings will be in Switzerland, at a lower tax rate. And net-net we expect that the tax rate will continue to come down a bit from the 28% that we're reporting for this year.

Can you give us any indication as to what that would be on a quantitative basis, a blended rate looking into the end of '08?

No, that's not something that we guide on. We only give the guidance on revenue, operating margin and gross margin percentages, so we're not prepared to add that to our mix at this time.

Okay, thanks, guys.

Thank you. Our next question is coming from Robert Breza with RBC Capital Markets.

Hi, Rob.

Rob, your line is live.

Sorry, had my phone on mute. Can you hear me now?

Yes, we can.

Sorry about that. Ken, or, I mean, Cliff, maybe just following up on the last couple of questions about looking at the spread between backlog to revenue, should we be thinking about that more in terms of an absolute dollar or maybe percentage increase on the absolute dollar amount? Or should we be looking at it is -- I think the prior person mentioned as a percent, which is how we've looked at it historically. What's the best way to think about that kind of going forward?

Obviously, I know the mix now is changing with a little bit more on the enterprise side and more geographies, so any kind of insight there about how to think about the backlog relative to revenue.

I can't make that judgment for you, but I look at it on an absolute basis first and a percentage basis second. Because what I've seen when I look at it on a percentage basis is there's a lot of fluctuation. For example, the backlog has been as high as 93%, 94% of what the full quarter turned out to be.

Now, more recently, that number's been trending in the high 80s and this quarter it was at 90%. But the absolute dollar spread has increased, which is what we want to see. So as long as the absolute dollar spread in terms of the difference between backlog and actual, to me that's evidence that our channel and our enterprise security market is gaining strength.

Now, the amount of the spread when I look at it, I also look at it in terms of historical quarters, because, again, the third quarter traditionally has been the seasonally weakest quarter for VASCO, so the spread in Q3 is generally going to be less than it is in the other quarters.

Okay. And maybe, Ken, just as an follow-up, I know, Cliff, in your prepared remarks you talked about the timing of sales in the quarter helped DSOs come down fairly dramatically. How do you think about or how should we be thinking about Q4 from a revenue or a timing of sales perspective?

Do you think it will be more front-end loaded or more back-end loaded towards the quarter? When you look at your backlog today, is it more consistent seasonality or how should we be thinking about that and then maybe the impact to DSOs?

I think quarter by quarter, I don't know that I can predict the timing of the revenue recognition in the quarter. It seems to vacillate, fluctuate. The customers make their determination when they want to place the order on VASCO and when they want to schedule the shipments. We don't try to control that, and so we just take the order flow as it comes. The enterprise side of our business, if you look at any other business, any other company, revenues tend to be back-end loaded for enterprise kind of business, regular corporations, regular business.

And I think that ours is similar. The enterprise side of our business is more likely back-end loaded. But the banking business is really dictated by when the customers want us to ship and when we ship, that's when we invoice, that's when we recognize the revenue.

Maybe just a clarification, Ken. When you talk about the backlog, I know how you define it in your prepared remarks, is that 100% guarantees or is there chances that sometime the backlog moves around where people push orders out?

No, it's not absolutely guaranteed. I'd say it's unusual that once you get into a quarter that a scheduled shipment from a firm PO is going to be delayed. That would be unusual.

Okay, thank you.

You're welcome.

Thank you. Our next question is coming from Nick Andrewes of Lazard.

Hey, guys, good morning.

Good morning, Nick.

Could you guys talk a little bit more about what you guys expect the breakout of revenue from banking and from enterprise to be going forward, specifically maybe in Q4 and then into '08?

Well, I'll take a shot at this and then I'd like Jan to comment. For a long time, revenue from the financial channel has been about 85% of our worldwide sales. Over the last several years, we've worked very hard at building a reseller channel, companies around the world that sell third-party products in their local geographic territory and are selling primarily to small and medium enterprises.

It's really an excellent channel for us and we support that channel. We have channel managers. We try to support those channel sellers any way we can, so our goal is to increase that percentage of revenue as a percentage of the whole, because we do sell in small quantities. They're very high revenue, respectively, deals. They're very high gross margin-producing deals and we're selling through other people's sales forces. So we'll continue to emphasize that.

In the third quarter, the enterprise revenue was 20% of our revenues. So it shows that that is working and working well. Jan, would you like to add anything to that?

Yes, maybe I can add something on the marketing side. Basically, what we are doing is that enter the new country, we go first to the banks. These banks are doing large deployments. And then our marketing is saying to the consumer and to the enterprises, small, medium and large enterprises, these Digipasses are coming from VASCO and secondly VASCO is doing more than just Digipass.

So that's our business model. We're entering in a country, the banks, the large deployments, hiring some people, opening an office and then going to the enterprise market through this two-tier model. And it's successful.

Any clarity on what you guys expect for the fourth quarter as a breakout?

No.

Thanks. Last question, can you guys talk a little bit about the business year-to-date versus last year on not necessarily what you guys are recognizing of revenue but what is booked as a new business going forward?

You're talking about order flow and gross orders?

Yes.

Jan, I don't know if you'd like to, but Nick, I think the revenues that you're seeing are reflective of the order flow. We don't give cumulative backlog or the full amount of backlog in our numbers, A, because there's quite a bit of fluctuation in that. And then we think that it would tend to confuse the market because our business is still of the size where one large order that comes in could substantially increase backlog, but you don't know the time over which that's going to be shipped.

Our traditional model is that that's a year's PO, but the rollout for the banks, as Ken was talking in his sustainable, repeatable model, is three to four. So I think for now you should use the revenue growth that you're seeing, 60% for the quarter, 75% on a year-to-date basis, and some percentage of the change in deferred revenues that Ken mentioned, we're selling more and more software. There's more license fees on a subscription basis that are coming in. But the some of those two and the change of those I think are reflective of the order volume. Jan, I don't know if there's anything you'd like to add.

No, it's fine. Yes.

All right, great, guys. Thanks.

Thank you, Nick.

Thank you, our next question is coming from Fred Ziegel with Soleil Securities.

Hey, guys.

Hi, Fred.

You need to go back I guess to 2003 and the first part of 2004 to find a quarter where the enterprise business was as high a percentage as it is. If we continue this going forward, and it sounded like that's part of the emphasis, we should have the ability to push through the top end of both gross and operating margin guidance? Is that a fair way to think about it?

Well, we really can't comment too directly on that, Fred, but one of the things I would point out is that as we grow our distribution channel and as we grow our OEM relationships, such as a Verisign deal, there will be more revenue that will go through enterprise security but some of that will be cyclical as well, because the channel will be whatever orders they're working and what we get from the OEM relationships will also be up and down in some periods.

But as the size of those deals gets bigger, the overall gross margins on those deals will also come down a bit. They won't come down to the banking levels, but they won't be at that 85%-plus that the small quantity deals have historically had for enterprise security.

So I would recommend that the guidance that we're giving is our best estimate at the time of what we think we can deliver, but I wouldn't get too far out in front of estimating that those operating margins are going to go through the roof because enterprise security is strong in this quarter.

So it's going to depend on channel and depend on size of the deal primarily?

That's right.

Was Tech Data involved in the Q3 business or was that subsequent to the quarter end?

We got an order from Azlan-Tech Data,

but it was not booked in this quarter.

In the third quarter.

Right. There's no revenue in the quarter for Tech Data.

The process has started.

It has.

Okay, thanks.

Thank you.

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

Thank you so much, and congratulations on the strong backlog, guys.

Thanks, Amit.

Just one question initially on how we should be looking at the U.S. deployments. Are these happening at the corporate level today and is that expected, or should we expect that to shift to the retail level in the coming months and how much traction will that give to the business overall?

Well, we are optimistic about the United States as a market. The FDIC, FFIEC guidance given October two years ago has jumpstarted the banking business for a strong two-factor authentication.

To date, the only deals that we've announced or acknowledged have been the corporate or business side of the bank, and that business is growing nicely. We are very optimistic about the retail side of the bank, that consumers will start deploying going forward.

The size of that, I can't really comment on, but we're optimistic about not just the corporate side or business customer of the bank but the retail and consumer customer of the bank in the United States and worldwide.

Great. Thanks. A couple of quarters ago, you brought up opportunities in China. Is that something we should be looking at for 2008 probably beyond that, if you could just provide some color on that.

Yes, I'd say that whole A-Pac, Asia-Pacific area is a very good opportunity for us. China, Japan, Korea, India, that whole area is untapped and is a great opportunity for us and we're focusing a lot of energies on those geographic territories.

I have one final question. The stock has pulled back specifically after today's results. How do you reassure investors about the macro picture and VDSI's place in it?

Well, I think the only thing I can say is our business continues to grow strongly. We're performing very, very well compared to anybody in the industry, anybody in our business.

We are not only growing strongly, but we are very, very profitable, and I think the results really speak for themselves. The investor really has to decide their risk profile and whether they want to invest in IBM at a very, very slow rate of growth and slow stock appreciation or if they want to invest in a company like VASCO that has those two components, high growth and high profits.

Thanks so much, Ken.

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

Thank you. Can you hear me okay?

We sure can.

Talk a little bit about the expenses, specifically I guess R&D and G&A during the quarter. It looked like it upticked at least sequentially a little more than we were expecting. Was that mostly because of new offices being opened or was there anything else in there? And do you expect this level I guess going forward to be at this level?

Well, on the R&D side, the uptick would not be related to any unique transactions. I think the uptick there compared to '06 would be largely the acquisitions of Able and Logico, because Able didn't come onboard until October of last year. It was a Q4 transaction, so the comparison this year has a full quarter of Able versus none in the prior period.

When it comes to the G&A side, yes, there was a significant amount of legal fees, but those will depend on the projects that we're doing. We use outside attorneys when we incorporated in Brazil. We're using outside attorneys for incorporation in Japan.

We use outside attorneys when in fact we're dealing with resellers or customers in countries that we don't have a presence, because we need their local expertise on imports and those kind of regulations. So that will vary more from quarter-to-quarter and it will ebb and flow with the activity that we have, so it's not as much a part of our permanent expense base.

Okay, but as far as the R&D, there was a meaningful uptick between the June quarter and the September quarter. Are you hiring more engineers, can you just talk about that?

Well, the uptick there would be the combination of two factors. One is the exchange rate, that the exchange rates are stronger in Q4 than in Q3, and second there was a one-time reclass of two persons on a year-to-date basis from sales and marketing into R&D. So what you may be seeing if you're comparing sequential quarters is a little bit of that reclass of the expenses of those two persons.

Thanks, and in the other income line, it looks like you've recorded an expense of almost $300,000. Can you go detail on what that was?

The majority of it was exchange loss, a $296,000 exchange loss for the quarter and that reflects a couple of things, one, the growth in our business and whether or not we can use our old methodologies as an effective hedge against exchange gains and losses.

And it also reflects the change in the business in moving to Switzerland, because we've changed currencies that we need to review for the hedges. So I think what you see there is, a) the euro getting much stronger. It went over 1.40 at the end of the period and that's when you see the measurement for financially denominated assets that would go through the P&L. And second, it's us needing to adjust our processes to reflect the reality of more of the business going through Switzerland with different currency dynamics and the need to hedge differently than we did in the past.

And lastly, as the authentication market is turning more towards software solutions, perhaps more even towards smart card-type solutions, what is the competitive dynamics in those areas compared to the competition you see in the OTP token business?

Well, I'm not sure if we necessarily agree that there's this rushto software only authentication solutions. We still have a very strong business in the physical token, our Digipass physical tokens. Many of our customers like the physical token because they can brand it. We manufacture it in their color, with their logo.

The physical token, the 250 and the 260, enable digital signatures so that they can sign transactions very securely and defeat man in the middle attacks. But, at the same time, yes, indeed, there are incremental opportunities -- I really think incremental opportunities for selling software that is VASCO software that is loaded on a customer's cell phone or PDA or loaded on their PC. On the PC with the capability of doing one-time passwords and the digital signature.

So we're prepared with our product line to I think meet a large percentage, a large portion of the specific audience requirements of our customers.

In the U.S. retail market, when it does pick up steam, do you anticipate that being more of a software market eventually, where you download the one-time password on your phone or PDA or do you think it will be a physical token market?

Jan, why don't you answer that question.

Yes, first of all we are a truly authentication company. That means if you look at the U.S., as you know, we have multiple, multiple banks that are using our VACMAN Controller technology for a corporate banking application with one of our Digipasses. The nice thing is that once a bank has that VACMAN Controller, they can deploy other Digipasses for, for instance, retail banking, hedge funds, whatever.

Now, if you look at the retail banking, it's going to be I don't know what it's going to be, really, in the U.S. But if you look at the criminal activities, we see that in the banking industry as such there is a move forward from easy-to-use tokens, easy-to-use Digipasses to a bit more complex Digipasses to tackle, in fact, the man in the middle attacks and the Trojan horses.

So I believe, if you ask me, for the retail banking, one, the question is when will the banks in the U.S. start to have the application where hardware strong authentication is needed? B) if that is the case, due to the increase of competition coming from foreign banks, then the question is, or the answer is, yes, then it's going to be hard to help devise and that's going to be used.

It's the only way to stop Trojan horses or man in the middle attacks.

I want to underscore something that Jan said. We're actually seeing current customers that have deployed our simpler products, the older AccessKey, one, the Go3, the single-button kind of product. They're upgrading to the multifunction Digipass 250, 260, with the keyboard to defeat man in the middle attacks, primarily generated by these criminal elements around the world.

Okay, all right, thanks, guys.

Thank you. Our next question is coming Scott Zeller with Needham & Company.

Hi, thank you. Ken, can you help us understand the vision you have for the U.S. business? We've seen a relatively stable percentage of revenue coming from the U.S. Can you lay out for us how you expect that to ramp up going forward, and what would be the catalyst?

Well, one of the catalysts, as you know, Scott, is this FDIC guidance issued two years ago. That has gotten all of the banks doing something. Not every bank has deployed anything, but at least they've gotten their attention and the banks are investigating or they're issuing RFPs or they're trying trials or they're implementing very simple applications like your mother's maiden name. At least they're doing something.

And VASCO's right in the middle of that. We're calling on the larger banks directly. We have some excellent partners that help us go into the smaller and regional-sized banks, like [FISERV]. And so we're optimistic about the U.S. We have our own plans, our internal plans. We are investing in the market with people and relationships, as I mentioned before.

So that's all I can say. We are optimistic. We think that the 9% where the percentage is right now, the 9% of the total revenues, can go higher because this is a big market.

And do you notice or could you share for us a feel for the urgency amongst the financial services companies because, as you'd mentioned these guidelines from FFIEC have been out for some time. Have you noticed a change at all in the level of urgency amongst the prospects?

Yes, I think so. Their urgency may be channeled different from bank to bank. When I heard this announcement two years ago, I said that I think many of the banks, because of their culture, because of their U.S. culture, many of the banks would adopt meets-minimum approaches. And I think many of the banks, at least on the retail or consumer side have indeed implemented meets-minimum approaches, the type of authentication or challenging that your mother's maiden name or your favorite pet would suggest. And those are banks that I think have deployed one-time throwaway solutions.

And I think that even those banks that have deployed those kinds of simple solutions are opportunities for VASCO in '08, '09 and forward. So, yes, there has been a sense of urgency. The banks are doing things. Some banks are doing nothing and simply paying fines or anticipating they'll pay fines for noncompliance, are not doing well in the compliance examination by the examiners when they come to the banks. But certainly there is an enhanced sense of urgency across the banking industry.

Thank you.

Sure.

Thank you. Our next question is coming from Katherine Egbert with Jefferies & Company.

Hi, good morning. The first question is how is linearity in the quarter? Meaning, how did this September compare to previous Septembers with the amount of revenue you booked kind of in the three months of the quarter.

I don't think we want to go there, Katherine, to get down to that level of detail. If you're trying to look at the DSO and how that happened, I don't know that there's any information there that would establish a firm trend. As Ken said earlier, we met the needs of shipping when the customer wants us and it's more a function of that process than it is anything that we're doing from a management point of view.

Okay, and then I think Jan in his prepared remarks talked about adding more technology in, particularly on the software side. Can you elaborate a little bit on that?

Yes, we're always listening very intently to what our largest customers, the banks, are telling us they want to buy. Last year, our R&D was about 7% of our total revenue. This year, on a year-to-date basis, we're running about 7%, maybe a little bit higher, as a percentage of our revenue. And that's a very controlled number because instead of trying to invent a new product and then go make a market, what we tend to do is to continue to monitor the success of small, little technology companies around the world.

And then when we meet with our big banks and they tell us the kinds of products they want for their various audiences, then we do a make versus buy. We decide whether we'll build that product to sell to the banks or we'll buy a small little tuck-in acquisition. Those same products, by the way, we're able to sell them through the channel to the small and medium enterprise companies around the world.

Is there any area you're looking specific in software?

Not anything that I care to talk about over the phone.

Okay, fair enough. And then last question, how was the competitive environment? I think the EMC sales force got the RSA technology for the first time in June. Did you see any impact there?

No, I don't think we have. In fact, on the banking side, we probably see less of RSA than we have a year, two years, three years ago. And again, I'm talking about where we call on the banks on the business unit that is supporting their corporate or business clients or the business unit that is supporting the retail or consumer client.

The channel is something that we're working very hard on and Azlan-Tech Data I think is a good example of our success in making progress in that market. Tech Data I think over the last several years has been one of the larger resellers for RSA.

The fact that we signed this very important deal in EMEA, Europe, Middle East, Africa, with Azlan-Tech Data I think is very important. Am I going to conjecture what that revenue will be from that new partnership? I'm not. That's not my style. But I can say that we are very happy with that relationship and we are very optimistic about what will come from it.

Okay, thanks, Ken.

You're welcome, Kathy.

Thank you. Our next question is coming from Brian Freed with Morgan Keegan.

Hey, guys, thanks for taking my call.

Sure, Brian.

As you look at software as a percentage of revenue, you saw a pretty good ramp in that over the past year or so, but it seems to have stabilized a little bit. Do you think that's a function of penetration base in your installed base or product cycle and where do you see software ultimately heading?

Well, Brian, and, Jan, you can comment on this in a minute. We've been focusing on non-hardware-related revenues now for a year or so. We put plans in place to focus on that, commissioned plans to focus on that, because we know that it will be good for the business, more software, more maintenance, more support, more subscription revenue will be good for the business and it will make our business more profitable through higher gross margins and more predictable because of the recurring nature of the business.

Where it will go, I can't tell you. We expect it to continue to grow, but what percentage overall it will end up being I can't tell you. I don't know.

Okay, and then kind of a follow-up to that, it was part of the driver of very strong year-on-year growth rates earlier in the year and it decelerated the last three quarters, I guess I imagine investors are concerned whether there is hope for any reacceleration in your year-on-year growth rate. When you look back at the earlier part of this year, was there any kind of one-time anomalies either in the market or your products that drove that upward spike? Where do you think we should look for it?

I think it's just the growth for VASCO has been a general awareness of the market that there are criminal elements out there, not just amateur hackers, but there are criminal elements out there that are making money by stealing from unsuspecting consumers, bank customers, Internet customers, their identities are stolen.

So I think just generally speaking there's a greater awareness worldwide that there is hacking going on and real money being lost and people are looking for solutions. And we've got one of the broadest areas of solution for strong authentication and signatures in the business.

Brian, too, if I understood your question correctly, you're asking about the deceleration in the quarter this year versus same quarter last year.

Well, if you look at you were up around 90% year-on-year growth and kind of 70s, 60s, so the trend line is somewhat down on a year-over-year growth rate for the last few quarters.

That's what I thought you were asking. Let me just remind you that the first quarter of 2006 was artificially low, that in the fourth quarter of 2005 we had $2 million of orders where customers said they wanted it sooner. So we had $2 million of revenue that was pulled out of the first quarter of '06, back into the fourth quarter of '05, at customer request. So we've talked about that before, but the market may be losing sight of the fact that Q1 '06, the first period of that comparison trend, was artificially low by about $2 million.

Okay, thanks.

Thank you. Our next question is coming from [Joseph Vente] with [Dante]. Joseph, your line is live.

Yes, good morning, gentlemen.

Good morning.

Just one question here. The plunge in the stock. What happened here?

I don't know.

Did you fellows come out with news that we haven't seen?

No, the news that we announced was in the press release issued this morning and our comments today during the earnings call. There's been no news that we haven't shared with the market, none at all.

Yes, but you haven't answered the question. There's a significant drop of over 10%, a $10.41 drop. Why is that?

I have no idea.

As far as you're concerned, your company is going ahead steadily, making more money, going into new venue areas and it still drops?

Cliff, do you have something to say?

The only thing that comes to mind, Joseph, and I sense that there's pain on your side --

There is, because we've got thousands and thousands and thousand of shares of this and we're taking a beating.

But when you look at the announcement that VASCO has made, our results today are right in line with the guidance that we've given in the market. We've reaffirmed today the guidance that we gave to the market. So we are performing exceptionally well, as evidenced by the result, 60% quarter-over-quarter prior year. We're performing at the top end of the guidance in terms of revenue. You'd have to ask the other investors, like yourselves, as to what the motivations are in terms of why the price ran up and why the price is what it is today.

The only thing we can see is what the analysts have been saying about the company.

Well, we've been consistent. We do not guide on a quarterly basis. We haven't for the last four and a half years. We guide only on an annual basis. We provide the range of growth for revenue year-over-year. We provide the range of gross margin percentage as a percentage of the top line and a percentage range of the operating margin as a percentage of the top line. We've been consistent with that. We will continue to be consistent with that.

It's very difficult to understand. It says that you missed your mark by 0.02. Now, 0.02 isn't very much.

Joseph, we understand the pain, but if you have another question that we can help with, that would be good. Otherwise, we need to give other participants a chance to ask their questions.

Yes, that was my question, why is it bottoming out like this? And you still haven't answered the question.

Well, we don't know.

Thank you. Our next question is coming from Santiago Rizzo with Straus

Hi, guys, thanks for taking my question. As previously asked, your backlog as a percentage was slightly higher than it was in Q3 of '06 and the last couple of quarters. But, as you mentioned, meanwhile your deferred revenue was up $1.2 million quarter-over-quarter versus down $200,000 quarter-over-quarter in Q3 of '06. Was there a higher percentage of your Q3 backlog deferred versus previous quarters and does that explain the confusion?

We don't include the items that would be deferred revenue in the backlog.

Okay, thank you.

Operator, one last question.

Thank you. Our final question is coming from Rob Owens of Pacific Crest Securities.

Hi, good morning, gentlemen.

Hi, Rob.

This is [Ross] for Rob, actually. Just wanted to talk about your cash balance for a minute. You're up to $40 million now. You had mentioned the various software areas that you were looking at. Is the acquisition potential, and then with the cash balance as it is , should we begin to see interest income sticking up here a

In terms of acquisitions, we're always looking for acquisitions, particularly, as I said before, particularly where there's an opportunity to acquire a team that has developed and perfected a technology that our banking customers want to buy. So that's always a good use for our money.

Our last several acquisitions have been almost all cash acquisitions, so that's what we use the cash for. Yes, we do have a very positive, very strong cash flow from the business, and we try to use it in the appropriate way. And what was the second part of the question?

If on a quarter-by-quarter basis, if we should begin to see interest income pick up here, as a return on that cash.

You actually saw that in third quarter over second quarter, $190,000 of income versus $80,000, so we doubled the interest income based on the stronger cash flow in this quarter. We'll continue to invest our cash in short-term instruments.

We're pretty conservative in our approach of managing that cash, so we tie it up for very short periods of time at the best market rates that we can get for those kinds of instruments. But we wouldn't expect to tie it up for long terms in high-risk, high-yield kinds of investments.

Okay, thanks.

Thank you. At this time, there's no further questions. We'll turn it back over to management for any closing remarks.

All right, well, ladies and gentlemen, thanks very much for joining us today. As always, we appreciate it and VASCO people around the world, keep doing your hard work. You know we all appreciate it. Thank you, and good morning.

Thank you, this does conclude today's VASCO Data Security International, Inc., third quarter 2007 earnings conference call. You may now disconnect.