VASCO Data Security International, Inc. Q3 2008 Earnings Call Transcript

VASCO Data Security International, Inc. (VDSI)

Q3 2008 Earnings Call

October 23, 2008 10:00 am ET

Executives

T. Kendall Hunt - Chairman and CEO

Jan Valcke - President and COO

Clifford K. Bown - EVP and CFO

Analysts

Daniel Ives - Friedman, Billing, Ramsey & Co.

Robert Breza - RBC Capital Markets

Frederick Ziegel - Soleil Mackinak Securities

Joe Maxa from Dougherty & Company, LLC

Andrew Abrams - Avian Securities

Brian Freed - Morgan, Keegan & Company

Nick Andrewes - Lazard Capital Markets

Scott Zeller - Needham & Company

Presentation

Operator

Good morning and welcome to the VASCO Data Security International Inc. third quarter 2008 earnings conference call. During the presentation all the participants will be in a listen only mode afterwards we will conduct a question and answer session. (Operator instructions).

I am pleased to introduce your host Mr.T. Kendall Hunt, Founder, Chairman and CEO. Sir, please go ahead, Sir.

Kendall Hunt

Thank you operator. Good morning everyone. For those listening in from Europe, good afternoon; and from Asia, good evening. My name is Ken Hunt and I’m the Chairman, Founder and CEO of VASCO Data Security International, Inc. On the call with me today are Jan Valcke, our President and Chief Operating Officer, and Cliff Bown, our EVP and Chief Financial Officer.

Before we begin the conference call, I need to brief all of you on forward-looking statements. Statements made in this conference call 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 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 for the third quarter of 2008. As always, we will host a question-and-answer session after the conclusion of management’s prepared remarks. If possible, I’d like to budget one hour total for this conference call. If you can limit your questions to one or two, it would be appreciated.

We are very pleased with our third quarter results and believe that 2008 will another year of strong growth despite the challenging business and economic environment. I am very proud that Q3 was the strongest quarter in the Company’s history. Revenues were $39.7 million, an increase of 32% over third quarter of 2007, and once again a very strong quarter. It was also our 23rd consecutive positive quarter in terms of operating income and cash flow. Our gross profit for the quarter was 70% of revenue and our operating income was 29% of revenue.

During the quarter we sold an additional 365 new accounts including 62 new banks and 303 new enterprise security customers. This compares to the third quarter a year ago in which we sold 608 new accounts including 106 banks and 502 enterprise security customers. We now have approximately 1200 banks and 6800 enterprise security customers in more than 100 countries.

On a year to date basis our pace of new accounts has slowed compared to 2007. Through the first 9 months of 2008, we have sold 212 new banks and 1260 new enterprise customers for a total 1472 new accounts. This compares to 313 new banks and 1545 new enterprise customers for a total of 1858 new accounts in 2007. In spite of this lower number of new accounts, our revenue grew 32% over the comparable third quarter of 2007 and 17% over the comparables 9 months of 2007.

What have we learned from this? As Jan Valcke will explain later our expanding product portfolio allows us to target larger new accounts from before with our IDENTIKEY server we can sell to larger enterprise security customers with more users than we were able to serve a year ago. We also know that Vasco salespeople have worked closely with our existing bank and enterprise customers to help them implement strong authentication for their applications.

While helping our core business produce very good result, we believe that this has had an adverse effect on the pace of new accounts in 2008. With pour added headcount our plan is to increase on marketing programs and actions while focusing more on new accounts going forward.

Highlights for Q3 include the following, VASCO launched our new enterprise security partner program and EMEA and Latin America to maximize enterprise security opportunities. We announced that Digipass Go 7 for a strong user authentication. VASCO introduced the DigipassA10 designed specifically for the Asian markets. We published the access guard survey for July 2008.

In the US we partnered with ANCORPAYMENT SYSTEM to secure remote access with Digipass GO3 and VACMAN middleware. We announced that WhiteGold will distribute VASCO products and solutions in Australia and last we launched the Japanese version of our website.

Now let us talk about our business. As you all know banking has historically contributed a significant portion of the Company’s revenue. However Digipass authentication is also used to secure many, many other applications including eGovernment, Healthcare, education, eGaming, automotive, human resources, social security, legal accounting and insurance public transport, and many more. In fact enterprise security revenue has grown at 34% year to date versus 14% for banking.

Let us examine some of these non-banking applications. First the eGaming sector, banks to strong authentication, internet gamers’ accounts are secured from fraudsters trying to steal their gaming credits and avatars. Account hacking poses a real threat which may erode customer’s confidence in their continued subscription participation.

Lizard Entertainment with its World of Warcraft Games realized the need for a secure online gaming platform and now offers its Blizzard authenticator to protect gamers’ accounts. We believe that secure accounts will prove to be the key to the success of online gaming developers and providers alike.

Another example is the GIRTHA Institute which organized some programs and events focusing on education, the arts, society and media science and research, Headquartered in Munich, Germany they employ over 3000 people in 77 different countries. Remote employees use VASCO’s Digipass authentication to log on to the corporate network from abroad or at home via a VPN connection.

Our authentication solutions and services are also widely used in the educational sector. The University of Groningen currently secures remote access to their network with Digipass technology allowing about 20,000 students and 5500 academic employees to access the university’s network anywhere at anytime.

Now let us talk about the world’s economic turmoil. The financial crisis has been the number one topic in the global media and on everyone’s lips on Wall Street. Governments worldwide are supporting their large financial institutions to help them weather the storm. The credit market is tight and companies are having trouble finding loans to fund new business opportunities. At this moment nobody knows what the long term impact of the financial crisis will be on the global economy.

At VASCO we view this turmoil as an opportunity. First at a macro level we believe that more and more banks will place more emphasis on internet banking as it is more cost effective than opening branch offices. Second, we believe that customers will open accounts at multiple banks to maximize the protection they have under the various government guaranteed program, as an example, the Federal Deposit Insurance Corporation in the US and as a result increased demand for our products.

Finally as banks merged we will have increased opportunity in one of two ways. If our customer acquires another bank we will be able to expand the deployment of our product to the customers of the bank being acquired. If our customer is acquired we will have the opportunity to open discussions with the new bank based on its strong reference smart existing customer.

While we expect that there maybe some delays in orders as banks go through the consolidation process, we believe the overall trend will be good for our business. At this time of uncertainty it is also clear that companies were to sound balanced sheet, a large install base and important business with them and beyond their traditional markets will prevail.

We believe that VASCO is such company. The Company has no long term debt. Has a sound cash position, loyal customers and we believe a huge growth potential in banking enterprise security, e Commerce, eGovernment and in new markets such as eGaming.

As a conclusion, we believe that VASCO offers the broadest range of strong authentication solutions in the sector for every application and for any company or institution. Let me remind all of you about what we have been describing for sometime.

First VASCO strategy is full option all through end. We offer many different products in order to meet the specific requirements of our varied customer and prospect base. Second we deliver our strong authentication for use in over 100 different applications. Last we have a business model that provides a sustainable repeatable source of revenue.

Our business outlook and performance remains strong on a global scale. VASCO is a stable healthy Company with a large install base, a string balance and important growth opportunities in our existing markets and beyond.

At this time, I would like to introduce Jan Valcke, VASCO’s President and Chief Operating Officer.

Jan Valcke

Thank you, Ken.

Ladies and gentlemen, we are proud to state that VASCO is doing well despite challenging market conditions. With regards to products, our strategy as a full option all-terrain authentication Company allows to offer our best of breed authentication solutions to any segment of our customers’ user base.

Soon we expect to announce many more cutting edge products that will allows us to broaden our customer base and to become even more successful in our key markets such as banking, enterprise security eCommerce, and eGovernment.

Our recent investments in NOMHATIE products already led to a year over year growing impact of our softer revenue. We invite you all to join us at the upcoming Car Trade Show in Paris France where we will shop our newest R&D successes. The market [1216] has lately met with difficulties caused by the worldwide credit crisis. Banks merge acquire and co acquire. Many of you are asking what the consequences are for VASCO’s future growth.

Our answer is threefold. From a global perspective, we believe that fewer banks are severely touched by the financial crisis, living in regions that have been hit such as the United States or Western Europe may give us a wrong impression about the crisis.

We serve two main applications in internet banking, corporate and retail banking. In corporate banking it is possible that you will experience a slower growth because there maybe fewer new companies starting up and because some existing companies may face bankruptcy. Corporate banking is only a small part of all business. In retail banking we hear from our customers that there is an increase in electronic accounts. More people for internet banking and more people have several accounts with multiple banks because they want to spread their money in order to reduce risk. Some of our customers in the banking sector even see the number of new accounts doubled due to the financial turmoil.

Also in many countries around the globe, we anticipate that some governments are preparing rules and regulations regarding the security of internet banking. Let it be clear that VASCO is prepared to take advantage of such opportunities.

Our install base is an important asset for VASCO’s stability. VASCO existing core customers give us recurrent business due to the growth of their applications. We do not see any delay in revenue coming from our install base.

We expect that banks that have already started to deploy our products will speak of their Digipass roll out and increase their efforts to secure ore applications. Internet banking is for financial institutions are very easy cost effective way to reach their customers. Therefore we are convinced that existing customers will bring us more business.

We cannot exclude that we might have a slow down in new orders but at this time we have no indication from the market that this is the case. Overall we believe that VASCO is very well prepared to continue its growth in the banking market. We are still limited in people so we have to aim before we shoot but we can still choose our targets.

Our enterprise business is continuing to evolve positively as our eCommerce and eGovernment markets. As you know the mix of all different businesses is the key to VASCO’s success.

Looking at our EPS for this quarter we can only conclude that we are on the right track. Even during an investment year or bottom line looks very healthy. In general the global market for VASCO is looking positive. We have to be close to the action. That’s why we keep opening new offices and we hire local people in geographic markets. In enterprise security we are investing more time and effort towards the larger enterprises our IDENTIKEY authentication server and our new Digipass family are instrumental for this evolution. The consequence is that we will 1607 huge contracts with higher number of users in enterprise security. Here too we expect our growth to be continuing. At the beginning of this year we told you that VASCO will execute an intensive hiring campaign during 2008. We needed more people because our organization is reaching its limits. Simply said we didn’t have enough people to deal all opportunities in our core business. Currently most of our new recruits are trained, integrated and brought up to speed. We will continue our investments in recruiting and I will maintain all training efforts towards our existing staff. The market climate will probably make recruiting easier. VASCO is convinced that the Company is well armed for the future with the right people the right products and services, the right market strategy, and a very strong balance sheet. Thank you.

Kendall Hunt

Thank you Jan. Now I would like to introduce Cliff Brown, VASCO’s EVP and Chief Financial Officer, Cliff?

Clifford K. Bown

Thank you Ken and welcome to everyone on the call. As noted earlier by Ken revenues for the third quarter were $39.7 million, an increase of $9.7 million or 32% over the third quarter. For the first nine months, revenues were $104 million, an increase of $50.5 million or 17% over the comparable period in 2007. The increase in revenue for the third quarter and the first nine months reflected double digit increases over the prior year from both the banking and in the enterprise security markets.

Revenues from the banking market for the third quarter in first nine months of 2008 increased 37% and 14% respectively from the same period in 2007. Revenues for the third quarter and first nine months of 2008 increased 14% and 34% respectively from the enterprise security market. It should be noted that the comparison of revenues was positively impacted by the weaker U.S. dollar in 2008.

We estimate that revenues in the third quarter and first nine months of 2008 were approximately $1.8 million and $5.8 million higher respectively than they would have been had the exchange rates in 2008 been the same as in 2007. Excluding the estimated impact of currencies, revenues were approximately 26% and 11% higher for the 3^rd quarter and nine months ended September 30^th respectively than in the comparable periods of 2007. The distribution of our revenue in the third quarter of 2008 between our two primary markets was approximately 83% from banking and 17% from enterprise security. This compares to 80% from banking and 20% from enterprise security in Q3 of 2007. For the first nine months of 2008 82% of our revenue was from banking and 18% from enterprise security and compares to 84% from banking and 16% from enterprise security for the first nine months of 2007.

Our revenues continue to come predominantly from outside the United States. The geographic distribution of our revenue in the third quarter was approximately 65% from EMEA, which is Europe, Middle East and Africa, 5% from the United States, 7% from Asia Pacific and the remaining 23% from other countries. The geographic distribution of our revenue for the first nine months of 2008 was approximately 67% from EMEA, 6% from the U.S., 8% from Asia Pacific and the remaining 19% from other countries.

Gross profit as a percentage of revenue for both the third quarter and first nine months of 2008 was approximately 70%. The rate in 2008 compares favorably to the 67% and 66% reported for the third quarter and first nine months of 2007 respectively. The increase in gross profit as a percentage of revenue for 2008 compared to 2007 is primarily attributable to four factors. The first, our non-hardware revenues continue to grow as a percentage of total revenue. Second we had a favorable change in product mix of our business with card readers declining as a percentage of our total revenues. Third we benefited from the strengthening of the Euro compared to the US dollar in 2008 over 2007 and fourth on a year to date basis as previously noted. Our revenues from the enterprise security market increased as a percentage of our total sales. Our non-hardware revenues were approximately23% of total revenue for the third quarter and first nine months of 2008 and compares to 14% of total revenue for the third quarter and first nine months of 2007.

Since a majority of our purchases in the inventory are denominated in US dollars, the strengthening of the euro compared to the US dollar also contributed to the improvement in our gross margins as a percentage of revenue. We estimate that the strengthening of the euro will increase our gross margin percentage by approximately 1.4 percentage points in the quarter and 1.7 percentage points for the first nine months.

Operating expenses for the second quarter of 2008 were $16.4 million, an increase of $4.7 million or 40% from the third quarter of 2007. Operating expenses for the first nine months of 2008 were $47 million, an increase of $13.3 million, which is also 40% from the same period of 2007. Operating expenses for the third quarter and first nine months of 2008 included $811,000 and $2.3 million respectively related to stock-based incentive plans. Stock based incentive plan expenses in the third quarter and first nine months of 2007 were $564,000 and $1.5 million respectively.

It should be noted that the comparison of operating expenses in 2008 to 2007 was negatively impacted by the weaker U.S. dollar in 2008. We estimate that expenses were $1.4 million, or 9% higher for the quarter and $4.3 million or 10% higher for the first nine months than they would have been had the exchange rates in 2008 been the same as in 2007.

For the third quarter, operating expenses increased by $2.6 million or 42% in sales and marketing, $503,000 or 20% in research and development, and $1.7 million or 63% in general and administrative categories when compared to the second quarter of 2007. The majority of the increase in sales and marketing area were related to the Company’s increased investment in sales staff and the cost associated with opening sales offices in Brazil Japan and India. The increase in research and development was primarily attributable to increased compensation expenses, and the increase in general and administrative expenses primarily reflected increased headcount and related compensation expenses, professional fees, travel expenses, recruiting costs.

For the first nine months of 2008, operating expenses increased by $6.6 million or 35% in sales and marketing, $2.2 million or 33% in research and development, and $4.8 million or 66% in general and administrative when compared to the same period in 2007. The reasons for the increases in expense for the first nine months are generally the same as for the third quarter.

Operating income for the third quarter of 2008 was $11.4 million, an increase of $3.2 million or 39% from the $8.3 million reported in the third quarter of 2007. For the first nine months, operating income was $26.3 million in 2008, an increase of $1.8 million or 7% from the $24.6 million reported in 2007. Operating income as a percent of revenue or operating margin was 28.8% for the third quarter and 25.3% for the first nine months of 2008. In 2007, our operating margins were 27.5% for the quarter and 27.7% for the first nine months. The increase in operating margin in the third quarter of 2008 compared to the third quarter of 2007 reflected the leverage in our operating model as the benefits from the increased revenue and the improvement in gross profit as a percentage of revenue exceeded the increase in our operating expenses.

The decline in the operating margin for the first nine month period is attributable to our planned and previously discussed increased investment in our infrastructure that is needed to support future growth.

The Company recorded income tax expense of $1.8 million for the third quarter and $5 million for the first nine months of 2008. The effective tax rate was 16% for the third quarter and 19% for the first nine months of 2008. For 2007, the Company reported income tax expense of $2.3 million for the third quarter and $6.9 million for the first nine months. The effective tax rate reported in 2007 was 28% for both the third quarter and nine months period ended September 30. The effective tax rates for both 2008 and 2007 reflect our estimate of our full year tax rate at the end of the third quarter in each period. The reduction in the tax rate is primarily attributed to the benefits expected from our new structure related to the Company’s ownership of its intellectual property.

Earnings before interest, taxes, depreciation and amortization, EBITDA, or operating cash flow, if you will, were $11.5 million and $28.4 million for the first nine months of 2008. EBITDA was $2.7 million or 31% higher in the third quarter and $1.9 million or 7% higher than in the first nine months of 2007.

The make up of our workforce as of September 30, 2008 was 289 people worldwide with 164 persons in sales, marketing and customer support, 81 persons in research and development, and 44 persons in general and administrative. The average headcount for the third quarter of 2008 was 64 persons or 30% higher than the average headcount for the third quarter of 2007. The average headcount for the first nine months of 2008 was 58 persons or 28% higher than the average headcount for same period in 2007.

On the balance sheet, our cash and working capital balances increased during the third quarter of 2008. As of September 30, 2008, our cash balance was $50.7 million, an increase of $8.6 million or 20% from $42.1 million at June 30^th 2008 and increase of $11.9 million or 31% from 38.8 million at December 3oth of 2007. As of September 30, 2008, our working capital balance was $73.8 million, an increase of $6.9 million or 10% from $66.9 million at June 30, 2008, and an increase of $21.3 million or 41% from $52.4 million at December 31, 2007. We had no debt outstanding during the quarter.

During the quarter also, our DSO – day sales outstanding and accounts receivables decreased to 69 days as of September 30, 2008, from 83 days at June 30, 2008, and from 76 days at December 31, 2007. The decrease in DSO was primarily related to the timing of when sales were made in the quarter.

Thank you for your attention. I would now like to turn the meeting back to Ken.

T. Kendall Hunt

Thank you, Cliff.

Summing up, we are pleased with progress we saw in the business in Q3. It was consistent with our belief that our growth over 2007 results would accelerate in the second quarter of this year. With regards to the full year we are reaffirming the guidance that we communicated to you at our last earnings call. We expect our full year revenue to grow from 15% to 25% over full year 2007. Next we expect gross margins to be in the range of 60% to 68% of revenue. And lastly we expect that full year 2008 operating income would be in the range of 20 to 25% of revenue.

In his testimony to the house budget committee on Monday of this week Tim Bernanke predicted the economy is likely to be weak for several quarters and with some risk of a protracted slow down. In contrast we expect to see continued strong order flow and a promising outlook elsewhere in the world where business has not been impacted to the degree found here in the US. However with this cautious tone in mind, VASCO management feels comfortable at the mid-range of its revenue guidance.

As described in our last earnings call this guidance reflects the Company’s strategy to continue its aggressive growth by investing in its people and the infrastructure necessary for longer-term profitability. It also reflects our evolution to a more software-centric-Company with a focus on recurring revenues and in some cases the recording of deferred revenue over multiple years.

Ladies and gentlemen, thank you for your attendance today. I look forward to your participation in our next earnings conference call for Q4 and full year 2008. Operator the floor is now open for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from Robert Breza from RBC Capital Markets

Robert Breza – RBC Capital Markets

Quick question for you Ken, you mentioned that web banking was 82% of revenue. Can you help us understand the difference between, or the split in terms of corporate banking and internet banking? What percentage that was?

T. Kendall Hunt

Jan I am honored to address that question. It is a question out of our banking revenue, what percentages, approximately what percentages is corporate type banking and what is retail banking?

Jan Valcke

Okay so corporate banking are also named cash management is a small part of our business in banking. I estimate that is around 10% of our banking business.

Robert Breza – RBC Capital Markets

Cliff as you look at deferred revenue it was down quarter per quarter and what the move more towards software, I would expect deferred revenue to start to see an uptake. Can you help me understand or when will we start to see that uptake or is deferred revenue not a good indicator for the software portion of the business.

Clifford K. Bown

Well, I think deferred revenue is a good indicator for maintenance as it relates to the business not necessarily software. Depending on how the transaction is bundled, if it is hardware-software-maintenance and other items, we have to un-bundle it using the accounting standards for the SOE. So if we have the SOE for all of the undelivered elements, we will recognize software currently. So, the only piece in that bundle would be maintenance. If however we do not have the SOE, the entire transaction would be deferred. Now as you look at this quarter Rob I think you have to continue to consider the impacts of currency because when we report, all of the balance sheet items are reflecting the currency rate as of the end of the quarter. So if you look at the currency rate at the end of June versus September, euros to dollars, and the dollar strengthened about 9% compared to the euro. A lot of those deferred revenues are going to be in euros. So naturally as a result of the strengthening currency you are going to see a smaller deferred revenue balance. So when I looked at it the overall deferred revenue has declined 11%. The euro declined about 9% versus the dollar. Those are quite comparable and to me the remaining balance then reflects the fact that we have slightly more amortization than we had additions during the quarter.

Robert Breza – RBC Capital Markets

That is helpful, Ken maybe one last question. If you look at the environment and you even talked about Bernanke’s comments you guys are aggressively hiring headcount. This reminds what we saw back in 2001-2002 where we came out of 9-11 Q3 was okay, Q4 was okay and Q1 we saw the brakes just gets stepped on as it relates to spending. How quickly given you guys are ramping up your business adding expenses. How quickly can you shut that down to protect earnings and protect margins?

T. Kendall Hunt

Yes that’s a good question and obviously that’s a question that we asked ourselves. We feel that we’re still a small business and we can react pretty quickly to evolving results. We are not too concerned about that but we do question ourselves. We have discussions about that frequently and it is something that we’re watching.

Robert Breza – RBC Capital Markets

So I guess asking you in a slightly different way-Is your organization flexible enough react to the global slow down?

T. Kendall Hunt

Yes I tried to answer that, yes we are.

Operator

Our next question is from Fred Ziegel from Soleil Securities

Frederick Ziegel – Soleil Mackinak Securities

Ken or maybe Jan, in the past and I am sure it is still true you’ve always talked about either install base of banks or the small degree to which you penetrated those accounts. What’s your guess as to where you stand on that, how much business in your banking vertical is coming from current customers as opposed to new?

T. Kendall Hunt

I don’t know that we have precise numbers on that Fred. You saw that in spite of the fact that our new accounts in banks and enterprise customers were down, we still had a very strong third quarter. That basically came from our core business and that came from our sales people addressing customers that we have signed on. Jan, in his comments, described that some of our new accounts are bigger that they have been in the past, so that has produced more revenue. We have also worked with the existing customers to generate more revenues. I personally think that ’07, in terms of new accounts was a spike, maybe tied to the FDIC guidance. In fact we were up approximately over a thousand new accounts over 2006 and 2008 is tracking a little above 2006 in terms of number of new accounts. So I think that we’ve always generated the majority of our business from our existing accounts and I think it was probably a little higher proportionately in the third quarter. We are going to renew our efforts going forward. We signed up more new accounts. We have hired more people, as Jan said, we have trained these people and they are new ready to produce so we’re going to renew our efforts in growing the new account business.

Frederick Ziegel – Soleil Mackinak Securities

I take from your guidance comments that you are continuing to see pretty good order flow this quarter?

T. Kendall Hunt

Yes

Frederick Ziegel – Soleil Mackinak Securities

A question for Jan, you mentioned that there could be some potential additional regulatory legislation to drive stronger on occasion. What parts of the world might that be?

Jan Valcke

That’s a very good question but that’s also very tough to answer because some of that information is still for computational reason. I would like not to address that too much but it is in all regions of the world.

Frederick Ziegel – Soleil Mackinak Securities

So we should expect perhaps to see some legislation in place somewhere in 2009?

Jan Valcke

I think it will be a continuing process that will be done in a lot of regions and countries.

Frederick Ziegel – Soleil Mackinak Securities

Ken last question, you mentioned in terms of bank consolidation, that you got opportunities that your customers are to acquire orders or, I guess an up-sell if they are being acquired and I lose track of all these guys and the Sovereign acquired, Wachovia is being acquired, who at this point is going the other way? Who are your bigger customers are in the acquiring range side?

T. Kendall Hunt

Jan, you know offhand any larger banks that have been re-acquirers?

Jan Valcke

Yes I need to think a little bit, I think in the UK Lloyd’s has acquired a lot of UK banks, there have been a lot of acquisitions done by bigger banks, by smaller banks, but I don’t have the most recent information. And it is a continuing process going on also.

T. Kendall Hunt

And Fred we want to make sure we’re not naming banks that aren’t customers, so I think you just need to make your own observations in the market.

Our next question is from Daniel Ives from FBR, please proceed.

Daniel Ives – Friedman, Billing, Ramsey & Co.

Hey guys two questions. First can you talk about backlog [3921] going through the quarter and comparing to a quarter ago so going into the fourth quarter, Do you see comfort level? Do you based on order info as you go into the third quarter?

T. Kendall Hunt

As of today we have a strong backlog. The definition of backlog is what we have already shipped and invoiced as of yesterday in the quarter plus what we have already shipped and invoiced through the rest of the quarter. So I will not comment on that relative strength to third quarter or to any other quarter other than to say it is a strong backlog.

Daniel Ives – Friedman, Billing, Ramsey & Co.

What was cash flow from ops in the quarter?

T. Kendall Hunt

We don’t publish cash flow from ops. We’ve got EBITDA which we talked to in terms of numbers Daniel. EBITDA for the quarter was $11.5 million so that is earnings before taxes, depreciation and amortization. The true cash flow from ops will be part of 10-Quarter filing.

Operator

Our next question is from Joe Maxa from Dougherty & Company.

Joe Maxa from Dougherty & Company, LLC

Ken I was just wondering if you saw any push-outs or delays in the quarter with the new banks that [Cross Talking]

T. Kendall Hunt

Jan, did we have any push out or delays?

Jan Valcke

Nope, not that I am aware of it.

Joe Maxa from Dougherty & Company, LLC

I am just looking again at your new banking customers, 62 and certainly been down from the last couple of quarters and last year. At some point your growth in 2009 or 2010 has to rely on your growing customers, I know your addressing that by adding headcounts and what not, have you been able to take up any correlation with the banks and maybe the size of the banks or roll-outs that should give us more confidence in the growth number for next year.

T. Kendall Hunt

Jan can you answer that question?

Jan Valcke

Can you maybe repeat? I did not hear your question?

Joe Maxa from Dougherty & Company, LLC

I am just concerned more of the number of banks, new bank wins declined and I am coming up with an expectation for growth next year and if you are…

Jan Valcke

First let me say we are working. We work with a very straightforward business plan where there’s a clean inventories and in those companies the screening the markets that we are working at. Basically it is corporate banking, retail banking, enterprise security, network security, and application security or eCommerce. We will be screening all those markets. Due to the trends that we see in the markets we invest our marketing money in regions and markets that we believe are profitable for VASCO so as an example and again if you read the newspapers in Western Europe and in the United States you should believe that this banking crisis is way worldwide. It is true that it is a worldwide crisis but on the other hand there are still a lot of reasons that we are not touched by the banking crisis. That is the first [4255] It is normal that we will put or press fresh harder on the buttons in those countries. The second thing is anyway we are limited to the number of people so we don’t have enough people to work in detail or in debt and the whole wide market so we need to make the choices and I believe what we’ve shown in the past that we know very well how we push on the right buttons. So, 2008 was and is a stabilization year for us so we needed to hire a lot of people, integrate them and let us say, those new people in sales, and marketing are still not 1% operational. So we believe that we will in next year increase a lot of marketing efforts again in those regions where we believe that we will have a direct profit. Now I cannot give numbers of new banks that we are going to acquire, we have a fair idea of that [4405]

Joe Maxa from Dougherty & Company, LLC

I guess Ken maybe just on the rollout of your banks which typically you are still seeing a 3 year or 4 year rollout or is that shortened?

T. Kendall Hunt

I think it has been shortened, Jan made that comment that he feels that his view with the market worldwide that the banks are probably accelerating those rollouts to try to reduce their cost later and to try the secure and retain their business and retail clients so instead of 2 to 4 years maybe it is 2 to 3 years but don’t forget that even though we signed 1200 banks as clients we still have of opportunities ahead. I am not sure exactly what the total number of banks is in the world because there has been some consolidation but that is probably north to 40,000 banks in the world. We have signed up as customers about 1200 and also don’t forget just signing up the bank doesn’t mean we only do one roll out with them forever. We have some clients that are in their fourth generation of VASCO Product. So it is a long, long standing relationship that we have established with the bank once we signed them up and began the initial rollout. It goes on and on.

Our next question is from Andrew Abrams of Avian Securities

Andrew Abrams – Avian Securities

Hi guys, I just wanted to follow up if I could. There are a couple of projects that you talked about last quarter that missed the end of the quarter and would have rolled into this quarter. Is there any way you can quantify both? Did they all actually happen in the quarter and to some degree give us an idea of what percentage of the revenues they might have looked like to quarter.

T. Kendall Hunt

First I guess we actually did roll into the Q3 and no we probably can’t give you a percentage because that is really part of the normal business. We are very focused on revenue recognition and when we can take the revenue for reporting purposes. The bad happens every quarter end. So at the end of this quarter we all saw some deals that got pushed into Q4 and so rather than talk exactly what the orders were and what just missed cut-off of revenue recognition one quarter that rolled into the other I think that after all we consider that part of our normal operations.

Andrew Abrams – Avian Securities

Got you and when your full year guidance, you comment at the midrange of that guidance. Where does that come from? Does that come from you and your conservative nature in terms of the business? Does it come from your lead of what your clients are telling you? Does it come from your read of what not what your clients are telling you but what you think what they\re actually going to be doing? Maybe if you could give some color there?

T. Kendall Hunt

Yes well objectively the best way for us to measure our business is the metrics that we always use to measure the business and that is what is our backlog going into the quarter, what’s our weighted forecast in that quarter, and what can we expect to generate through our reseller channel that gives us turns business. In other words they give us an order we turn the order around. We ship it and we take the revenue in that quarter and so without reading the newspapers without listening to the radio and watching TV our business is very strong. We said that before and I said it a few minutes ago but there are all kinds of dynamics and there are emotions going on in the world. We can’t control those things so we’re trying to be conscious and conservative in terms of guiding the market.

Andrew Abrams – Avian Securities

Just last on new products. How far a field are we going on new products I am just trying to get a handle on where you guys are looking over the next 6 to 12 months in terms of are these token oriented specialty products or are we talking about additional software layers, additional software applications. Can you give us a little color there?

T. Kendall Hunt

Yes we’re not the kind of Company that goes too far a field from our basic product strategy. We do have the good fortune that we have some very large customers that is the banks that tell us the kind of products they want us to provide to them. They like the fact that VASCO has a variety of product and solutions so we regularly talk to those banks and they tell us the kinds of products that they are interested in buying from us and we’ve talked about this a lot. Once we know a product a demand a product we do a make versus buy. We have always kept in touch with our small companies around the world that have been funded locally in their country. They assemble an R&D team. They produce the product. They sell it in the local market and they ran out of gas and so we go to them and say “Well your product is very interesting we would like to buy your company. If we come up with a reasonable price we buy the company if not we build the product ourselves. So you won’t find us out trying to make markets happen by inventing a new wiz bank product. We try to follow the lead of our customers. We hang back a little bit. The latest product that we’ve announced and Jan you might tell them about the two products we announced a couple of days ago, I think that was an example of what I’ve just said, an indication through RFPs through conversations in developing these new products. Jan, why don’t you describe in just a couple of sentences the latest product announcement?

Jan Valcke

We are confirming, of course our full option strategy here where we are putting all authentication technologies on one unique platform that is called VACMAN Controller. VACMAN Controller is basically a very large SDK and we have also IDENTIKEY and later on we will do announcements with our access card product line. We are accompanying our software strategy where the hardware and add on to the software. Now what has been announced lately is that we have launched a PKI middleware it is called certiID, A PKI middleware is software that is placed on the PC, the computer of the user. What is very typical for VASCO is that you will all see in all product lines that we are producing that this software also agnostic to all kinds of operating systems that is coming from Smartcard Technology. This software, based again on the client PC is completely compatible with the whole range of USB devices which Smartcard devices which is connected to readers and so on and we believe that again, confirming our strategy that we go very much beyond. It is also for the banking but then again, a hair beyond banking business and that this products can also be used in eGovernment and eScurity aookication and that you will see more and more coming. Autovolt software Company more and more products that are in fact designed in the first place for the banking industry but at the same time can be deployed in eGoverment, eSecurity, eCommerce applications.

Andrew Abrams – Avian Securities

Thank you and congratulations on the quarter.

Your next question is from Scott Zeller of Needham & Company, please proceed

Scott Zeller - Needham & Company

Thanks two questions could you tell us the percentage of revenue from your core, largest customers near the top ten customers.

T. Kendall Hunt

On a year to date we don’t have any customers that are more than 10% of our revenues. For the quarter we had two customers that were more than 10% but not by a significant percentage. So we’ve been consistent with our past factors. We will identify the customers that would be 10% on afull year basis for the K but they are just for the quarter we wouldn’t identify by name because with the flow of our orders and given the size of the Company that we are, it is very easy for a customer to have a very large deployment that if it is in quarter, it doesn’t carry forward into the other. So we think that the full year look is the more appropriate way to do the business.

Scott Zeller - Needham & Company

Fair enough, that was helpful but I was interested in more was the argument that you have a core group of very large banks that wind up being repeat long term customers and I am wondering if you could give us some color whether that is not actually true and if so what does that group of your largest customer represent typically revenues. Even just color will be helpful.

T. Kendall Hunt

I won’t have any specific numbers for you but suffice it to say that when I look at the list of top ten customers and we do that analysis every quarter probably six to eight of the names in any given quarter are the names that we’ve seen in that list before. When we roll up the annual data it is similar. It is probably six or seven of the top ten or customers that have been there year before or year before that. The sustainable, repeatable source of revenue that can Ken talks to is very evident in that list of top ten.

Scott Zeller - Needham & Company

And then the follow on would be with the mix shift continuing towards non hardware. Why would we not see gross margins actually higher than where they are right now? If the mix is more favorable towards I guess what [Inaudible] off for revenue.

T. Kendall Hunt

It goes to what’s happening with the rest of the business. There are competitive pressures on the card reader segment, for example and card readers are still a very significant part of our business but as you know the card readers are largely and Europe and largely related to the Europe Mastercard scenario. So we have a number of competitors in the European market that have very low end, low feature readers that compete against us for that kind of business. It still raw margin gets into that combination. The more we have business in security the more we have in non hardware revenue the better the margins, but then again to the extent that we still have 77% of our revenues that are hardware based. Those are going to be under constant pressure from competitive pricing pressure on the top line and we’ve seen some pressure on the cost of those items as well especially hen oil prices were higher the manufacturing sector was looking for higher prices on their production so those margins on the hardware can get squeezed from both direction.

Scott Zeller - Needham & Company

If that’s the case would you, without giving official guidance, but would you say that we should expect a net flattish gross margin in the future because the trends will continue as you say.

T. Kendall Hunt

It has to be written but at least in terms of our strategies that is consistent with some of our general thinking. The more we can go to the software, the more it will help us offset any negative impact on the hardware side.

Scott Zeller - Needham & Company

Basically net each other out. Thank you very much.

]

Your next question is from Nick Andrewes of Lazard Capital Markets, please proceed.

Nick Andrewes - Lazard Capital Markets

Good morning guys I guess good evening as well. In the past you guys have talked about the organic growth from existing bank customers have been basically 15% to 20% per year. Can we get an update on, I am just thinking of those numbers, what is [Inaudible] with what’s going out on the market right now?

T. Kendall Hunt

Nick what percentages did you used?

Nick Andrewes - Lazard Capital Markets

I think you guys have said, talked about 15% and 20% customer growth from existing banking customer on a year on year basis. You talked about it at the last [58:01]

T. Kendall Hunt

Jan I think that is rate percentage that you’ve talked to potentially in the past?

Nick Andrewes - Lazard Capital Markets

What percentage is it? It is the percentage that we should expect this from our customer base because of replacement of existing [Inaudible].

Jan Valcke

Let us say there are a couple of organic growth in the existing customer base and if I talk existing customer base I mean here banks. So basically in the retail banking what do we see, we see first of all that due to difficult things that are happening in the business, lost of digi-passes, the lost machines, broken digi-passes by the fault of the user and also acquisition of new customers, that is a percentage after the roll-out of all the electronic accounts. There is a percentage that gives us organic growth. So what Ken said a couple of minutes ago, a typical deployment today is 2 or 3 years but after that deployment we can expect a percentage of growth that by recent suggestion told you. Second thing I also mentioned in my expose that the banks today or some of our customers anyway are opening more electronic accounts due to the risk because the consumer has not seen what risks there is to stay with one bank so most consumers are opening more electronic banking accounts in different banks to spread out that risk.

Nick Andrewes - Lazard Capital Markets

So that 15% to 20% numbers are still valid?

Jan Valcke

Yes

Nick Andrewes - Lazard Capital Markets

Okay great just to follow up on the gross margin question. Are you seeing anything specific in Q4 in the back end of Q4 that we believe that the gross margin in Q4 is going to be essentially different from the first three quarters?

T. Kendall Hunt

When I have done my analysis of the numbers, we keep coming back to the annual values. I think there is potential for there to be a heavier portion of lower end products in Q4 so our guidance for gross margins is actually below our year to date actual, actuals or about 70% of our guidance is in that 60% to 68% range. We‘ve allowed for that in our guidance but I think the most important number in our guidance other than the revenue is the operating margin. How much of the gross margin falls through the operating income.

Nick Andrewes - Lazard Capital Markets

Okay, thanks and when you look past 2008 and 2009, is 2009 going to be, are you going to see some operating margin expansion. Hopefully a lot of the headcounts increases this year?

T. Kendall Hunt

We are not really ready to talk about 2009 Nick at this point. We’ll address those but potentially our guidance in February according to our past practice.

Operator we have time for one more question.

Your last question comes from Brian Freed of Morgan, Keegan & Company, Inc

Brian Freed - Morgan, Keegan & Company

Hi thanks for putting me to the wire, real quick, can you comment a little bit on the linearity of the quarter and how that may have impact or altered your current impact and secondly given the recent move in currency can you give a little more granularity on how you see currently impacting the current quarter?

T. Kendall Hunt

I guess on a couple of fronts, the linearity as evidenced by our DSO more heavily weighted toward the first part of the quarter than it was the last part of the quarter. When we talk about DSO and we talked about a factor of 83 at the end of last quarter and 69 days at the end of this quarter really talks to the linearity. In terms of the exchange rate, the exchange rate today, the number of dollars that it takes to buy a euro is about 1.34 and the average rate in the current quarter or toward the fourth quarter of last year was about 1.44 so we actually expect currency to have a negative impact in Q4 if the rates stay as the way they are. As I look at rates last year’s rate versus this year as the year progressed last year the rates increased pretty much throughout the year. They peaked in the middle of this year and they’ve headed down so through the first three quarters rates this year US to dollars were stronger than they were in last year but in Q4 I see it sort of crossing. Where Q4 of last year was stronger than what they were at Q3 of this year. Since our revenue that’s denominated in euro another currency exceeds our operating expenses in those currencies, we would expect that currency would have slight negative impact in Q4 of ’08 versus Q4 ’07. Now all of that said please recognize that the impact on revenue versus operating expenses has been relatively small throughout the year. In this quarter it is about a $400,000 benefit year to date it is about $1.5 million benefit. So I don’t think the impact of currency in Q4 is going to be material but I do expect it to go the other direction.

Brian Freed - Morgan, Keegan & Company

Okay thanks

T. Kendall Hunt

Alright operator, that’s all the questions we have time for. Everyone I just want all of you to know that VASCO’s management, VASCO’s people and staff around the world are focused on one thing, not reading the newspaper, not watching the TV, we are focused on one thing and that’s execution and you can rely on us executing. At this time I would like to say goodbye to everybody. Thanks for participating in the call and as always thanks to the great people, the VASCO people around the world for doing all your hard work and I am very, very proud of all of you. Thanks everybody.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation and ask you to disconnect your lines.

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