VASCO Data Security International, Inc. Q4 2007 Earnings Call Transcript

Feb.21.08 | About: VASCO Data (VDSI)

VASCO Data Security International, Inc. (NASDAQ:VDSI)

Q4 2007 Earnings Call

February 21, 2008 8:00 am ET

Executives

T. Kendall Hunt - Chairman, CEO

Jan Valcke - President, COO

Cliff Bown - EVP, CFO

Analysts

Daniel Ives - Friedman Billings Ramsey

Sean Jackson - Avondale Partners, LLC

Rob Owens - Pacific Crest

Brian Freed - Morgan, Keegan & Company, Inc.

Fred Ziegel - Soleil Securities

Amit Dayal - Rodman & Renshaw

Joe Maxa - Dougherty & Company

Jordon Roberts - Jefferies and Company, Inc.

Martin Yokosawa - Oberweis Asset Management

Operator

Good morning, ladies and gentlemen. My name is [Bree], and I'll be your conference operator today. At this time, I would like to welcome everyone to the VASCO Data Security International, Inc. 2007 earnings conference call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, T. Kendall Hunt, Founder, Chairman and CEO. Sir, you may begin your conference.

T. Kendall Hunt - Chairman, CEO

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 related to future plans, events or performances are forward-looking statements. Any statement containing words such as believes, anticipates, plans, expects and similar words is forward-looking, and these statements involve risks and uncertainties and are based on current expectations. Consequently, actual results could differ materially from the expectations expressed in these forward-looking statements. I direct your attention to the company's filings with the Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard.

Today we're going to review the results for fourth quarter and full year 2007. As always, we'll 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.

First I'd like to address revenue for fourth quarter 2007. It was $31.2 million, an increase of 23.9% over fourth quarter 2006, and once again, a very strong quarter. It was also our 20th consecutive positive quarter in terms of operating income and cash flow.

I'm here to report to you that results for 2007 fell within the company's annual guidance for revenue, gross margin and operating margin that we reaffirmed on October 25, 2007.

Total revenue for 2007 was $120 million, an increase of 58% over 2006. Our gross margin for full year 2007 was 67% of revenue, and our operating margin for full year 2007 was 25.7% of revenue.

Consistent with our growth in revenue, operating income increased 63% and earnings per share increased 65% over the full year 2006.

In addition to the strong growth reflected in the numbers, we made a number of investments in 2007 that we believe will provide a benefit in future years. In 2007, we hired and integrated 56 people, which was a 30% increase in staff from December 31, 2006. The new staff included significant additions to our sales, research and development, and administrative groups, including new positions that will manage our worldwide human resource, information systems and legal functions.

We opened our new international headquarters in Zurich, Switzerland, we established new subsidiaries and opened sales offices in Brazil and Japan, and we launched several new products, including the aXs GUARD Authentication Appliance, the Digipass 840 for the blind and visually impaired, the Ultra-light Digipass 805 One-Button Reader, and the next generation of Digipass Packs for small and medium-sized enterprises.

Overall 2007 was the most successful year in VASCO's history. Having said that, VASCO's management was not happy with its results in the fourth quarter of 2007. For various reasons, three relatively large transactions moved from the fourth quarter of 2007 into 2008. However, some of the merchandising capacity freed up by these accounts was redirected to other orders which were shipped in Q4. The net result of these activities was that approximately $3.6 million of revenue moved from 2007 into 2008.

I won't go into great detail in describing the reasons for the movement of these three accounts, but I can say the following:

One was delayed because we needed to obtain an industrial security certificate required by that customer. We now that certificate.

One was delayed due to a new product that required additional final testing before shipping. The final testing has been completed, and this new product is now shipping.

The last was delayed due to the request of the customer based upon their deployment schedule. You should remember that - our just-in-time delivery promise that we made and announced in Q1 2003. We don't try to manage our quarters, but we do our best to accommodate the wishes of our customers.

During the fourth quarter we continued to make progress in our efforts to increase the software content of our business. Our deferred revenue increased approximately $2.1 million in Q4 and $4 million for the full year. While these revenues are not reflected in the comparison of 2007 to 2006 results or in 2007's operating margins, they are revenues that will benefit us in future years.

New accounts continued to grow during the fourth quarter. During the quarter we sold an additional 651 new accounts, including 66 new banks and 585 new enterprise security customers. For the full year 2007 we sold 2,509 new accounts, including 379 new banks and 2,130 new enterprise security customers. Comparatively, for all of 2006 we produced 1,553 new accounts, including 233 banks and 1,320 enterprise security customers. We now have over 1,000 banks and almost 6,500 enterprise security and e-commerce companies, including corporations, federal, state and local governments as customers located in over 110 countries around the world.

Since the first quarter of 2003, VASCO has experienced steady controlled growth and continued growing profitability. Over the past couple of years, this growth has occurred worldwide from the Americas to EMEA to Asia. This has resulted in a worldwide market leadership position for VASCO. We are a market leader, and we are perceived as a market leader. For example, in the U.S. we currently have 50 percent of the Top 10 banks as customers, 52% of the Top 25 banks and 38% of the Top 100 banks.

Because of our strong performance and resulting operating cash flow in 2007, we were able to invest aggressively in people and infrastructure to support our long-term growth. That investment will continue in 2008.

Before I introduce Jan Valcke, I'd like to emphasize one thing. Some have said that the subprime loan crisis would have a negative effect on VASCO. We have not seen any evidence that this is the case.

Actually, we believe the subprime crisis is an opportunity for VASCO. We say this because banks and other financial institutions are actively trying to cut costs. The most cost-effective banking channel is the Internet. We expect that U.S. banks will invest more in their Internet banking applications, adding new functionality, such as more flexible online transactions. These applications will need good security. VASCO, with its hard and software Digipass strong authentication and its strengthened server offering is well positioned to take advantage of this possible evolution.

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

Jan Valcke - President, COO

Thank you, Ken.

As noted by Ken, VASCO has a very successful year in 2007 as reflected in both the full year numbers as well as the investments that are an expected benefit to our shareholders in the future years.

Looking forward, we believe that the market for strong authentication will continue growing at a rapid pace. Our challenge is to continue to make investments that will meet the needs of the evolving market and the allow us to maintain or increase our market-leading position.

We know that healthy business makes our banking and enterprise security important for our margins. The banking sector gives us high volumes with lower volumes. Enterprise security deals are smaller, but the margins are a lot higher.

With that thought in mind, our co-strategy for 2008 will be as follows:

First, we will offer the financial sector a full array of authentication products and services.

Second, we will take our banking authentication products to other, non-traditional markets and sectors.

And third, we will strengthen our position in non-banking markets and sectors by offering sector-specific authentication products and services.

To further explain our 2008 strategy, I'll talk about three important pillars of this company - the first one, the geographic and vertical markets; second, the products, and third, the people.

In geographic markets, we plan to continue opening new offices in the world's leading business hubs. As always, we follow a three-step strategy when we enter a new country. First, we gain a foothold in the country's banking market. Second, we hire local people to reinforce our position in the banking market. And third, we open an office in order to tackle non-banking verticals.

In 2008 we are planning to invest strongly in all aspects of our enterprise security market, which includes all nonbanking verticals. We plan to add new people, expand our marketing efforts, add new products and strengthen the channel. In addition to small and medium businesses, vertical markets may include other application-specific areas such as healthcare, gaming, e-commerce and egovernment.

Our products are being used in more than 50 different applications, and we believe that we will be able to identify and leverage our knowledge with those applications to increase our penetration in the more promising markets. While the e-commerce and e-government markets are more complex, we expect that we will start to see business opportunities in both markets in 2008.

In addition to increasing our emphasis on new vertical markets, we also plan to increase our marketing efforts. We plan to organize two marketing events a week. We estimate that we will be able to organize between one and two banking summits a month or around six enterprise security/application security events per month and one corporate event per month.

Our plan for 2008 also calls for increased investment in new staff. In order to support our growth, we expect to create approximately 100 new jobs in 2008. These people will be employed mainly in sales and marketing and R&D, with a clear focus on enterprise security. In addition to direct hires, we expect to also invest in attracting new channel partners in supporting our current channel.

To facilitate the training and integration of our new staff and channel partners, we plan to launch our SEAL Academy. SEAL stands for Security Experts Academy Learning. Under the SEAL label, we are planning to organize external training, often by third parties. We are also planning to increase our efforts to create VASCO certified engineers and VASCO authorized training centers in the channel. SEAL replaces the previous VASCO school and includes the internal training of new recruits directly from college and universities and experienced professionals.

In the product category, we plan to continue our full option strategy. We expect to have our complete new server offering, available in the market in 2008. This offering includes our co-authentication engine VACMAN Controller, Identikey, the complete authentication server based on VACMAN Controller technology, and aXs GUARD Authentication Appliance. This is a plug-and-play authentication engine. With this service-side authentication family, we believe that we will have a competitive offering for any authentication application in the market.

We also plan to strengthen our hard and software client authentication offerings in 2008. We are planning to launch trendsetting products that are unique in the market. Digipass 110, announced at the end of January, is the first example of this approach. Digipass 110 is a true zero footprint e-signature solution, combining the assets of both hard and software strong authentication.

We believe that we will be able to enhance our service offering as well. Digipass Plus was the first step. You can expect a lot more to follow in the service field.

Currently, we are a world-leading software company specializing in strong authentication products. Soon, we will be a world-leading software company specializing in strong authentication products and services.

Thank you.

T. Kendall Hunt - Chairman, CEO

Thank you, Jan.

Now I'd like to introduce Cliff Bown, VASCO's Chief Financial Officer. Cliff?

Cliff Bown - EVP, CFO

Thank you, Ken, and welcome to everyone on the call.

As noted earlier by Ken, revenues for the fourth quarter of 2007 were $31.2 million, an increase of $6 million or 24% over the fourth quarter of 2006.

For the full year, revenues were $120 million, an increase of 58% over the comparable period in 2006.

The increase in revenue for the fourth quarter and full year reflected significant increases from both the banking and enterprise security markets. Revenues in the fourth quarter of 2007 from the banking and enterprise security markets increased 18% and 60% respectively compared to the fourth quarter of 2006.

For the full year 2007, revenues from the banking and enterprise security markets increased 54% and 78% respectively compared to the full year 2006.

It should be noted that the comparison of revenues was positively impacted by the weaker U.S. dollar in 2007. We estimate that revenues in the fourth quarter and full year 2007 were approximately $2 million and $5.8 million higher respectively than they would have been had the exchange rates in 2007 been the same as in 2006.

The distribution of our revenue in the fourth quarter of 2007 between our two primary markets was approximately 82% from banking and 18% from enterprise security. This compares with 86% from banking and 14% from enterprise security in the fourth quarter of 2006.

For the full year 2007, 84% of our revenue was from banking and 16% was from enterprise security, and compares to 85% from banking and 15% from enterprise security for the full year 2006.

The geographic distribution of our revenue in the fourth quarter was approximately 79% from EMEA, 5% from the U.S., 6% from Asia, and the remaining 10% from other countries.

In the fourth quarter of 2006, 63% of the revenue was from EMEA, 11% from the U.S., 10% from Asia, and 16% from other countries.

For the full year 2007, the geographic distribution of revenue was approximately 68% from EMEA, 8% from the U.S., 11% from Asia, and the remaining 13% from other countries.

For full year 2006, the distribution was approximately 62% from EMEA, 10% from the U.S., 8% from Asia, and the remaining 20% from other countries.

Gross profit as a percentage of revenue for the fourth quarter of 2007 was approximately 67.2%, which compares to 70% for the fourth quarter of 2006.

For the full year, gross profit as a percentage of revenue was 65.9% in 2007 compared to 68% in 2006.

The decrease in gross profit as a percentage of for both the quarter and full year 2007 compared to 2006 primarily reflects the increase in card readers sold, both in absolute dollars and as a percentage of total sales, and the competitive pricing pressures in the card reader business. The decline in gross margin from these two factors was partially offset by an increase in the percentage of business coming from the enterprise security market, an increase in the percentage of business coming from the non-hardware products, and the strengthening of the euro compared to the U.S. dollar.

Our non-hardware revenues were 17% of total revenue in the fourth quarter and 14% for full year 2007, and compares to 14% of revenue for the fourth quarter of 2006 and 12% of the total revenue for full year 2006.

Operating expenses for the fourth quarter of 2007 were $14.6 million, an increase of $4 million or 38% from the fourth quarter of 2006. Operating expenses for the full year 2007 were $48.2 million, an increase of 15.5 or 47% from the same period in 2006.

Operating expenses for the fourth quarter and full year 2007 included approximately $688,000 and $2.157 million respectively related to stock-based incentive plans. Stock-based incentive plan expenses in the fourth quarter and full year 2006 were $448,000 and $1.615 million respectively.

The comparison of operating expenses in 2007 to 2006 was negatively impacted by the weaker U.S. dollar in 2007. We estimate that expenses were $1.3 million higher or 12% higher for the quarter, and $3.2 million or 10% higher for the full year than they would have been had the exchange rates in 2007 been the same as in 2006.

For the fourth quarter, operating expenses increased by $1.7 million or 27% in sales and marketing, $1 million or 52% in research and development, and $1.3 million or 64% in general and administrative when compared to the fourth quarter of 2006.

The majority of the increase in the sales and marketing area were related to the company's increased investment in sales staff and the related travel expenses, increased marketing expenses, and higher depreciation costs, primarily related to the cost of training films developed in 2006.

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

The increase in general and administrative expenses primarily reflected increased compensation expenses, recruiting fees, third-party consulting costs and an increased provision in allowance for doubtful accounts.

For the full year 2007, operating expenses increased by $7.7 million or 40% in sales and marketing, $3.9 million or 71% in research and development, and $3.4 million or 48% in general and administrative when compared to the same period in '06.

In addition to the factors mentioned previously related to fourth quarter comparisons, sales and marketing expenses reflected an increase in recruiting fees and third-party consulting and commission costs, and general and administrative expenses reflected an increase in professional fees, largely related to the creation of our international headquarters in Switzerland and the opening of our offices in Brazil and Japan.

Operating income for the fourth quarter 2007 was $6.3 million, a decrease of $700,000 or 10% from the $7 million reported in the fourth quarter of 2006.

For the full year, operating income was $30.9 million in 2007, an increase of $12 million or 63% from the $18.9 million reported in 2006.

Operating income as a percent of revenue or operating margin was 20.3% for the fourth quarter and 25.7% for the full year 2007.

In 2006, our operating margins were 27.8% for the quarter and 24.9% for the full year. The decrease in operating margin as a percent of revenue in the fourth quarter reflects the mathematical fact that the operating expenses grew faster than the revenues.

The calculation of operating margin does not, however, consider the impact of the growth in the deferred revenue, which was $2.1 million during the fourth quarter 2007. The calculation of operating margin is also sensitive to timing of when sales are recorded. As noted in previous calls and as noted by Ken in his comment regarding the just-in-time policy, our revenues can move between quarters while our operating expenses tend to be fixed over the short term.

In the fourth quarter of 2007 we continued to invest in the infrastructure needed to support the growth of the company even though a portion of the revenue slipped from 2007 into 2008. We believe that the operating margin is a more indicative measure of performance or operating efficiency over a longer period of time. The increase in operating margin as a percent of revenue for the full year 2007 over 2006 reflects the basic fact that the growth in our revenues and gross margins exceeded our increased investment in infrastructure.

The company recorded income tax of $3 million for the fourth quarter and $10 million for the full year 2007. The effective tax rate was 49% for the quarter and 32% for the full year 2007.

For 2006, the company reported income tax expense of $2 million for the fourth quarter and $6.1 million for the full year. The effective tax rate reported in the fourth quarter of 2006 was 28.5%. For the full year, the effective tax rate was 32%.

The effective tax rate, excluding the impact of the impairment charge, was 33.2 for full year in 2006.

The rate reported for the fourth quarter of both years reflects the yeartodate adjustment that is needed to reflect the rate calculated for the full year. In 2007, an adjustment was needed to increase the rate from 28% reported in previous quarters to 32%. The increase in the rate reflected lower than anticipated revenues in Switzerland and the United States.

In 2006 the adjustment reduced the full year tax rate from 33.2% to 32.5%.

The makeup of our workforce as of December 31, 2007 was 240 people worldwide, with 137 in sales and marketing and customer support, 72 in research and development, and 31 in general and administrative. The average headcount for the fourth quarter of 2007 was 231 persons, or 34% higher than the average headcount for the fourth quarter of 2006. And the average headcount for the full year 2007 was 211 persons, or 40% higher than the average headcount for the same period in 2006.

The strength of our operating performance is also reflected in our balance sheet. Our net cash and working capital balances both increased from the prior quarter and prior year end.

As of December 31, 2007, our net cash balance - which is defined as total cash less bank borrowings - was $38.8 million, an increase of $2.1 million or 6% from $36.7 million at September 30, 2007, and an increase of $26.2 million or 208% from the $12.6 million at December 31, 2006.

As of December 31, 2007, our working capital balance was $52.4 million, an increase of $5.8 million or 12% from $46.6 million at September 30, 2007, and an increase of $30.4 million or 138% from $22.1 million at December 31, 2006.

There were no bank borrowings as of December 31, 2007.

During the quarter our days sales outstanding in accounts receivable increased to 76 days from 55 days at September 30, 2007 and from 72 days at December 31, 2006. The increase in DSO was primarily attributable to the timing of when sales were made in the quarter.

I would now like to turn the meeting back to Ken.

T. Kendall Hunt - Chairman, CEO

Thank you, Cliff.

Today we are announcing that we will no longer comment on what we have referred to in the past as backlog. Despite VASCO's continued success starting in 2003, we are still a relatively small company. The timing of large orders still has a big impact on our quarterly results, which at times are irregular or lumpy. Therefore we can no longer find backlog to be appropriate in our communications to the market.

However, we will continue to offer full year guidance for 2008. As in the past, we will only comment on annual numbers, not quarterly numbers.

First, we are providing guidance that our full year 2008 revenue will grow from 25% to 35% over the full year 2007.

Second, we are providing guidance that full year 2008 gross margins will be in the range of 60% to 68% of revenue.

Finally, we are providing guidance that full year 2008 operating income will be in the range of 20% to 25% of revenue. This is a decrease from our 2007 range of 23% to 30% and is due to our continued investment in our long-term growth.

This guidance reflects our strategy to continue our aggressive growth by investing in our people and the infrastructure necessary for long-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.

In summary, we are very pleased with our results for 2007. We also feel very comfortable about VASCO's long-term growth. And as always, you can rely on VASCO's people to do their very best.

This concludes our presentations today, and we will now open the call for questions. As I mentioned earlier, as a courtesy to others on the call I would appreciate it if you would limited your questions to an initial question plus a follow up. If you have additional questions, please re-enter the queue after the answers to your initial questions have been given.

Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from Daniel Ives of Friedman.

Daniel Ives - Friedman Billings Ramsey

Yeah. A few questions. First, I mean, Ken, you guys have missed the street's numbers, okay, for two quarters in a row, so what should give investor's confidence that you could hit your guidance for the year for '08?

T. Kendall Hunt - Chairman, CEO

Well, I would guess the confidence you should have is that we easily met our guidance for annual 2007. In fact, mid-year we updated our guidance for the revenue top line, and easily met our range for 2007. I feel equally confident that we can meet our guidance annually for 2008.

Cliff Bown - EVP, CFO

Daniel, I would point out that VASCO does not comment on the street's numbers. They are just exactly that. They're the numbers that are developed by the analysts that follow VASCO, and we do have dialogue with them but only within the context of publicly available information. So when Ken says we issue the annual guidance and that's what we are standing behind, that's exactly right.

So I don't think necessarily that you should conclude because we didn't meet the street's numbers that we're not meeting what we're communicating to the market and therefore the market should have confidence in the numbers that we're providing for 2008.

Daniel Ives - Friedman Billings Ramsey

What, I mean, going into the year, what sort of visibility and conservatism do you have into the '08 numbers?

T. Kendall Hunt - Chairman, CEO

Well, as we've discussed before, a number of our transactions are under firm POs with scheduled shipments over 12 month periods, so the company does have this view, this look, at what our firm backlog is in terms of firm POs.

So it's that plus looking at our forecast system, that's proven to be pretty reliable, plus looking at what we've come to expect from our channel in terms of transactions, revenue, gross margin. It's a combination of those three things that we use to create the guidance that we've announced today.

Daniel Ives - Friedman Billings Ramsey

Okay, thanks.

T. Kendall Hunt - Chairman, CEO

Thank you, Dan.

Operator

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

Sean Jackson - Avondale Partners, LLC

Yeah.

T. Kendall Hunt - Chairman, CEO

Hi, Sean.

Sean Jackson - Avondale Partners, LLC

Good morning. The three slipped deals that you mentioned, I think you said that combined they were about $3.6 million of revenue. Is that correct?

T. Kendall Hunt - Chairman, CEO

The net effect was about $3.6 million, yes. Some of the assigned manufacturing capacity for those three deals we reallocated to others, other customers, but the net effect was about 3.6.

Sean Jackson - Avondale Partners, LLC

Okay, so even with that, adding that to the reported revenue, you're still - it's still just a little bit higher than the stated backlog that you stated back in October. I guess is there anything more macro related that you're seeing that I guess didn't come in in the fourth quarter, because as you know, typically the actual revenue number's a lot, usually a lot higher than that versus the backlog.

T. Kendall Hunt - Chairman, CEO

No, I don't think there's any particular message in those numbers. As we've stated, the timing of the revenues is really not ours. It's in the hands of the clients, and we try to accommodate them.

Sean Jackson - Avondale Partners, LLC

Okay. And can we assume that - it sounds like two of the three slipped deals that shipments have already started in the first quarter?

T. Kendall Hunt - Chairman, CEO

Yes.

Sean Jackson - Avondale Partners, LLC

Okay. And also, were all those deals in the Asia region?

T. Kendall Hunt - Chairman, CEO

No, they weren't.

Sean Jackson - Avondale Partners, LLC

Okay. How many were there, two out of three?

Cliff Bown - EVP, CFO

The majority of deals would have fallen into the European region.

Sean Jackson - Avondale Partners, LLC

Okay.

Cliff Bown - EVP, CFO

And when we talk about tax rate, had they fallen into the European region, the overall tax rate would have been substantially lower as well.

Sean Jackson - Avondale Partners, LLC

Okay. Do you have any assumptions for the tax rate for '08?

Cliff Bown - EVP, CFO

We have our internal assumptions, but that's not anything that we publish publicly.

Sean Jackson - Avondale Partners, LLC

Okay, but just based on, I guess, the trends, it looks like a 32% number is probably more accurate than a 28?

Cliff Bown - EVP, CFO

Well, again, all of the analysts will have to make their own conclusions, but our expectation is with the move of our intellectual property to be jointly owned by Switzerland and the United States that we should see a reduction in tax rate over time.

Sean Jackson - Avondale Partners, LLC

Okay. And just lastly, it sounds like the investment that you're making in '08 is more weighted to the enterprise security side. I think you mentioned that you intend to hire 100 more people, and it seems to be weighted more toward enterprise security. One, is that correct, and two, if it is, does that indicate that that's where you see the opportunity or that, you know, the banking market is getting a little saturated, or could you just comment on that?

T. Kendall Hunt - Chairman, CEO

Yeah. We don't feel the banking business is anywhere close to saturated, but we do, as we've talked about our mix of business, we do think it's important to have a reasonable percentage of our business coming from the enterprise because the prices are higher, the gross margins are higher, and this blend that we've talked about for quite some time is very important to the health of the business, not only in terms of the profitability of the business but our ability to internally fund and aggressively fund our growth.

Jan, do you have any other comments on that?

Jan Valcke - President, COO

Yes. What I can comment on that is as you know, we are a quite prudent company, so we launched in 2007 some new products for the applications security and enterprise security market or the non-banking security market. We waited first to see what was the reaction of the market on those products. We feel very comfortable about those products in those markets.

And we started a more aggressive hiring process a couple of months ago that will continue in 2008. The timing we will have those people on board will also reflect the growth of VASCO in 2008.

Sean Jackson - Avondale Partners, LLC

Okay. Thank you.

T. Kendall Hunt - Chairman, CEO

I could add one other thing. You know, we're very strong in banking historically because we have indeed made significant investments of people and marketing and events. And so the enterprise opportunity is a big opportunity, so we are going to invest in that as well.

Operator

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

Rob Owens - Pacific Crest

Yeah. Good morning, guys.

T. Kendall Hunt - Chairman, CEO

Hi, Rob.

Rob Owens - Pacific Crest

Could you comment a little bit on deal size and what you saw in the fourth quarter versus maybe what you expected in the fourth quarter? Was there any compression in the size of deals that you had anticipated coming out of backlog?

Cliff Bown - EVP, CFO

I'll comment first, Rob. I don't think there was really any substantial change in the size of deal or mix of deals. Normally you would see that show up in our gross margin percentage, and we didn't have a significant fluctuation in that gross margin.

If we had gone to a much smaller deal, we would expect our gross margin rate to go up and vice versa.

So from my point of view, no, there wasn't anything substantial or significant in terms of that area, but Jan, I'd also ask if you'd noted anything on the sales side?

Jan Valcke - President, COO

No. The only comment, I guess, on deal size, it's business as usual, certainly in the banking, and that we are spending more time, more people in the enterprise security.

Rob Owens - Pacific Crest

Okay. Well that being said, can you address your turns business or your channel business which, you know, we can back into being the weakest it's been in probably seven quarters? Kind of what's going on there, and when should we see any benefit from the Azlan-Tech Data relationship?

T. Kendall Hunt - Chairman, CEO

Overall, I'm not quite sure what you're looking at. Our enterprise security business grew 60% this quarter over the same quarter a year ago and yeartodate it's up 78%, so I can only sort of read between the lines of your questions and sort of infer that you're talking about the difference versus backlog and what we announced in backlog. Is that correct, Rob?

Rob Owens - Pacific Crest

Yeah. Yeah. Because if I read your comments right, you're saying outside of the 3.6 that slipped, the rest of backlog was fine and contributed to revenue in the quarter.

Cliff Bown - EVP, CFO

Yeah, I think what you'd have to do is go back in the analysis and sort of take the gross amount, which we did not disclose, of the slipped deals because those were banking deals and a significant portion of the substitutions were in the enterprise security or turns business.

So we haven't provided the data to allow you to do that precisely, and I don't think we would want to do that because we don't want to highlight those three deals anymore than what Ken included in his prepared remarks. But there was that substitution effect, so it won't be perfectly transparent in this period.

Rob Owens - Pacific Crest

Okay. Great. Thanks.

Operator

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

Brian Freed - Morgan, Keegan & Company, Inc.

Hi, guys. Could you comment a little bit more about your gross margin guidance? You mentioned that you were looking to drive more software, which should have a positive bias, yet your margin guidance was trending downward as I understand the operating investments, the gross margin guidance. If you can give a little more detail there, I'd appreciate that.

T. Kendall Hunt - Chairman, CEO

The gross margin guidance itself is exactly the same in 2008 as it was in 2007, and we continue to guide a fairly wide range on all of the numbers, in part because of the just-in-time on the revenue line philosophy, so we don't know exactly when those deals will hit.

As it relates to gross margin, we have a number of factors that are in that line that can create a fair amount of volatility. The card reader business for VASCO is a much more competitive business, so depending on the percentage of our total volume in card readers, that will have a depressive effect on our overall margin.

Within the context of the split between enterprise security and banks, the higher enterprise security is, the better it is for our margins because it is smaller deals, higher margins, than our banks.

Currency plays a factor, and so far that has had a positive effect because most of our costs in the business are denominated in dollars but our revenues are denominated in various currencies, so if the U.S. dollar gets weaker, it generally creates more revenue with a constant cost of goods sold.

So there are a number of factors there, which is why we're comfortable operating in the range. As we look forward into 2008, we do expect to be able to maintain that balance, that as we continue to experience competitive pressures on the pricing of our products we'll be able to offset the effects of the competitive pricing by having more non-hardware revenue, which will have a higher margin, having more enterprise security revenue, that will have a higher margin. And that's the general game plan for that guidance item.

Brian Freed - Morgan, Keegan & Company, Inc.

Okay. And on the enterprise security side, you know, these 100 additional heads you plan to hire, does it imply a move from a purely channel model to more of a direct approach?

T. Kendall Hunt - Chairman, CEO

No, I don't think so. I think that historically the products that we have have been suitable for the very large banks with the very large deployments, and at the small and medium enterprise side, it's been a very simple solution. The Identikey server is more of a true server and allows us to serve larger enterprises and medium-sized banks.

Jan, would you like to add anything to that?

Jan Valcke - President, COO

Yeah, what we can add on that is we have - today we have a full product range for the enterprise security. That product range is called Digipass Pack. It's a strategy that starts with remote access and ends up with web security software, so that a customer and end user, through a two-tier model, distribute [reseller] and user, can in fact start with securing his remote people and ending up by securing his customers.

Besides that, we started, then, the strategy, and that was what I was talking about, the 2007 market that we tested, is with the more application security, more the larger companies. It's also the new products like the 110, a combination of software and hardware authentication. It's not only for banking; it's also for more application security oriented, and that goes also in our channel model.

Brian Freed - Morgan, Keegan & Company, Inc.

Okay, thanks.

Operator

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

Fred Ziegel - Soleil Securities

Good morning.

T. Kendall Hunt - Chairman, CEO

Hi, Fred.

Fred Ziegel - Soleil Securities

What has changed in the business such that backlog numbers are, I guess, no longer being given and I guess relevant to a particular quarter? What are you seeing?

T. Kendall Hunt - Chairman, CEO

I think it's a - I guess it's our message that we really don't want to have the market or investors focused on our quarterly results, again, because we are a small company - and I've talked about this many, many times - because we are a small company and because some of our customers are these larger banks, the timing of their orders and when we ship and when we record revenues is really that justintime delivery philosophy that we announced in the first quarter of 2003. And we want people to focus on our full year results, not quarterly results, so that's why we're moving to an annual only guidance.

Fred Ziegel - Soleil Securities

The $3.6 million worth of deals that moved out of Q4, were those all banks?

T. Kendall Hunt - Chairman, CEO

They were.

Fred Ziegel - Soleil Securities

They were all banks, okay. It sounds like - and I think to a prior question - a lot more emphasis on let's call it the non-banking, whether that's e-commerce or egovernment or the enterprise market. That said, and if we look at a revenue mix which was 18% enterprise in Q4 - I presume that moves up - should we not be looking for higher gross margins relative to what we've reported heretofore?

T. Kendall Hunt - Chairman, CEO

Well, there's certainly that opportunity, but as you've seen, we've had that 60% to 68% gross margin range for some time.

There are no absolutes in life, and we're doing our best to manage the business profitably and to focus on incremental opportunities like the channel that produce incremental opportunities in terms of revenue and higher gross margins, and the execution of that will drive the gross margin that we realize. Also, the non-hardware revenues will also help drive that gross margin.

So it's not a precise science, and that's why we do have a fairly large gross margin range, Fred.

Fred Ziegel - Soleil Securities

Okay. And e-commerce and e-government, what would be sort of a gross margin expectation on that? Would those tend to be higher gross margins or where would you sort of position those?

T. Kendall Hunt - Chairman, CEO

Well, it would depend, of course, upon the size of the deal. If it's an e-commerce partner or transaction that has lots and lots of volume, you're going to see lower gross margins. It's all deal size driven. The smaller the deals, the higher the gross margin. The larger the deals, the lower the gross margin.

Cliff Bown - EVP, CFO

Yeah, but our strategy, Fred, with that, as we've talked in the past, just as it is with the banks, those larger volume deals, while they have lower gross margin, don't have a lot of incremental operating expense associated with it, so those translate into higher operating margins and more of those dollars actually flow through to income for the shareholders. So I wouldn't get too concerned on the gross margin changes coming from those. As Ken said, they may be, would expect to be, lower margin deals because those should be high volume kinds of activities over time, but those wouldn't require a lot of incremental sales and marketing expenses or other kinds of expenses. So once those start to happen, you should see more of those margin dollars fall through to income.

Fred Ziegel - Soleil Securities

Okay. Last question - I'm not sure where the stock's going to be, but it'll be probably in the low teens. Any thoughts about stock repurchase?

T. Kendall Hunt - Chairman, CEO

That's a topic that we do consider and we do discuss, and certainly it will be a topic of discussion.

We've never done that before. We've always used our money to invest back in the business and use for acquisitions, but as a smart executive team and a smart Board, we're always reassessing a number of items. That would be one of those.

Fred Ziegel - Soleil Securities

Okay. Thanks, guys.

T. Kendall Hunt - Chairman, CEO

Sure.

Operator

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

Amit Dayal - Rodman & Renshaw

Thank you. Again on the banking side of the business, the products seem to have done really well at the corporate level. Do you think you're getting some resistance on retail deployments of these offerings?

T. Kendall Hunt - Chairman, CEO

Well, certainly the retail deployments that we've had historically have all been international, and in fact it's been a big part that's driven our business, is retail deployment.

Here in the United States, the deployments so far have been for the corporate clients of the bank. We do expect to see a movement on the retail side, but at this time we have nothing to announce.

Amit Dayal - Rodman & Renshaw

Great. And just a follow up to that, when you talk about international business, is any revenue currently coming from India or China and, you know, when should we be looking at opportunities from these countries, you know, coming into play?

T. Kendall Hunt - Chairman, CEO

Well, yes, we have revenues from India, China, Korea, Japan. We have a fairly strong business in APAC, Asia-Pacific, and we expect more results from that area.

Amit Dayal - Rodman & Renshaw

Great. Just one more question. In terms of the enterprise security strategy, I mean, could you just provide some more clarity on what specifically are you focused on? Is it authentication or is it some other level of service that you're providing? You talked about service security initiatives that are, you know, [inaudible]. I mean, if you could just provide some clarity on what the strategy on the enterprise side is.

T. Kendall Hunt - Chairman, CEO

Sure. Jan, would you address that?

Jan Valcke - President, COO

Sure. We are, of course, an authentication company. We call ourselves even the authentication company. We see authentication really as the application in the middle of all other security application.

So basically we don't change that in the enterprise security market, the application security market. We say to the market if we compare that to physical security, please secure first your door before you secure the rest of your house. So we do the same thing in our logical security - first authentication and then we have a commitment to the market that all the other security applications - firewall, [inaudible], whatever, name it - that they are compatible with our products range. That is the same thing we are doing in the enterprise security.

Now when it comes to services - and I can give you an example that's already happening in some countries, Luxemburg, Korea, and other countries, where in fact Digipass, with one authentication product, that Digipass is now a token, a reader, a smart card, a mobile authentication that, with one Digipass you can access multiple applications. We see that in Korea where, with one Digipass, you can access multiple accounts of different banks. The same thing in Norway. The same thing in Luxemburg.

So there are already more and more applications on the market, some in the banks, some in the enterprise security, some in the application security, where with one authentication product you can access multiple applications. And we believe that that will also be a growth in our business.

Amit Dayal - Rodman & Renshaw

Thank you.

T. Kendall Hunt - Chairman, CEO

Thanks, Amit.

Operator

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

Joe Maxa - Dougherty & Company

Thank you. Ken, your guidance for the full year of 25% to 35% revenue growth, there's also a comment in the press release that you're expecting the growth to accelerate in the back half of the year. Is that what's factored into the guidance and what we should be thinking about second half of the year being much higher than the first half of the year?

T. Kendall Hunt - Chairman, CEO

Yes, that's true.

Joe Maxa - Dougherty & Company

Okay, I just wanted to -

T. Kendall Hunt - Chairman, CEO

That's the way we look at it.

Joe Maxa - Dougherty & Company

All right. Thank you. I wanted to clarify that.

And then Cliff, on the tax rates, should we be thinking, based on your comments, that the 31% tax rate would be the highest you would expect to see in the near future?

Cliff Bown - EVP, CFO

Well, the tax rate really will vary by where the earnings are. Under our new structure - and we've talked about this a couple of times in 2007, but it is very complex - with our new structure we've moved the ownership of the intellectual property basically to Switzerland and to the United States. And those two entities have rights within defined reasons. The Swiss entity basically owns the intellectual property and the rights to market it throughout the world with the exception of the Americas, where the U.S. has those rights.

So the overall tax rate will be a function of where those earnings are and where the expenses are incurred and the use of the NOL.

So I'm not sure, Joe, if I'm addressing this very well, but as we go forward over the next five years, both the U.S. and the Swiss company have to buy the intellectual property rights from the other countries that previously owned it. But during that time period, the other countries - the Belgians, the Australias, the Singapores - those will all be basically generating profits and more likely to be guaranteed profits because we transferred the business risk more from them to the Swiss company and to the U.S. company. But the amount of profits should be lower, and therefore we should minimize the amount of taxes that we're paying in those jurisdictions.

What happened in the fourth quarter of this year was indicative of what can happen if some deals don't happen in the quarter that were expected to happen in the quarter or for the full year. That reduces the overall profitability; then we look to see what region that reduction happened. In this case it was European sales, primarily banking, which would have been at a reasonably low tax rate, the Swiss tax rate.

Also within the context of the United States, we hit the profitability there that we had forecasted where we could use NOLs to offset those items of income. The combination of those two factors was really what drove the tax rate for 2007 higher than we'd previously forecast.

Joe Maxa - Dougherty & Company

I see.

Cliff Bown - EVP, CFO

But going forward, we would anticipate that we would - we believe that the overall tax rate will come down in 2008 and certainly come down even more dramatically once the buy-ins are done.

T. Kendall Hunt - Chairman, CEO

And by the way, it's the only reason we've gone to the - one of the main reasons that we've gone to the effort of setting up the operation in Switzerland. A reminder, the plan - that took about two years to start the execution - was to find a location where we could excellent global middle managers to build out our management team and at the same time have a place of business where we could optimize our taxes. So certainly our goal, our plan, is to reduce our taxes going forward.

The other key strategy behind Switzerland was work rules. You know, when we looked around the world and particularly within Europe, we saw that the work rules in Switzerland were much more conducive toward business, much more favorable toward business, more comparable to the United States, where many of the other European countries tend to have a lot more rules regarding the workforce and how you can add people or reduce people - the cost of the social systems, et cetera, et cetera.

So Switzerland had a number of advantages - high quality workforce, better work rules, and more favorable taxes.

Joe Maxa - Dougherty & Company

Okay. Very good. That's all I have, guys. Thank you.

T. Kendall Hunt - Chairman, CEO

Thank you, Joe.

Operator

Thank you. (Operator Instructions) Our next question comes from Jordon Roberts from Jefferies and Company, Inc.

Jordon Roberts - Jefferies and Company, Inc.

Hi, guys. First off I was hoping you could maybe provide any color on deferred revenue growth in '08? I mean, it's obviously been pretty brisk the last few quarters. Can we expect it to continue at this trend or slow down a little bit?

Cliff Bown - EVP, CFO

Well, there are a couple of factors that are affecting the deferred revenue. One is the increase in maintenance and support because obviously those are going to be earned over the period of the maintenance.

The second is due to some fairly specific technical accounting terms. For those that follow software companies, you're aware of the concept of bundled transactions and something called VSOE - vendor specific objective evidence.

What has happened in 2007 is, as we have moved to redefine our product structure, we have created in some cases a structure where we cannot demonstrate VSOE. For VSOE to be demonstrated, you have to show specific evidence of what the value of each element of that bundled transaction is, and as we were creating new types of transactions, we could not demonstrate VSOE on some of the new offerings.

Those items weren't deferred just for the maintenance, but they were deferred for the total transaction - the Digipass hardware, the software, and the maintenance and support all had to be deferred over the term of the maintenance and support.

As we move into 2008, we would expect that to moderate a bit because we will then be able to demonstrate VSOE as those maintenance agreements, if they were annual maintenance agreements, renew. And so we have to go through a cycle here of once we define new products, we're bundling those products, those new structures will be deferred in their entirety until we get to a point where we see renewals and can start to demonstrate VSOE for each of the elements of that deal.

So long answer - the short answer would be we expect that in 2008 the deferred revenue would moderate a bit more because it would be more just maintenance and support going into deferred revenue instead of entire transactions.

Jordon Roberts - Jefferies and Company, Inc.

Across or historical level?

Cliff Bown - EVP, CFO

It would be more reflective of historical levels of increases, yes.

Jordon Roberts - Jefferies and Company, Inc.

Great. And then just a real quick follow up here. You know, when Ken was talking about, you know, kind of macro concerns driving or perhaps driving increased investment in Internet banking in the U.S., I mean, is that something you're actually seeing start to materialize at all when you're talking to customers? Are you looking at your pipeline or is that more kind of theory at this point?

T. Kendall Hunt - Chairman, CEO

Jan, why don't you answer that question? The question really is, I think, directed towards the U.S. and whether or not the banks are indeed investing in these online banking initiatives to cut costs, basically.

Jan Valcke - President, COO

Okay. So first of all, to make it very clear, to use our products in retail banking, the banks must offer transaction applications toward the customers. Today, that is not the case in the U.S. Most of the banks, they're offering traditional balance information and when it comes to transaction it is to predefined accounts.

We see a trend in the U.S. market that's a slowing but changing attitude that banks are more and more offering applications where real strong authentication will be needed. So basically I should say you can see it on your own when you see that banks will offer applications that - or let's say transaction applications  that need strong authentication, then you will see that the market is ready for strong authentication products.

Jordon Roberts - Jefferies and Company, Inc.

Ken, I mean, yeah, I understand that you guys aren't, you know, you're still waiting for kind of the retail start in the U.S., but did I understand what you were saying correctly? I mean is that what you were referencing when you made that comment?

T. Kendall Hunt - Chairman, CEO

Yeah. That's right. And don't forget, our strategy worldwide historically has been to go into a bank, make the first sale with the business unit that is supporting the corporate clients of the bank, install our VACMAN Controller, get that program up and running, and then be introduced over to the other department, which is the retail or consumer department. And that is the strategy that we deploy worldwide, and that's the strategy that we're deploying here in the United States.

Operator, we have time for one more question.

Operator

Thank you. Our next question is coming from Martin Yokosawa from Oberweis Asset Management.

T. Kendall Hunt - Chairman, CEO

Hi, Martin.

Martin Yokosawa - Oberweis Asset Management

I just jumped on for a second. I just wanted to check back with something. The delayed orders, how much was it - the pushed out orders?

T. Kendall Hunt - Chairman, CEO

$3.6 million.

Martin Yokosawa - Oberweis Asset Management

Okay. Okay, nothing to do with $6 million, right? I thought I heard somebody say that.

T. Kendall Hunt - Chairman, CEO

No, it was 3.6.

Martin Yokosawa - Oberweis Asset Management

Those first two, the delays, you know, the security certificate and the final testing, does that - you said they're completed. Does that mean it's going to be in the first quarter?

T. Kendall Hunt - Chairman, CEO

Not necessarily all in the first quarter. Our comment was it's in 2008.

Martin Yokosawa - Oberweis Asset Management

Yeah.

T. Kendall Hunt - Chairman, CEO

I don't have precise numbers.

Martin Yokosawa - Oberweis Asset Management

Okay. And then the deployment schedule, is that - and there's no timeframe on that because it just depends on what that customer's going to roll out, or can you give us any color on it?

T. Kendall Hunt - Chairman, CEO

I don't know. Jan probably has the closest [inaudible], to be honest, to when those are scheduled to ship.

Jan Valcke - President, COO

The deployment starts in the first quarter, but that does not mean that all will be delivered in the first quarter.

Martin Yokosawa - Oberweis Asset Management

Okay. That's good enough. And what was kind of interesting, the opportunity with the banking and, you know, the cost-effective channel makes sense, but have you seen evidence that this is actually - the banks are actually embracing that idea and executing it?

T. Kendall Hunt - Chairman, CEO

Jan? The answer's yes.

Jan Valcke - President, COO

The answer's yes, yeah.

Martin Yokosawa - Oberweis Asset Management

And any empirical evidence for us or anything? Can you - other than yes? I mean, they're aggressively, they are several banks, there's - any -

Jan Valcke - President, COO

What is typically in banking is that - and that's not only in the U.S. but in the whole world - is that banks, when there is one bank starting that the others will follow.

So I should say for retail banking - again, it has nothing to do with will the U.S. consumer use tokens, will they use several tokens for several accounts? Really, that has nothing to do with it. It has to do everything with the applications, that today the application does not need strong authentication. And we see some banks moving forward. We see also that at all banking summits. At our road show that we are doing in the U.S. we get more and more attraction, yeah, that more and more people are attending our summits.

Martin Yokosawa - Oberweis Asset Management

Thank you. I appreciate your comments.

T. Kendall Hunt - Chairman, CEO

Sure, yeah. Ladies and gentlemen, that concludes our conference call for today. I want to thank everybody for attending. I want to thank everybody for their attention. And as always, I want to thank VASCO people around the world for their hard work, execution and performance. Good morning, everybody.

Operator

Thank you. That does conclude today's VASCO conference call. You may now disconnect and have a wonderful day.

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