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Executives

T. Kendall Hunt – Chairman and Chief Executive Officer

Jan Valcke – President and Chief Operating Officer

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

Analysts

Brian Freed – Wunderlich Securities, Inc.

Elizabeth Colley – Needham & Company

Joe Maxa – Dougherty & Company LLC

VASCO Data Security International, Inc. (VDSI) Q3 2012 Guidance Update Conference Call October 9, 2012 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the VASCO Data Security International Inc. Q3 2012 Guidance Update 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).

I’d now like to turn the conference over to our conference leader Mr. T. Kendall Hunt, Founder, Chairman, and CEO. Please go ahead, sir.

T. Kendall Hunt

Thank you, operator. Before we begin the conference call, I’d like to brief all of you on forward-looking statements. Statements made in this conference call that relate to future plans, events or performances are forward-looking statements. Any statement containing words such as believes, anticipates, plans, expects, projects and similar words is forward-looking, and these statements involve risks and uncertainties and are based on current expectations.

Consequently, actual results could differ materially from the expectations expressed in these forward-looking statements. I direct your attention to the company's filings with the U.S. Securities and Exchange Commission for a discussion of such risks and uncertainties in this regard.

Good morning, everyone. Earlier today, we issued a press release stating that we expect revenues for the third quarter of 2012 to be approximately $36 million and that we also expect to fall short of our previously published guidelines for full year 2012 revenue and operating income as a percent of revenue.

Our current revenue estimate for Q3 2012 of $36 million is approximately 12% lower than our revenues for Q3 2011. The estimate of revenue for the quarter is subject to completion of our normal quarterly review processes, which we expect to compete on or around October 25, 2012.

We currently believe that our revenue for full year 2012 will be in the range of $150 million to $157 million, down from previous guidance of $175 million or more. We also believe that our operating income, excluding amortization of acquisition related intangible assets will be in the range of 11% to 13% of revenue, down from our previous guidance of 13% to 16% of revenue.

We are very disappointed to inform you of this news. The lower than expected revenues for the third quarter and our lower guidance for the full year 2012 reflects the fact that our order intake in the third quarter of 2012 for delivery in both the third and fourth quarters of 2012 was below our expectations.

We believe that the shortfall and order intake is primarily related to timing of the receipt of orders from the banking market. We do not believe that the shortfall and order intake reflects a fundamental weakening of either the global banking market or our competitive position in that market. Many of the purchase orders our sales organization had expected to receive from the procurement departments of our banking customers, failed to materialize during the third quarter. We believe that they were delayed for a number of reasons including but not limited to the unanticipated delays and increased complexity of the procurement processes of our customers.

In these uncertain economic times, it appears that our customers are being more demanding relative to the terms of the deals and more cautious in the issuance of purchase orders. It is important to note that, we have not received cancellation of the orders, just delays.

We expect that most if not all of the delayed purchase orders will be issued either in Q4, or early in 2013. That said, given the limited time remaining in the year, such delayed orders, even if received in Q4, may not result in Q4 revenues. While the forecast processes inevitably include a significant amount of subjective judgment relative to both the amount and timing of orders from customers, which leads to an inherent uncertainty, the current result is unacceptable to executive management and we believe we must and can do a better job forecasting in the future.

Executive management is actively evaluating our forecasting processes and will be implementing new processes and taking other actions to improve our forecasting. I will provide you an update on these actions taken at our regular earnings conference call at the end of the month.

Notwithstanding this immediate disappointment, our pipeline of new orders remain strong and we are encouraged by the fact that, we continue to participate in a number of significant RFPs and expect to win many of these opportunities.

At this time, I would like to open the call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) One moment please for your first question. Our first question is from the line of Brian Freed with Wunderlich Securities.

Brian Freed – Wunderlich Securities, Inc.

Good morning, Ken. I have three quick questions. The first is, can you give a little more color around geographic concentration, specifically was, where Europe the primary source of weakness in the quarter, or was it more broad-based than that? Second, can you give us any additional color on the Enterprise segment versus the Banking? Did the enterprise side of your business meet objectives? And then third, any update you can give us on and did you pass the service?

T. Kendall Hunt

Yes, as far as the areas are concerned, the area that gave us the most challenges was indeed EMEA. We had a good performance in the other geographic areas. So it was focused on EMEA mainly. As far as enterprise is concerned, we were below last year, below our internal targets. I think to some degree that maybe the fact or driven by the fact that we’re a little under head count, planned head count for salespeople in that unit. We’re finding recruiting a little more challenging than we thought, because in uncertain economic times, sometimes it’s harder to get really good people to move from their current companies.

And as far as DPS, I think we’re making progress. You’ve seen some announcements about different transactions, different partnerships, improvement in the products like our MYDIGIPASS.COM platform now has three different languages. So we’re encouraged by it. It’s not, historically hasn’t gone as fast as we want, but we’re making good progress and we’re still optimistic.

Brian Freed – Wunderlich Securities, Inc.

All right, thanks.

Operator

Thank you. (Operator Instructions) Our next question is from the line of Elizabeth Colley with Needham & Company.

Elizabeth Colley – Needham & Company

Hi, can you tell us about the person you see purchasing at the large banks? Is it still on the commercial side of banking, is the buyer still the same?

T. Kendall Hunt

Jan, why don’t you answer that question? Elizabeth, I will let Jan answer the question, but just introduce it. Historically, our banking business has been stronger and areas outside the United States and believe it or not, the largest audience using our products is the retail or consumer banking customer. Here in the United States just the opposite. It’s mainly the corporate user. Jan, would you like to add some color to that?

Jan Valcke

Yeah, basically the way it works thus far…

T. Kendall Hunt

Jan, I think you are too far away from the speaker.

Jan Valcke

Sorry, is it better now?

T. Kendall Hunt

Yeah, it’s better. Thank you.

Jan Valcke

So basically there are four departments that are in the role for taking the decision if it comes to security mainly for consumer banking. The first one is, of course, the security officers that gives advice on the level of security that is needed by the application. The second one is the IT department, because a lot of the software needs to be integrated on that platforms.

The third one is marketing, because the DIGIPASSES need to deployed, sold to the customers even if they’re giving it always for free, it is still a marketing challenge to do that. And fourth one is procurement. Now and above that, it is always a VP or a Senior VP that takes the final decision. That’s the way it works. Normally, there is a decision to go for one vendor and then procurement contemplates and then there is long discussions today with procurement, with legal about the content of the contract, not to anymore about the business decisions, but all terms and conditions in our business and so on.

Elizabeth Colley – Needham & Company

Okay. Thank you.

Jan Valcke

Does that answer your question?

Elizabeth Colley – Needham & Company

It does. Thank you.

Operator

Thank you. (Operator Instructions) Our next question is from the line of Joe Maxa with Dougherty & Company.

Joe Maxa – Dougherty & Company LLC

Thank you. Ken, I’m just curious, can you give us an idea like the timeframe of when you started to see these orders be pushed out. Given that first half was a record order intake and you had very strong backlog in the Q2. Just kind of get an idea of how that transpired during the quarter?

T. Kendall Hunt

Yeah, it was a little deceiving as we’ve announced. We saw that you will recall that we started the year with a backlog that was in a deficit compared to the year earlier. Entering 2011, we had a backlog of about $56 million. And most of that backlog was actually shipped and recorded its revenue in 2011.

Entering 2012, we had a backlog of about $33 million, so about a $23 million deficit compared to the year earlier. Comparatively though, our order intake was stronger and we reported that every quarter. And by the end of the second quarter, it was the highest order intake in the company’s history. And in fact, because of the so high, even at the end of the third quarter, order intake was higher than last year.

As far as what happened, I’m not exactly sure, I haven’t talked to all the procurement officers and why they delayed of pulling the trigger and issuing the purchase order. We can’t do anything unless we have a purchase order. I’m not sure if I know for sure, my suggestion or thought processes is that, it’s just generally the malaise and concerned in the Euro Zone. We don’t like to lay that off, but I’m not sure what else do as I said and as Jan said, we feel the procurement department is a lot more thorough and a lot more demanding than they’ve ever been.

Clifford K. Bown

Yeah, Joe just a few metrics, this is Cliff. When we talk about the order intake being strong in the first half, it actually was about 44% stronger than last year in the first quarter, 55% stronger than last year through the first six months, and then the third quarter was 31% weaker. So the specific answer to your question is, we only saw the issue cropping up in the third quarter, and within Europe as you know in our seasonality, third quarter is always a period of heavy vacations in Q3.

So we really needed to see the full quarter numbers for Q3 and the comparisons before we knew where we would be for the full year. So the answer specifically is Q3 is when we thought at the end of Q3 year-to-date, our order intake is about 18% stronger than it was last year, but at 18%, it’s not enough to overcome the backlog deficit entering the year that Jan or Ken mentioned.

Also, the pattern of delivery was different this year than last year. As I said a few minutes ago a great percentage of the backlog going into 2011 was shipped in 2011, the patterns are little different, has evolved to be different in 2012. A lot of the backlog that we have, a lot of the RFPs that we expect to get before the end of the year won’t be shipped until 2013 and beyond.

Joe Maxa – Dougherty & Company LLC

So, Ken, are you still seeing a number of large 12-month POs that you historically have, I know they went away during the last recession, but are you seeing any slippage of that?

T. Kendall Hunt

We’re seeing some slippage. I think one of the additional big difference is that would be comparing 2012 to 2011. Last year, we had several very, very large deals. A typical large deal is $1 million or $2 million or bigger. Last year we had some monsters. We expected that we might have some large deals in 2012, we could see that in the forecast, but we didn’t have enough additional medium size large deals to overcome these three very, very large transactions last year.

Joe Maxa – Dougherty & Company LLC

Okay. And lastly from me is just the, you talked about the complexity of the procurement process, can you just elaborate on that a bit again?

T. Kendall Hunt

Well, the way it works in an RFP is that, you compete for the business and sometimes even if you have a customer, you compete for the business, so I want to keep you honest. And I would like to say, we haven’t lost any competitive fields. Once we win the deal, once the operating manager or the department manager says okay, VASCO you won it, you still have to go to procurement and negotiate the deal.

And procurement is always trying to do the best transaction they can for their company. And in today’s environment, I think they feel like they have an opportunity to do better than in non-challenging environment. So they are trying to negotiate the best price they can, the best terms they can, and that takes time, because they might be asking for terms that they didn’t last time. So that takes time, with legal it takes time to negotiate all those terms. So that’s I think what is different than past years.

Joe Maxa – Dougherty & Company LLC

Then I got one more based on that. So does that suggest that there have been a little bit more strict on terms and getting the best deal, should we be looking at your margins as potentially coming off a bit?

T. Kendall Hunt

Cliff, I don’t see it. Our business is evolving into more software. The transactions that drive our margins down are the really, really large transactions, where we get volume discounts. As we do smaller deals, the gross margins are going to be a little higher as we do more software, that’s very high margin blending together, we’re probably in the mid 60 range.

Clifford K. Bown

Yeah, to add a little more color on that, Joe, I would say, no. It’s not having a significant effect on margins. The competitive landscape is still largely the same with Gemalto being our most notable global competitor in the banking segment, or as they being the most notable competitor globally in the enterprise and application security.

We don’t believe that their cost structures have changed a lot neither have ours. So when it comes to pricing and what the other firms are bidding, we haven’t seen any subsidy of change there. The more strict terms generally relate to the kinds of warranties that they are looking for in the intellectual property. The indemnifications that they are looking for in terms of direct versus indirect damages, the time periods for prepayment of the invoices and those kinds of things. So it’s a fairly detailed legal review of all of the other terms and conditions within the contracts with price being largely determined by what the competitors are doing.

Joe Maxa – Dougherty & Company LLC

All right. Thanks, guys.

Clifford K. Bown

You’re welcome, Joe.

Operator

Thank you. Our next question is from the line of [Robby Ganten] a Private Investor.

Unidentified Analyst

Hi. I was just wondering if you had any comments on the acquisition of PhoneFactor by Microsoft regarding your competitive positioning.

T. Kendall Hunt

I don’t have a comment on it. I don’t know that we see PhoneFactor’s competitor. So no, I don’t have any comments.

Unidentified Analyst

Thank you.

T. Kendall Hunt

You’re welcome.

Operator

Thank you. (Operator Instructions) Our next question is a follow-up from the line of Brian Freed with Wunderlich Securities.

Brian Freed – Wunderlich Securities, Inc.

Hey, a quick follow-up on the operating expense side of things. You kind of indicated gross margin hadn’t seen a material shift in the quarter. As we look at operating margin, how should we think about OpEx in absolute dollar? Should we think of it is fairly similar to the June quarter in September or have there been hiring an investment activities that would tend to ramp that up?

Clifford K. Bown

Brian, I would consider more in the context of the second quarter. The exchange rates haven’t changed a great deal. We haven’t done any significant new investment in Q3. And in fact, as I mentioned before, Q3 is a heavy period of holidays in Europe. And with that a lot of the salary expense we would normally have go against accruals for those holidays. So I would expect in general that our OpEx in Q3 would be stable to slightly down from where it was in Q2. And at this stage and as we’ve talked before, we don’t plan any significant new investments or had not planned any significant new investments in 2012. So the overall run rate, I think you should view as reasonably stable.

Brian Freed – Wunderlich Securities, Inc.

Okay. Thanks so much.

Operator

Thank you. (Operator Instructions) And at this time, I’m showing that we have no further question.

T. Kendall Hunt

All right, thank you, operator. Well, thanks to everybody for coming to our updated guidance call. Again, we’re disappointed that we have to deliver this news. But as I also said before, we’re still optimistic, because our pipeline of orders in our forecasting system is strong. We have a lot of activities in RFP participation, and so we are still very, very optimistic. With that, I’ll update everybody a good day.

Operator

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

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