VASCO Data Security International, Inc. (NASDAQ:VDSI)
Q2 2016 Earnings Conference Call
July 29, 2016 04:30 PM ET
John Gunn - VP, Corporate Communications
Ken Hunt - Chairman, Founder and CEO
Jan Valcke - President and COO
Mark Hoyt - CFO
Joe Maxa - Dougherty & Company
Robert Maltbie - Singular Research
Matthew Delinco - Sidoti & Company
Ladies and gentlemen, thank you for standing by and welcome to the VASCO Data Security International Inc. Q2 2016 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions]. Your host for today is John Gunn, Vice President of Corporate Communications. Please go ahead, sir.
Thank you, Operator. Greetings everyone and thank you for joining the VASCO Data Security second quarter 2016 earnings conference call.
My name is John Gunn, and I'm the Vice President of Corporate Communications. This call is being broadcast over the Internet and can be accessed on the Investor Relations section of VASCO's website at ir.vasco.com.
With me on the call today and speaking first will be Ken Hunt, VASCO's Chairman, Founder and Chief Executive Officer; followed by Jan Valcke, our President and Chief Operating Officer; and then, Mark Hoyt, our Chief Financial Officer.
This afternoon after market close, VASCO issued a press release announcing the results for our second quarter of 2016. To access a copy of the press release and other investor information, please visit our website. Following our prepared comments of today, we will open the call for questions.
Please note that statements made during this conference call that relate to future plans, events or performance including the guidance for full-year 2016 are forward-looking statements. We have tried to identify these statements by using words such as believes, anticipates, plans, expects, projects, and similar words 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 today's press release and the company’s filings with the US Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard.
Please note that certain financial measures that may be discussed on this call are expressed on a non-GAAP basis and have been adjusted from a related GAAP financial measure. We have provided an explanation and reconciliation to these non-GAAP financial measures to the most directly comparable GAAP financial measures in the earnings press release that can be found on the investor relations section of our website at ir.vasco.com.
In addition please note that the date of this conference call is July 28, 2016, and any forward-looking statements and related assumptions are made as of this date. Except as expressly required by the Federal Securities laws, we undertake no obligation to update these statements as a result of new information or future events or for any other reasons.
At this time, I will turn the call over to Ken.
Thank you, John. And thank all of you for joining us on the call today. First, I am very pleased to update you on the positive progress we’re making and expanding market opportunities for VASCO and the strong results we achieved for the second quarter of 2016.
Total revenue for the second quarter of 2016 was $54.3 million, which was in line with our expectations at the start of the quarter and was supported by wins in many areas of our business. As you are likely aware, prior year quarters include the largest transaction in company history so comparisons are challenging.
During the second quarter, we continued to gain momentum and building revenue and executing our strategy. Our strategic plan includes an ongoing investment in eSignLive, our recently acquired electronic signature and document management solution and hiring additional people to expand our capabilities to develop and deliver industry leading solutions.
This impacted our operating results in a significant manner in the second quarter with operating income continuing operations and net income from continuing operations down significantly compared to the same quarter of last year. We believe that the investments we are making in the short term will help accelerate our growth and produce positive results in the future, ultimately making VASCO a stronger, more competitive company. In an industry where many of our peers are struggling to reverse losses, we are pleased extend our win streak with our 54th consecutive quarter of positive results for our investors.
Our newest solutions continue to gain traction, these include our Cronto technology, pure code based visual authenticators, DIGIPASS for apps, mobile authentication security suite and eSignLive, our electronic signature and document management solution. All of these deliver higher gross margins in our traditional solutions.
For the first six months of 2016, our gross margins were 72%. This compares to 58% for the same period last year. We expect our gross margins to remain at approximately this level for the remainder of 2016.
We believe that demand for our market leading solutions will remain strong and that our unified platform provides security and business enablement capabilities that are well aligned with evolving market needs. Here are six examples of how VASCO is creating value by enabling our customers to respond to current business trends and challenges.
First, in banking where the majority of our revenue is generated, the adoption of EMV cards in the US at retail is already pushing hackers in to other channels including online and mobile banking where VASCO excels. A research firm [ITAE] Group quantifies this impact in a recently published report. ITAE Group estimates it account turnover losses for the US financial institutions will increase by almost 20% this year to $75 billion.
This is a pattern that has been repeated around the globe. Our innovative Cronto technology and DIGIPASS for apps mobile application security suite are highly effective defenses against hackers and account takeover. Following a remarkable launch of our Cronto technology with Rabobank, we are seeing adoption by other major banks in additional global regions.
The second trend is the rapid adoption of mobile banking. The just released consumer loss Barometer survey by KPMG reveals that nearly three out of four consumers and almost 90% of millennials are using mobile banking. As mobile banking continues its march to becoming the preferred channel of banking customers, our DIGIPASS for apps mobile application security solution is providing an unmatched combination of transparent security, enhanced user convenience and rock solid application protection.
We are demonstrating leadership again by delivering Runtime Application Self-Protection also called RASP, as a part of an integrated solution. This solution protects the normal operation of mobile applications, even in the presence of malware. It is a powerful differentiator for VASCO and a strong draw for customers in banking and other vertical markets as well. As many of you have probably read, we recently made a strategic investment in Promon, our partner in developing this technology.
The third trend and still on mobile banking is the proliferation of biometrics used for authentication. New research published this week by Acuity Market Intelligence reaffirms the adoption of biometrics. In their new report, the estimate that by 2018 100% of smartphone shipments will include biometric technology. VASCO invested early in this area and is a leader at integrating biometrics in to mobile banking security.
We recently expanded DIGIPASS for apps beyond finger print authentication to now include face recognition what Master Card calls selfie authentication. VASCO’s biometric authentication solutions allow our customers to bridge the gap between their need for higher levels of security and the imperative to deliver a frictionless user experience. This allows our customers to profit by attracting and retaining more customers with an enhanced user experience.
The fourth trend is the enduring nature of hardware based security. Over the years and my many discussions with investors, they often ask me about the future of VASCO’s hardware business. During the second quarter, we again answered that question as we have delivered an increase in revenue from our traditional hardware authenticators over the prior quarter.
We also benefited from an increase in the average selling price of our products, as major customers continue their migration to our newer more advanced products including our Cronto technology that utilizes a patent high-definition QR code to expand customer convenience.
The demand for this solution has been driven by more advanced hacker attacks that are defeating less sophisticated solutions such as SMS, where a user receives a one-time password via a text message. In an announcement this week, that we expect will have a profound long term impact on this segment NIS, the US National Institute of Standard provided a preview of their forthcoming digital authentication guide line.
It essentially calls for the end of SMS authentication saying that out of band authentication using SMS is deprecated and will no longer be allowed in future releases of NIS guidance. For this and other reasons, we believe our hardware authentication business will remain strong. Our backlog in pipeline demonstrates that there continues to be demand for our traditional solutions. In large part this has driven our impressive growth in Japan.
My fifth trend is the rapid rise in demand for solutions that enable agreement and documents to be signed electronically. As you know, VASCO has more than a decade of experience with transaction data signing based on PKI technology and digital certificates. With our acquisition of eSignLive, we expanded in to the area of electronic signatures and document management for a broad range of applications including mortgages, car loans, business agreements, purchase orders and insurance essentially everything that used to be signed in old fashioned and inefficient manner with paper and ink.
Market demand for electronic signatures is increasing as businesses around the globe implement their digital agendas and drive cost savings and efficiencies in their operations. In fact Forrester Research has forecast growth in a number of electronic signatures at over 50% and we believe that with our acquisition of eSignLive, we have the most robust and market ready solution available.
Our work to integrate eSignLive into VASCO remains on track and the number of opportunities we are addressing is growing daily. Our VASCO sales team is engaged with eSignLive sales opportunities with existing VASCO customers and new opportunities across all of our global regions.
During Q2, we announced the release of Spring ’16 update to eSignLive, which enhances the solution and adds to its unique capability to deliver on-premises and cloud implementations, full private labeling capabilities and a highly detailed active audit trail that satisfies compliance and evidentiary requirements.
More recently, the eIDAS regulation that took effect in the EU on July 1; enables citizens, businesses and public organizations to utilize a commonly accepted and secure digital signature that carries the same legal weight as a paper signature. This new regulation will eliminate fragmented rules and enable accelerated adoption of electronic signatures among the 28 member nations.
eSignLive support the stringent requirement of the eIDAS regulation for both advanced and qualified electronic signatures. We now provide full operability with all qualified EU trust service providers.
The final trend that I’d like to discuss is the rise in demand for a security solution in the healthcare market. As I’m sure you’ve read, healthcare has become the number one target of hackers. Healthcare organizations have high value personal information and hackers want this. We expect that as the attacks and breaches continue, the result will be additional regulation and increased spending on security solutions such as ours.
Some of the investment activity that I mentioned earlier is focused on this promising opportunity. VASCO is investing and building partnerships and solutions for this market. An example of this is our DIGIPASS GO 7, which is a device that has been validated as FIPS 140-2 Level 2 compliant by the Federal National Institute of Standards Technology, NIST. It satisfies the requirements for the electronic prescription of controlled substances.
I wanted to emphasize that a significant opportunity that we see in the healthcare market and the initial traction that we are achieving with new customers and partnerships as this market increasingly takes on characteristics of the banking segment where we have been so successful.
We have many solutions that are best in category. Our solutions combine to form a powerful anti-fraud and business enabled platform with tools for customer onboarding, fraud prevention, electronic signatures, mobile applications security and risk analysis. Our mission remains simple and focused. We help our customers to fully leverage their online and mobile channels to enhance growth and profitability.
To summarize, where we are today, our core business is solid and our new business lines are achieving the traction that we had envisioned. We are making strategic investments to accelerate growth, while adhering to our core philosophy of creating value for customers and shareholders.
Our solutions meet the needs of businesses that are striving to realize the efficiencies of an ongoing digital transformation in an increasingly hostile hacking environment. Businesses worldwide depend VASCO every day to safeguard their online and mobile transactions and to make their business transactions easier to conduct.
We remain confident that we are on the right path to continued success and growth, as we play an important role in transforming the online and mobile security landscape.
At this time I’d like to introduce Jan Valcke, VASCO’s President and Chief Operating Officer. Jan?
Thank you Ken. We are pleased with our strong performance in the second quarter and in particular with the significant gains we achieved in the Asia-Pacific region. Our revenue in Asia-Pacific grew substantially in Q2 2016 increasing to 32% of total worldwide revenue. This compares to 90% for the full year 2015. This increase was driven primarily by sales to large banks in Japan.
As many of you know, we have a very strong position in the Japanese market and provide the largest Japanese banks with digitized authentication solutions. Large customers are refreshing their hardware solutions with the next generation solutions and some of these orders include our Cronto technology.
We are also gaining adoption of our DIGIPASS for apps mobile application security suites in a Japanese bank and in all the regions as well. Our gains in Japan are the product of a sustained investment in people and development. (inaudible) it was an overnight success that was many years in the making.
We continue to win new business with DIGIPASS for apps in every region. This solution provides the broadest area of security features and it enables customers to select the security features that are the best match to their business needs. In addition, customers can quickly upgrade to new modules such as risk analyzers and last as their requirements change.
For the first six months of 2016, our revenue for DIGIPASS for apps is close to double what it was for the first six months of 2015 and we expect that DIGIPASS for apps will continue to gain acceptance.
We have multiple large opportunities that have the potential to close in the 12 to 18 months. The investment in internal resources that can spike up is allowing us the improvement of our team with many additional talented developers and strong business development people in key regions such as the US.
We believe we have the potential to grow our business in the country with DIGIPASS for apps, which has strong appeals to US banks. We are excited by the opportunities we are developing and we remain optimistic that we will be able to convert many of these opportunities in to revenue in the future. We are also expanding our healthcare team with key personnel that have extensive industry experience and important relationships with prospects and partners.
We continue to add new customers and build strategic partnerships in the healthcare segment and now we are seeing a significant growth in our healthcare opportunities in the EU as well. We recently launched new solutions designed specifically for the healthcare market and we have a strong product pipeline.
Brexit has been a concern of many investors, so I will comment on this. HSBC has historically been one of our major customers and we continue to enjoy a strong relationship with the largest bank in UK. We sell [vast] solutions to HSBC organizations in 56 countries around the world and most of this business is not denominated in sterling. We expect HSBC to remain strong and that Brexit will not have a significant impact on our business.
In many regions, our customers are increasing their focus on reducing costs. This is an environment that favors (inaudible) and that we expect to benefit from as our solutions help our customers improve productivity and reduce expenses.
We enable our customers to realize significant efficiencies by integrating paperless processes in their business with electronic signatures and document management, and our security solutions enables secured business through online and mobile channels, which are universally more efficient at lower cost.
Our global sales team has a comprehensive platform that incorporates security for online and mobile applications, electronic signatures, identity management and risk analyzers. This powerful combination delivers effective protection against increasingly frequent and sophisticated hacker attacks and also enables our customers to manage their business in a more efficient and profitable manner, which we believe is a winning combination.
Thank you, and I will return the call to Ken.
Thank you Jan. At this time I’d like to introduce Mark Hoyt, VASCO’s Chief Financial Officer. Mark?
Thanks Ken. As noted earlier revenue for the second quarter of 2016 was $54.3 million, a decrease of 17% from the second quarter of 2015. Revenue for the first six months was $101.1 million, a decrease of 23% for the comparable period in 2015. The mix of revenue in the second quarter led to an increase in the gross margin or gross profit as a percentage of revenue up to 71% from 59% during the second quarter of 2015.
I want to remind everyone that 2015 results included the large Rabobank order, and that if we remove the impact of that single deal, VASCO’s revenue has grown in the low double-digits year-over-year.
We continue to generate the bulk of our revenue outside of the US. As I compared the first six months of 2016 with the same period in 2015, you will note an increase in the share of our revenue from Asia and a corresponding decrease in the EMEA in these year-over-year figures. This is the result of large contracts in Japan in 2016 and the Rabobank impact on EMEA in 2015.
For the first six months of 2016, 49% of our revenue came from EMEA, 33% from Asia, 10% from the US and Canada and 8% from other countries. For the first six months of 2015, 71% of our revenue came from EMEA, 17% from Asia, 4% from the US and Canada and 8% from other countries.
Even though a majority of VASCO’s revenue was generated outside of the US in the second quarter of 2016, approximately 71% of our revenue was denominated in US dollars, 23% was in Euros, 6% was in other currencies. Note, less than 1% of our second quarter revenue was denominate in British pounds.
Regard FX, demonstrating our natural hedge, for the second quarter of 2016 revenue and operating expenses were each approximately $200,000 higher than they would have been had exchange rates remained confident with Q2 of 2015 rates. Accordingly, the impacts on operating income of the changes in the exchange rates related to revenue and operating expenses were approximately offsetting.
The mix of our revenue in the second quarter of 2016 compared to the second quarter of 2015 continues to be heavily weighted towards the banking market. Revenue from the banking market was 79% of our total revenue in both the second quarter and first six months of 2016, compared to 88% for comparable periods in 2015. The company had strong hardware sales in Q2 2016 with growth from Q1 2016.
As both Ken and Jan noted, the growth in hardware was driven by large orders in Japan for Cronto and other digitized authenticators. Deferred revenue for the second quarter of 2016 was $28.3 million, a decrease $800,000 or 3% from 29.1 million at March 31, 2016, and an increase of $5.9 million or 26% from $22.4 million at the end of 2015. This quarterly reduction in deferred revenue is driven by several factors including the lumpy nature of our software sales and software renewals.
On a consolidated basis, our operating expenses for the second quarter of 2016 were $35.1 million, an increase of $12.4 million or 55% from the second quarter of 2015. The increase in operating expenses is in line with internal expectations and is primarily related to the eSignLive acquisition and increases in headcount in R&D and sales and marketing.
The total headcount at VASCO was 615 as of June 30, 2016, compared to 545 as of December 31, 2015. The split amongst our teams at the end of the second quarter of 2016 was 299 in sales and marketing, 231 in research and development, and 85 in general and administrative. We believe the investment in expanding our team specifically in the areas of product development and sales will strengthen our competitive position and allow us to accelerate revenue growth.
Operating income for the second quarter of 2016 was $3.4 million, a decrease of 12.4 million or 79% from $15.8 million in the second quarter of 2015. Operating income as a percent of revenue or operating margin was 6% for the second quarter of 2016 down from 24% for the second quarter 2015.
The company reported income tax expense of $1 million for the second quarter of 2016 compared to $2.3 million for Q2 2015. This expense reflected an effective tax rate of 26% in Q2 2016 compared to 14% in Q2 2015. The primary differences due to eSignLive losses for which we cannot take a current tax benefit as of June 30, 2016 our net cash balance including short term investments in commercial paper was $135.8 million, an increase of $10.6 million or 8% from $125.2 million at March 31, 2016.
Our earnings before interest, taxes, depreciation and amortization, EBITDA was $6.3 million for the second quarter of 2016, a decrease of $11.2 million or 64% from the second quarter of 2015. The company had no debt outstanding during the quarter. Thanks for your attention.
I’ll now turn the meeting back to Ken.
Thank you Mark. At this time I’d like to highlight our guidance for 2016. VASCO is reaffirming its guidance for revenue and operating margins for the full year 2016 as follows: revenue is expected to be in the range of $205 million to $215 million and operating income as a percentage of revenue excluding the amortization of purchased intangible assets is projected to be in the range of 10% to 12%.
This concludes our presentations today, we will now open the call for questions. As you may have noticed, we have kept todays’ prepared comments brief to allow more time for questions. As a courtesy to others on the call, I would appreciate it if you would limit questions to an initial question plus a follow-up. If you have additional questions, please get back in to the queue. Operator?
[Operator Instructions] one moment for our first question which comes from the line of Joe Maxa with Dougherty & Company. Your line is open. Please go ahead.
First question is, I wondered if you can give me a little more color on the strength in Japan and if that is expected to continue for the back half of this year and maybe in to 2017?
Well my own personal view on that is that first you have to understand that that was a strategic market for us many years ago, five or six years ago and [Dan Deaca], our area manager, country manager down there working with [Di Cunata] and his group had a plan, had a strategy and they are now executing on that strategy and delivering results.
I think there’s still quite a bit of opportunity for expansion in our existing banks and other banks in Japan. Jan do you have any additional comments about that?
No, not really. I can only repeat what you’re saying.
Okay, good. Thank you.
In the follow-up then you talked about a large Cronto order in Japan, so is that the one with the EMV carbonator or not and then are you seeing Cronto hardware sales in other countries too.
Jan you should answer that question.
So EMV is to my knowledge not used in Japan. So that means basically it’s a traditional DIGIPASS product with or without Cronto technology.
Just a follow-up from Joe there, this is Mark. We did see the Cronto order in Japan and it was the DP 760 the traditional (inaudible) traditional Cronto device there not the EMV reader. And we’ve also seem traction in other markets as well, Japan was the largest this quarter.
And our next question comes from the line of Robert Maltbie with Singular Research. Your line is open. Please go ahead.
Wanted to ask a little bit about a couple of items, first have you received any RFPs from the DNC?
That’s funny you had me there for a second.
I guess there more or less email stuff, right? I had to, I had to. Wanted to get a little sense of the backlog growth progress there and trying to confirm on your non-banking. I think you mentioned a figure of may be 20% or so and what the projected or what the current type of run rate is on that.
Robert this is Mark. We saw last year the figures were impacted by the large Rabobank transaction, that’s what we saw 88% of our business going through our banking channel. We continue to see enterprise come up with it as a percentage of our total sales as the Rabobank tail diminishes. And we expect that the enterprise business will continue to grow as we see increases in healthcare and our eSignature businesses.
Operator next question. Thank you Robert.
We do have a follow-up question from the line of Joe Maxa with Dougherty & Company. Your line is open. Please go ahead.
The DIGIPASS for apps and you talked a lot about US banks over the last year more so, how about an update on expectations and where that’s headed perhaps if the sales cycle has taken longer than expected or maybe compare or contrast that with some other regions.
Well I think that and Jan can have his own comments here, but we’ve been working for a while on several very large transactions in various markets around the world including the United States, driven by the strong adoption of mobile banking. So we expect to produce a lot more than we have historically in North America. Elsewhere there are banking customers that have the older VASCO products, many of the countries or the bank in the countries around the world are seeing the same growing adoption of the mobile platform for particularly retail banking. So generally speaking I’d say we are very optimistic about banking around the world. And in the United States we have a lot of opportunity. Jan do you have anything to add to that?
Well what I maybe can add is that in most cases in almost all cases DIGIPASS for apps is securing mobile banking application and is really incremental to the existing business. We see in the US a strong demand for all our DIGIPASS for apps. What I can add to is DIGIPASS for apps needs a time probably six months for an implementation in the existing mobile banking application. So, that means we have a quite good view even it does not materialize today in real large orders.
I think another fact that could be helpful Joe and the other listeners, the RASP technology, the Runtime Applications Self-Protection that I’ve mentioned several times before is a very popular feature as a part of our DIGIPASS for apps. It’s one of the many functions that are available from that library of functions.
Our strategy is to get the installation with a couple of the functions primarily RASP and get that installed and then build on that and add additional functions from DIGIPASS for apps to the customers. So our strategy is to have an entry point, probably using something like GPS as a function, the finger print, RASP and then as time goes on, we continue adding additional functions to continue to make the user experience transparent, frictionless and enjoyable.
Hope I get a little clarity on what you said Jan regarding banks today. It sounds like the six month implementation cycle, does that mean they already are implementing your products and it just takes six months before they’ll actually roll it out and you can generate revenue on it.
DIGIPASS for apps is a set of SD case, so depending what you’re taking, it takes probably six months to really to implement it due to this banking application. And we are not talking there yet about the [products], we’re talking there really about developing so that it works with the existing mobile banking applications.
[Operator Instructions] We do have a follow-up question from the line of Robert Maltbie with Singular Research. Your line is open. Please go ahead.
Yes, gentlemen if you could speak a little bit to the strategic acquisition strategy in terms of the path ahead and the opportunities I know are here for us that focus mainly in banking, but do you expect also to look at other outside non-banking opportunity?
Yes Robert certainly another very, very strong vertical for us is healthcare. As I mentioned before, the hackers have turned their attention to healthcare because having information about the patient, about the doctors is worth far more on the market where they can sell it than simple user name and password. So that’s a very strategic market for us.
We have partners already that have platforms that they sell in the application platform that is not security with application platforms in to the hospitals, in to the clinics and generally the healthcare market, and as partners we have integrated and are integrating our various securities to make the user experience again secure yet frictionless as best we can.
That’s a very big opportunity for us, the government is now enforcing HIPPA as an example is enforcing the requirement for a strong two-factor authentication. We expect like what we talked about before that fairly soon SMS as a means for security will go away, and you know there are a lot of particularly in the United States in the banking business there are a lot of banks that have been using SMS for security for authentication for a long time. While that doesn’t pass muster anymore. So that’s a great opportunity for us.
Other verticals, you know government is a very strong vertical, gaming, gambling, we’re getting some traction with our identity brokering in Belgium. We are optimistic about that being able to take on other markets around the world.
And our next question comes from the line of Matthew Delinco with Sidoti. Your line is open. Please go ahead.
I guess my question is generally with respect to the larger opportunities that you are recording in DIGIPASS for apps in the US. I’m just curious, do you see them as being more of a perpetual opportunity, a recurring opportunity or if it just stays to the deal cycle you have a feel for which way they might skew.
You mean what they would choose in terms of a perpetual license or a term license is that what you mean?
You know our attitude is they can choose either one. Either one’s good, we just want them as customers, so we don’t really have a chip on our shoulder. If they want to pay us overtime like a three year term a four year term, we’ll accommodate them. If they want to purchase something outright, capitalize it and amortize it overtime, we’ll sell it to them outright. So it’s really their choice.
And there appear to be no further questions on the phone line at this time.
Alright, thank you operator. And everybody on the phone call thanks for the good questions and other that were simply in listening mode I hope that we covered all the information that you signed on for. And as always I want to thank the VASCO people around the world for your great attitude, your great efforts. This has just been a terrific quarter and I thank you very, very much. Have a nice day. Bye, bye.
Ladies and gentlemen that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines.
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