VASCO Data Security International Inc. Q2 2009 Earnings Call Transcript

Jul.23.09 | About: VASCO Data (VDSI)

VASCO Data Security International Inc. (NASDAQ:VDSI)

Q2 2009 Earnings Call

July 23, 2009 10:00 am ET

Executives

T. Kendall "Ken" Hunt – Chairman and Chief Executive Officer

Jan Valcke – President and Chief Operating Officer

Clifford K. Bown – Executive Vice President and Chief Financial Officer

Analysts

Brian Freed – Morgan, Keegan & Company

Daniel Ives – Friedman Billings Ramsey

Fred Zeigel – Mackinac Research

Operator

Ladies and gentlemen, thank you for standing by and welcome to the VASCO Data Security International, Inc. second quarter earnings conference call. (Operator Instructions). I would now like to turn the conference over to T. Kendall Hunt, Chairman, Founder and CEO. Please go ahead sir.

T. Kendall "Ken" Hunt

Good morning everyone, for those listening in from Europe, good afternoon, and from Asia, good evening. My name is Ken Hunt. I'm the Chairman, Founder and CEO of VASCO Data Security International, Inc. On the call 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 of the second quarter of 2009. 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.

Despite today's challenging economic climate, VASCO is pleased to report that the first two quarters of 2009 were profitable quarters. Revenues for Q2 were $24.5 million, a decrease of 31% compared to second quarter 2008 and up approximately 6% over Q1 2009.

Q2 2009 was our 26th consecutive positive quarter in terms of operating income. Our gross profit for the quarter was 68% of revenue and our operating income was approximately 6% of revenue. During the quarter, we sold an additional 350 new accounts including 44 new banks and 306 new enterprise security customers.

This compares to the second quarter a year ago in which we sold 560 new accounts including 79 banks and 437 enterprise security customers. We now have approximately 9,000 customers, including almost 1,300 banks in more than 100 countries.

Although management considers the number of new customers as an indicator of the momentum of our business and effectiveness of our distribution channel, the number of new customers is not indicative of future revenue.

Our revenue for Q2 was up only slightly when compared to Q1 2009. This compares to past second quarters that were historically much stronger than the first quarter. We expect the third quarter, which has historically been weaker than the second quarter, to continue to be challenged by the economic headwinds we've been experiencing over the last three quarters.

However, we are very encouraged by an increase in RFPs, requests for proposals, and an improvement in our weighted forecast, both signs that the financial crisis is bottoming out and that VASCO's business model is holding up in these difficult times.

As you know, we began to diversity our business model approximately six years ago. VASCO has diversified its business on several levels, its technology, its targeted vertical markets, its targeted geographic markets and its customer concentration.

In the technology field, VASCO has invested in software, PKI or public key infrastructure and services. These technologies are now part of our market offerings and are creating significant revenues. In 2002, we decided to increase our investment in businesses outside of the banking market.

In order to diversity our business we increased our focus on selling through the reseller channel in order to bolster our enterprise and application security business. We have been successful with this strategy, and in 2008, we reported $24 million in revenue for enterprise and application security compared to only $3.2 million in revenue for 2002. This $24 million actually exceeded all of our revenue for 2003.

We have also diversified geographically. Our global reach is another strong point for VASCO. We have a worldwide presence and customers in over 100 countries. Regions such as Southeast Asia, Latin America and the BRIC countries in general have grown significantly in importance for VASCO.

VASCO's recognized as a market leader in those countries. This was illustrated by strong attendance at recent VASCO marketing event, including the Banking Summit in Beijing, China and the CIAB, Brazilian Federation of Banks Conference in Sao Paulo, Brazil.

Last, our customer concentration has improved. In 2002, our top ten customers accounted for 67% of our revenue. In 2008, our top ten customers accounted for 44% of our revenue. In 2003 we had two 10% customers. We have had no 10% customers since 2006. This means that today our business has a much broader customer base and is less exposed to the decisions of a concentrated customer group.

I'm very pleased to report that Q2 produced a positive cash flow of over $10 million. This positive cash flow and our cash balance of over $67 million give us the flexibility to manage our business intelligently and to look for investments in growth opportunities.

Other companies not so fortunate may be limited in their ability to invest in their business for long-term growth. We hope to take advantage of this edge. In fact, although we will continue to maintain our general cost containment programs due to challenging market conditions, we've already began the process of adding additional sales staff where opportunities for growth are promising.

In times of crisis companies often attempt to focus on the short term while forgetting the long term. At VASCO we are determined to focus on both our short and long-term success. With our strong fundamentals including a healthy cash position, no debt and 26 consecutive profitable quarters, we are better equipped than many to weather this economic storm.

We are convinced that VASCO will be a stronger company than before the crisis began once the banking market recovers. The evolution of our non-banking business, our multilevel diversification and our strong fundamentals are all strong indicators to support this view.

In conclusion, I'd like to congratulate VASCO's employees for their outstanding work. Our people are professional, hard-working, focused and dedicated. The ingredients of a winning team are a good organization, good coaching, professionalism, know-how and the right spirit. I am convinced that VASCO has that winning team.

At this time I'd like to introduce Jan Valcke, VASCO's President and Chief Operating Officer. Jan?

Jan Valcke

Thank you, Ken. Ladies and gentlemen no company is immune to the current global recession. Nevertheless, the second quarter of 2009 was VASCO's second profitable quarter this year. Due to VASCO's focus, business mix and execution the company has been able to stay successful in today's challenging business climate.

In the first quarter '09 earnings call we identified some important business trends. These trends are still valid today. First, our existing banking customers are reducing and carefully managing their inventory of DIGIPASS authentication products.

Due to the effect of the financial crisis, they are ordering new products in a conservative way with more but smaller orders as a result. As a consequence we are getting a reduced volume from our banking business. Nevertheless, as Ken already mentioned, we are seeing an increased demand for our products in new projects and an increase in RFPs.

Second our non-banking business has not been affected as much by the economic situation. Revenue from enterprise and application security is fast growing. So what does that mean now for our business mix? The proportion of enterprise and application security is growing and it's offsetting somewhat the banking sector's lower volume. The revenue from enterprise and application security also produces higher gross margins and is contributing to VASCO's profitability.

The fact that VASCO is free of debt and has a healthy cash position allows us to maintain our focus and gives us the opportunity to keep investing in the development of our enterprise and application security markets and the maintenance of our banking markets. We need to keep investing in the banking markets. During the second quarter, we organized or participated in several banking events, such as the Trade Show CIAB in Brazil and our banking summit in Beijing, China.

In the technological area we are building on the strong foundations we developed last year. VASCO is further strengthening its offerings in software, PTI and services area. For new technology VASCO has a make or buy strategy in place. Once we are convinced that the new technology is required by our customers, we try to locate and buy a small company that already has the technology. We call this a technology tuck-in. If we are not able to find such a company we make the products ourselves.

As a conclusion I can say that VASCO is well armed not only to overcome the recession but to come out stronger once the economy picks up again. I repeat, our non-banking business is growing quickly. We believe that our banking revenue has temporarily decreased due to the world's economic situation and specific challenges in the financial sector. We believe that VASCO will be a stronger company than before once the crisis in banking has bottomed out. The maturity of our nonbanking markets and the future growth of our reseller channel will contribute to that evolution. Thank you.

T. Kendall "Ken" Hunt

Thank you, Jan. At this time I'd like to introduce Cliff Bown, VASCO's EVP and Chief Financial Officer. Cliff?

Clifford K. Bown

Thanks, Ken, and welcome to everyone on the call. As noted earlier by Ken, revenues for the second quarter of 2009 were $24.5 million, a decrease of $10.9 million or 31% from the second quarter of 2008. For the first six months, revenues were $47.6 million, a decrease of $16.7 million or 26% from the comparable period in 2008.

The decrease in revenue for the second quarter and first six months reflected significant declines in revenues from the banking market partially offset by increases in revenues from the enterprise security market. Revenues from the banking market decreased 43% and 35% for the second quarter and first six months of 2009 respectively when compared to the same periods in 2008.

Revenues from the enterprise security market increased 28% and 15% for the second quarter and first six months of 2009, respectively, again when compared to the same periods of 2008. It should be noted that the comparison of revenues was negatively impacted by the stronger U. S. dollar in 2009. We estimate that the revenues in the second quarter and first six months of 2009 were approximately $1.8 million and $3.7 million lower respectively than they would have been had the exchange rates in 2009 been the same as in 2008.

The percentage of revenue coming from the enterprise security market has increased substantially in 2009 when compared to 2008. The distribution of our revenue in the second quarter of 2009 between our two primary markets was approximately 68% from banking and 32% from enterprise security. This compares to 83% from banking and 17% from enterprise security in 2008.

For the first six months of 2009, 71% of our revenues was from banking and 29% was from enterprise security, and this compares to 82% from banking and 18% from enterprise security for the first six months of 2008.

Our revenues continue to come predominantly from outside the United States. The geographic distribution of our revenue in the second quarter was approximately 70% from Europe, 6% from the United States, 9% from Asia and the remaining 15% from other countries. The geographic distribution of our revenue for the first six months of 2008 was approximately 71% from Europe, 5% from the United States, 11% from Asia and the remaining 13% from other countries.

Gross profit as a percentage of revenue for the second quarter and first six months of 2009 was approximately 68% and 70%, respectively. 2008 gross profit as a percentage of revenue was 72% in the second quarter and 71% for the six months ended June 30.

The decrease in gross profit as a percentage of revenue for 2009 as compared to 2008 primarily reflects in non-hardware revenue as a percentage of total revenue, an unfavorable change in the mix of products sold and the impact of currency, partially offset by the benefit of our enterprise security revenues increasing as a percentage of our total revenues. Our non-hardware revenues were 24% and 22% of total revenue for the quarter and first six months of 2009 and compares to 25% and 23% of total revenue for the quarter and first six months of 2008.

The mix of the product sold in the second quarter and the first six months of 2009 reflected an increase in card readers sold as a percentage of total revenue when compared to the same periods in 2008. Revenues from card readers were 22% and 18% of our revenue for the second quarter and first six months 2009 respectively compared to 20% and 17% for the comparable periods in 2008. As noted on previous calls, our card reader product line has lower margins due to competitive pricing pressures.

In addition, the strengthening of the euro compared to the U.S. dollar also contributed to the decline in gross margins as a percentage of revenue. We estimate that the strengthening of the U.S. dollar versus the Euro decreased the gross margin percentage by approximately 2.2 percentage points for the second quarter and first six months of 2009, compared to the comparable periods in 2008.

Operating expenses for the second quarter of 2009 were $15.4 million, a decrease of $1 million or 6% from the second quarter of 2008. And operating expenses for the first six months of 2009 were $27.3 million, a decrease of $3.2 million or 11% for the same period in 2008. Operating expenses for the second quarter of 2009 included $427,000 of expenses related to stock-based incentive plans.

For the first six months of 2009 operating expenses included a benefit of $1.3 million related to stock-based incentive plans. As noted in the first quarter conference call, we reversed approximately $2 million of accruals that had been established in prior years for long-term, incentive-based compensation plans where it was no longer likely that the performance targets would be met.

Stock-based incentive plan expenses in the second quarter and first six months of 2008 were $803,000 and $1.473 million respectively. It should also be noted that the comparison of operating expenses in 2009 to 2008 was positively impacted by the stronger U.S. dollar in 2009. We estimate that expenses were $1.9 million and $3.3 million lower for the second quarter and first six months, respectively, than they would have been had the exchange rates in 2009 been the same as in 2008.

For the second quarter, including the benefit of currency, operating expenses decreased by $1 million or 11% in sales and marketing, increased by $51,000 or 2% in research and development and decreased by $30,000 or 1% in general and administrative when compared to the second quarter in 2008. The decrease in the sales and marketing expense primarily reflected the benefit of the change in exchange rates partially offset by our increased investment in sales staff and costs associated with opening sales offices in Brazil, India and Japan.

The increase in research and development expense primarily reflected our increased investment in R&D staff partially offset by the benefit of the change in exchange rates, and the decrease in general and administrative expense primarily reflected lower recruiting expenses, lower provisions for uncollectible accounts receivable and the benefit of the change in exchange rates partially offset by our increased investment in staff.

As a result of our investment in new staff throughout 2008 our average headcount in the second quarter of 2009 was 16 persons or 11% higher in sales, marketing and operation staff, 19 persons or 25% higher in R&D staff and 11 persons or 30% higher in general and administrative staff. For the first six months of 2009 operating expenses decreased by $1.6 million or 10% in sales and marketing, $195,000 or 3% in research and development and $1.2 million or 15% in general and administrative when compared to the same period in 2008.

In addition to the reasons noted for the changes in the second quarter, the decrease in expense for the first six months reflected the benefit from the reduction in stock-based incentive plan compensation expenses noted previously. Our average headcount for the first six months of 2009 was 23 persons or 16% higher in sales and marketing and operations staff, 14 persons or 18% higher in R&D staff and 12 persons or 34% higher in general and administrative staff.

Operating income for the second quarter of 2009 was $1.4 million, a decrease of $7.7 million or 85% from the $9 million reported for the second quarter of 2008. For the first six months operating income was $6.1 million in 2009, a decrease of $8.8 million or 59% from the $14.9 million recorded in 2008. Operating income as a percent of revenue or operating margins was 5.5% for the second quarter and 12.8% for the first six months of 2009.

In 2008, our operating margins were 25.5% for the quarter and 23.1% for the first six months. While we have benefited from our cost containment actions, the decrease in operating margin reflects the fact that we have continued to maintain the investments we made in our infrastructure in 2008 that will be needed to support future growth.

The company reported income tax expense of $680,000 for the second quarter and $1.8 million for the first six months of 2009. The effective tax rate was 25% for both the second quarter and first six months of 2009. For 2008 the company reported income tax expense of $1.8 million for the second quarter and $3.3 million the first six months.

The effective tax rate reported in 2008 was 20% for the second quarter and 21% for the first six months of 2008. The effective tax rates for both 2009 and 2008 reflect our estimate of our full year tax rate at the end of the second quarter in each period. The increase in the tax rate is primarily attributable to a reduction in pre-tax profits. Under our current structure our effective tax rate will be very sensitive to the level of pre-tax income. As pre-tax income increases we expect the effective tax rate to decline. As pre-tax income decreases the effective tax rate will increase.

Earnings before interest, taxes, depreciation, amortization, EBITDA or operating cash flow if you will was $3.2 million for the second quarter and $8.5 million for the first six months of 2009. EBITDA was $6.7 million or 67% lower in the second quarter and $8.4 million or 50% lower than in the first six months of 2008.

The makeup of our workforce as of June 30, 2009 was 298 people worldwide with 156 in sales, marketing and customer support, 95 in research and development and 47 in general and administrative. The average headcount for the second quarter of 2009 was 45 persons, 17% higher than the average headcount for the second quarter of 2008. The average headcount for the first six months of 2009 was 49 persons or 19% higher than the average headcount for the same period in 2008.

We continued to maintain strong net cash and working capital balances during the second quarter of 2009. As of June 30, 2009 our net cash balance, which is defined as total cash less bank borrowings, was $67.6 million, an increase of $10.3 million or 18% from $57.3 million at March 31, 2009, and an increase of $9.9 million or 17% from $57.7 million at December 31, 2008.

As of June 30, 2009 our working capital balance was $79.9 million, an increase of $4.7 million or 6% from $75.3 million at March 31, 2009 and an increase of $4 million or 5% from $75.9 million at December 31, 2008. We had no debt outstanding during the quarter.

During the quarter our days sales outstanding and accounts receivable decreased to 65 days as of June 30, 2009 from 84 days at March 31, 2009 and from 79 days at December 31, 2008. The decrease in days sales outstanding was primarily related to the timing of when sales were made in the quarter.

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

T. Kendall "Ken" Hunt

Thank you, Cliff. Summing up we expect to be profitable for the full year 2009 through focus and execution. We will continue to invest in our marketing activities, our people and our infrastructure while containing our costs. In light of the continued uncertainty in the market, VASCO will continue to temporarily discontinue providing annual guidance.

At this time we will open the call for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Brian Freed – Morgan Keegan.

Brian Freed – Morgan Keegan

Real quick, just a couple or three questions, first, it looks like there's a $1.2 million reversal on the quarter. Can you give us a little more detail around that and also since there's been some kind of one signs in the last couple quarters, can you give us a little more clarity on where a normalized trend line from an OpEx perspective would be excluding those items?

T. Kendall "Ken" Hunt

Cliff, would you address that please?

Clifford K. Bown

I’m not sure where you referring to the $1.2 million reversal in the quarter, Brian?

Brian Freed – Morgan, Keegan & Company

Okay, that might just be a misunderstanding on my part, but so if there wasn’t then that’s good. So current trend line is where the operating income came into this quarter then, correct?

Clifford K. Bown

Yes, if you look back across the year-to-date, we had $2 million of reversal in the first quarter of 2009. That $2 million was related to the reversal of our long-term incentive-based stock compensation where we didn’t believe that the performance targets that were set associated with those long-term incentives would be met. But there weren’t any similar reversals in the second quarter. So the second quarter should reflect a normalized operating expense base with the exception of changes in currency rates going forward.

Brian Freed – Morgan, Keegan & Company

And below the operating line is where I missed the other income line. It looks like there was kind of a one-time thing. I’m sorry, that was just kind of a mistake on my part. Can you talk a little bit about what happened in other income in the quarter?

Clifford K. Bown

Sure, what’s in other income and expense are two things. The first is the exchange gains and losses related to the changes in currency rates associated with transactions that are denominated in currencies other than the functional currency of the country in which they are located. With the strengthening of the euro in the second quarter compared to the dollar, and that’s not relative to the same period last year; that’s relative to the rate at the end of March 31st, 2009. With the strengthening of the euro versus the dollar, we ended up with exchange gains in this quarter.

If you look back at the first quarter when the euro was weaker, we had exchange losses in that quarter. So within the $1.2 million there’s approximately $850,000 of exchange gains in the second quarter on a year-to-date basis. In other income and expense there’s approximately $300,000 of exchange gains. Then balance that’s going in other income and expenses largely related to government grants and subsidies we get for our research activities in various countries around the world.

Brian Freed – Morgan, Keegan & Company

So what would be a more normalized rate for other income if you didn’t get the exchange impact and grants in the quarter?

Clifford K. Bown

Well, because we cannot forecast what’s going to happen with exchange rates, we generally forecast internally for no exchange gain or loss and we’ve got some programs that we try to use to balance that exposure which to date has not been effective, as evidenced by the fact that we do have the exchange gain.

But we would then forecast on a normalized basis, say, a continuing level of other income for the government grants and subsidies similar to what is there in the first and second quarters, somewhere between $250,000 and $300,000.

Brian Freed – Morgan, Keegan & Company

And then lastly, if turning to the balance sheet, you have a couple items – it looks like inventories increased pretty significantly and accounts receivable also were relatively high relative to history. Can you talk a little bit about linearity on those receivables and also inventory trend?

Clifford K. Bown

Well, the inventory compared to December 31 and 3/31 should be trending down slightly. Toward the end of 2008, we were notified by our semiconductor processor manufacturer Samsung, that some of our core processors were going to be phased out over the coming year. So we increased our inventory of those processors to allow us more flexibility in our production runs going forward. So that was the reason for the increase toward the end of last year in inventory.

Since then, we’ve been working down that inventory, albeit with the lower levels of revenue, our inventory turns this year are not as high as they were a year ago. On the receivable side, our overall receivables were $24.9 million at the end of December. There are $17.4 million at the end of June. Again, that trend line is coming down as we have lower sales volume.

Our days sales that outstanding and receivables really reflects how high that ending balance is relative to the sales that were made at the quarter and our DSO at the end of this year or end of this quarter were 65 days, which is down appreciably from both March 31 and December 31. So I think both of those trend lines are coming down, but they’re more a function of what you see on the revenue line.

Brian Freed – Morgan, Keegan & Company

And lastly, just in terms of as you looked out at your various vertical, particularly on the enterprise side, we understand banking is struggling, but I know the gaming vertical’s been good for you. Are there any particular verticals that are driving the strength in enterprise as of late?

T. Kendall "Ken" Hunt

Jan, would you address that question?

Jan Valcke

Yes, thank you. Well in those verticals, we have basically two verticals. One is called the enterprise security. You could also translate it for security for the employees of a company. Basically, we have there a strategy where we have low-entry products, what we call the DIGIPASS Packs, which are excellent products for remote access security. And then we have more sophisticated, more complex products, products with high value for the network security. That is typically something that works to all of our model distributors and resellers.

Besides that, we have more and more verticals, what we call application security, that gives them security for the customers of an enterprise, and those products are used to secure the transactions, gaming being one of them, Social Security, distribution of all kinds of products. It’s in that application security that we see fast growing, and today we have over 40 – 50, sorry, over 50 verticals using them. The fastest growing is the gaming industry.

Operator

Our next question comes from Daniel Ives – FBR Capital Markets.

Daniel Ives – FBR Capital Markets

I know you don’t give an actual backlog number, but can you just speak to, anecdotally, did it improve sequentially?

T. Kendall "Ken" Hunt

No, I think that I made the comment that we’d been encouraged by a couple of things. Our weighted forecast, which is very predictive of our business that, and for the most part, those are customers, not new account prospects, but customers, that weighted forecast is improving. And also the number of new possible deals, requests for proposals; those have also increased. It’s those two things that we’re looking right now. And as far as backlog, I’d prefer not to talk about that.

Daniel Ives – FBR Capital Markets

Okay, and then just on the expense side with G&A in the quarter, just sequentially, what was the major reason that we saw suck an uptick sequential?

T. Kendall "Ken" Hunt

Well, within the G&A, Daniel, you’re talking about –

Daniel Ives – FBR Capital Markets

Yes, I mean, with that as expected, I was just –

T. Kendall "Ken" Hunt

I’m struggling here just a little bit to get the first quarter numbers in front, but what is happening is as I look at it, it’s really that reversal of the long-term incentive plans that happened in Q1. The majority of the $2 million that was reversed based on those long-term stock-based incentive plans in Q1, the majority of that would have been in G&A. In Q2, we would have had our normalized expense because we didn’t have the comparable reversal.

Daniel Ives – FBR Capital Markets

Okay, so Ken you’re still flying coach. This is not because you’re flying first class, right?

T. Kendall "Ken" Hunt

I’m still flying coach. So far this year I’ve gone to a number of east banking and enterprise summits. I’ve been to India, I’ve been to Brazil. I just got back from Beijing, China. I fly coach.

Operator

Our next question comes from Fred Zeigel – Mackinac Research.

Fred Zeigel – Mackinac Research

Let me ask a longer term question around banking and enterprise, and I guess if we key off Q2 and let’s call it 70/30 mix, and realize that banking is under duress at the moment, is it your feeling that over the long-term, two, three, four years, that even though banking will ultimately recover will continue to see a revenue shift toward the enterprise? And if that’s true what are the implications because gross margins on enterprise I think are still in the 80s versus the 50s for banking.

T. Kendall "Ken" Hunt

Fred, this has been a strategy of ours now about six years, so we determined that we were too reliant on the big banks for our revenue. We had too many top 10 customers that represented too much of our revenue, and so we had to concentrate a strategy and effort to diversify our revenue sources.

One of those was to sign up with resellers around the world and to have an easy to sell, easy to install product. We call it DIGIPASS Pack, and you can see the results of that effort and that execution. We'll continue to look for additional sources of revenue.

Gaming is one of those that 3 years ago I would have not thought was an opportunity because it really didn’t involve risk of money. It involved risk of the gamers, loss of their warrior or avatar. So yes, I think you could anticipate that as we continue to grow a larger percentage, relatively speaking, of our revenue will come from non-banking.

Fred Zeigel – Mackinac Research

The implications on gross margins would be the obvious?

T. Kendall "Ken" Hunt

We do expect it to be positive, yes.

Fred Zeigel – Mackinac Research

Okay, because if I look back over the – I guess going back to 2003, your banking versus enterprise mix was 80/20. Fourth quarter of last year it was 82/18, so it didn’t change hardly at all until we got into Q1 and Q2 of '09 and certainly some major portion of that shift was economic as opposed to a VASCO strategy, yes?

T. Kendall "Ken" Hunt

Yes.

Fred Zeigel – Mackinac Research

So we would expect some upward bias on growth margins, all other things being equal if the mix continues to shift toward enterprise.

T. Kendall "Ken" Hunt

Well, we can't guarantee it but that would be a logical conclusion I think. Also another strategy we had was to drive more non-hardware revenue, and we've done that as well. More services charging seat licenses, soft DIGIPASS, professional services, so that’s been a part of our strategy as well. We're trying to broaden our base, broaden the number of markets that we're selling to and enhance our profitability by selling higher gross margin items.

Fred Zeigel – Mackinac Research

You’ve made a big push on expanding your distribution in reseller channels for the enterprise. What are you looking at or thinking about in terms of new enterprise security technologies and products that you need to have in the bag?

T. Kendall "Ken" Hunt

That’s a good question. Jan, would you address that, please?

Jan Valcke

So the lines are a little bit bad, so the question is the new technologies?

T. Kendall "Ken" Hunt

Jan, Fred was asking since that is the enterprise and applications security markets are an ever-growing focus for us, what are we doing in terms of identifying or developing products for those markets?

Jan Valcke

Thank you. So first of all, there are some trends in the market of course when it comes to security. There are first of all the traditional applications like the banks, where a service supplier like a bank is saying that is the way we're going to do security and it's going to be for everyone the same. That is very typical in the bank. So if a bank chooses for its cash management do you use two factor authentication, then all the customers in cash management will need to do that.

There is no trend outside of banking that security becomes more and more the responsibility. That’s the first trend. The responsibility of the consumer, of the citizen, compared to a physical security. It's your responsibility to put an alarm on your house if you want it to be more secure. So basically that trend is also coming in the logical security, security with computers. That is the responsibility, again, of the consumer to secure his applications. That’s the first trend.

The second trend is then is that there are a lot of applications where traditional security for authentication due to the fact that the usage of those applications, think about as an example to your frequent flier miles, that usage is too low to have traditional two factor authentication.

As a consequence that means consumers want to secure their applications but in a multi application environment. What do I mean with that is while it's in our terminology, if you have one DIGIPASS you want to secure multi applications with it, it's like using your bank card.

You could use it, your PIN code and bank card, well if you should use it only to retrieve once money every two months you will use your password. It will be too expensive. It’s the same here. There's a lot of applications, again, where security is needed, is a must, but the frequency of usage is so low that we need to go to a multi application system.

The third thing is that it's traditional technology. What do I mean by that is the computers are becoming faster. There is more speed. There is the mobile authentication, the mobile platforms. Think about the netbooks. Think about your iPhone, your Blackberries and so on. It's becoming more and more popular. People want to have that as their platform so that our traditional trends that are coming.

That means that basically if you look at the – VASCO of course, as trend watcher as certainly as trend maker in all those applications, is much ahead in the development to have DIGIPASS that A, will be multi application in the first place, in the enterprise security.

What do I mean by that is the DIGIPASS will be used in a multi application environment. It means that with one DIGIPASS you can as well secure your, let's say your salesforce.com, your SAB, whatever applications, business applications you have internally, under cloud. That trend will continue towards the consumers where mobile authentication will be very, very important.

As you probably know those platforms are not very secure today. As you probably know there is a lot of shops in the clouds, shops, e-commercials that are coming where security is needed. So that trend is that authentication will be a part of those platforms, will be maybe embedded, maybe on the smart cards, maybe on the SIMM cards but what I mean by that is that the embedded way so the dormant way of having DIGIPASS all over this platform is certainly the trend that's coming.

So we believe that we have the strength of all those technologies, that we have the people to develop that. Having said that it is also possible that of course that we hire to re-develop, we have that make or buy strategy or if we find companies that are advanced in technology that we believe interesting that we will go for acquisitions.

I don't know if I give you an answer on that Fred.

T. Kendall "Ken" Hunt

You can tell from Jan's answer we really don't want to be that specific about – especially for competitive reasons. We continue to look at the market and how it's evolving and where strong authentication has an application and if you look at our product array, we are one of the most, if not the most, prolific company in terms of new product announcements. And you can anticipate that going forward we'll be that same company.

So those are the markets we're looking at. Those are the trends we're seeing happen and through our make or buy strategy, we will have the technologies need to meet the needs of the market.

Fred Zeigel – Mackinac Research

So we should stay tuned.

T. Kendall "Ken" Hunt

Yes, absolutely.

Operator

And we have no other questions at this time, sir. I'll turn the call back to you.

T. Kendall "Ken" Hunt

Thanks ladies and gentlemen for your attendance today. I look forward to your participation in the next Q3 conference call, and once again I want to thank the VASCO people around the world for your hard work and your dedication. Good morning.

Operator

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

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