Item 1 - Business
VASCO Data Security International, Inc. was incorporated in the State of Delaware in 1997 and is the successor to VASCO Corp., a Delaware corporation. Our principal executive offices are located at 1901 South Meyers Road, Suite 210, Oakbrook Terrace, Illinois 60181; the telephone number at that address is 630 932 8844. Our international headquarters in Europe is located at World-Wide Business Center, Balz-Zimmermannstrasse 7, CH-8152, Glattbrugg, Switzerland; the phone number at this location is 41 (0)43 555 3500. Our principal operations offices in Europe are located at Koningin Astridlaan 164, B-1780 Wemmel, Belgium and the telephone number at that address is 32 (0)2 609 9700. Unless otherwise noted, references in this Annual Report on Form 10-K to “VASCO”, “company”, “we”, “our”, and “us” refer to VASCO Data Security International, Inc. and its subsidiaries.
Additional information on the company, our products and services and our results, including the company’s annual report on Form 10-K, quarterly reports on our Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with the Securities and Exchange Commission (the “SEC”) are available, free of charge, on our website at https://www.vasco.com. You may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our reports are filed electronically with the SEC and are also available on the SEC’s website (http://www.sec.gov).
General
VASCO is an IT security company that designs, develops and markets security solutions that secure and manage access to digital assets and protect transactions. VASCO is a world leader in providing two-factor authentication and digital signature solutions to financial institutions. VASCO solutions secure access to data and applications on-premise in global enterprises and in the cloud, and provide tools for application developers to easily integrate security functions into their web-based and mobile applications. Two-factor authentication (also known as 2FA) strengthens the process of verifying the identity of users by means of a combination of two different components. These components may consist of something that the user knows, such as username, and another item that the user possesses, such as a VASCO hardware or software authenticator that generates a one-time password (OTP). Two-factor authentication is a type of multi-factor authentication. VASCO’s security solutions include both open standards-based and proprietary solutions, some of which are patented products and services used for authentication, digitally signing transactions and documents, and identity management in Business-to-Business (“B2B”), Business-to-Employee (“B2E”) and Business-to-Consumer (“B2C”) environments.
Historically, we have focused on two target markets, the banking and/or financial services market (which we refer to as the “Banking Market” or “Banking”) and the enterprise and application security market (which we refer to as the “Enterprise and Application Security Market” or “Enterprise and Application Security”). Our target markets include all applications where individuals use a username and password to access assets, information, and transactions that have value.
In this increasingly connected world, online and mobile application owners and users benefit from our expertise in two-factor authentication, transaction signing, and application security. Our convenient and proven security solutions enable trusted interactions between businesses, employees, and consumers across a variety of online and mobile platforms.
In order to grow in this rapidly evolving market, VASCO has developed a growth strategy. Our strategy includes the following;
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Bringing the next generation of authentication and digital signature technologies to our customers to coincide with their authentication refresh cycles,
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Driving increased demand for our products in new applications and new markets,
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Increasing the adoption of our Authentication-as-a-Service and cloud-based solutions,
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Continuing to expand our client base in segments beyond our core business, and
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Acquiring security technology companies that either expand our technology portfolio or our customer base.
Our newest product offerings add risk-based solutions using a scoring mechanism to our existing authentication product lines. The risk-based solutions are being integrated into our on-premise, cloud-based, and mobile solutions. This enables us to offer our customers security that is appropriate for their task or transaction.
The number of people using the internet via computers, tablets, and smart phones continues to grow at a rapid pace. Consumers are embracing online and mobile purchasing and banking in ever-increasing numbers. Organizations of all types have an increasing number of employees and business partners accessing protected resources from remote locations. New business paradigms such as these introduce new security risks for all participants, especially banks, merchants, and online service providers. Large and powerful criminal hacking organizations have emerged. The criminal activities of private and state-sponsored hacking organizations has driven an increased need for security solutions and the expansion of regulations requiring organizations to improve their security measures to protect against hacking attacks and breaches. Several governments worldwide have recognized the risk associated with using fixed passwords for internet applications and have issued specific rules requiring two-factor authentication for online banking security. We anticipate that this trend may continue and that governments in other countries could prepare similar guidance or rules in order to protect their citizens’ online assets.
Our Background
Our predecessor company, VASCO Corp., entered the data security business in 1991 through the acquisition of a controlling interest in ThumbScan, Inc., which we renamed as VASCO Data Security, Inc. In 1996, we expanded our computer security business by acquiring Lintel Security NV/SA, a Belgian corporation, which included assets associated with the development of security tokens and security technologies for personal computers and computer networks. Also in 1996, we acquired Digipass NV/SA, a Belgian corporation, which was also a developer of security tokens and security technologies and whose name we changed to VASCO Data Security NV/SA in 1997.
In 1997, VASCO Data Security International, Inc. was incorporated and in 1998, we completed a registered exchange offer with the holders of the outstanding securities of VASCO Corp. In December 2006, we opened our international headquarters in Zurich, Switzerland. In 2007, we established wholly-owned sales subsidiaries in Brazil and Japan. In 2008 and 2009, we established wholly-owned sales subsidiaries in Mumbai, India and Bahrain, respectively. In 2011, we completed the establishment of our wholly-owned sales subsidiary in China and received our trade license for a new subsidiary in Dubai, United Arab Emirates.
Since the 1998 exchange offer, we have engaged in ten acquisitions and one disposition. Our most recent acquisitions have included Cronto Limited and Risk IDS Limited.
In May, 2013, we acquired Cronto Limited (“Cronto”), a provider of secure visual transaction authentication solutions for online banking. Cronto’s patented solution offers a robust, yet simple way to assure
that a financial transaction has not been compromised, or “hacked.” The Cronto solution has been integrated into VACMAN Controller and IDENTIKEY Server, VASCO’s security platforms that support VASCO’s entire family of strong authentication and e-signature products.
In May 2014, we acquired Risk IDS, a provider of risk-based authentication solutions to the global banking community. The platform is designed to evaluate the profile of the user requesting access to the system to determine the risk profile associated with the transaction. It features a real-time analysis engine that uses rules and statistical techniques to improve real-time fraud detection. The Risk IDS solution is being integrated into our family of strong authentication and e-signature products.
Our Approach
We believe that security solutions for authentication, digital signature, and identity management that protect access to financial accounts and internal and cloud applications as well as the integrity of transactions, must be broad in scope and address all of the critical aspects of data security. The market requirements for security continue to evolve and we are responding by expanding our solutions beyond traditional authentication to include more channels such as mobile and ATM security. We believe that effective security solutions must address and assimilate issues relating to the following:
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Speed and ease of implementation, use, and administration,
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Reliability,
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Interoperability within diverse applications on-premise and in the cloud,
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Scalability, and
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Overall cost of ownership.
Accordingly, we have adopted the following approach to data security in designing our products:
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Where appropriate, we incorporate industry-accepted, open and non-proprietary protocols. This permits interoperability between our products and multiple platforms, products, and applications widely in use.
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We minimize the effort required for implementation and integration with existing legacy applications and infrastructure.
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We try to offer a more attractive total cost of ownership than competing products and services.
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We support a wide variety of devices used to gain access to applications through the internet including personal computers, smart phones, tablets, and other personal devices.
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We develop products that are designed to provide a balance between ease of use and the strength of the underlying authentication technology used. Our single sign-on product allows users to access multiple applications using one credential. Some of our client products use quick-response (“QR”) codes that allow a user to minimize key strokes by optically scanning a QR code that may be encrypted, thus increasing the strength of the security being used.
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We provide multiple choices to our customers with our cloud service platforms. By using our authentication platform, customers can deploy two-factor authentication quickly.
As a result of this approach, we believe that we are a leading provider of two-factor authentication, digital signature, and identity management security solutions that can help reduce customers’ losses to fraud and hacking.
Our Products and Services
Our authentication product line provides a flexible and affordable means of authenticating users to networks and to web-based and mobile applications. Our products calculate dynamic passwords, also known as one-time passwords (“OTP”), that authenticate users logging onto networks or other applications. In addition, our products can be used to calculate digital signatures to protect electronic transactions and the integrity of the contents of such transactions.
Multi-factor authentication consists of several factors:
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What the user knows (such as a username or a PIN code);
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What the user has (such as a DIGIPASS authenticator, hardware or software version); and
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Who the user is (biometrics).
Our product family is currently based on the first two factors. Using our solution, to enter a remote system, access protected applications, or digitally sign a transaction, the user needs the following:
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Knowledge of either a username or a PIN code, and
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An authenticator, either a DIGIPASS hardware authenticator or a DIGIPASS software authenticator downloaded onto existing compatible device.
Both factors help ensure that the correct person is being granted access to an application, protected data, or signing a transaction, instead of a hacker. This helps reduce fraud and protect valuable assets.
VASCO’s primary product and service lines include three categories of solutions; Host System products, which is typically a component of an organization’s IT infrastructure, Client Authenticators, which are devices used by end users for authentication, and Developer Tools, which are used by application developers to increase the security of their mobile applications.
Host System products:
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VACMAN Controller: Core host system software authentication platform, combining all technologies on one unique platform;
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IDENTIKEY Authentication Server: Software that adds full server functionality to the VACMAN core authentication platform;
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Cloud Services: Authentication and digital signature software services for web and mobile application developers run on VASCO’s servers. This includes our DIGIPASS as a Service solution for cloud-based authentication services primarily for enterprise customers and our MYDIGIPASS solution for end user authentication in the cloud
Client Authenticator Products:
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DIGIPASS Hardware Authenticators: A broad family of multi-application hardware authenticators in a variety of form factors and feature sets to meet the diverse security needs of clients across multiple vertical markets. The hardware form factors include one-button, e-signature, card reader, PKI, and Bluetooth enabled devices.
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DIGIPASS Software Authenticators: These are authenticators that run on existing non-VASCO devices, such as PCs, mobile phones, tablets, etc. Built around our cornerstone DIGIPASS API, software authenticators include DIGIPASS for Apps (a library of security APIs for mobile applications), DIGIPASS for Mobile (a security application for mobile devices), DIGIPASS for Web (for web browsers), DIGIPASS for Windows (desktop application) and Virtual DIGIPASS (Server-Side generated OTP).
Developer Tools:
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In addition to being a client authentication device when downloaded onto a mobile device, DIGIPASS for Apps is also a comprehensive software development kit (“SDK”) that allows software developers to quickly and easily integrate application security elements and other security features into mobile applications.
We offer our Host System products in one of two models, an on-premise model or an in-the-cloud services model:
1. Our on-premise model, which is our traditional approach to the market, allows a customer to license our host system software for installation on their on-premise systems in their applications. Similarly, our customers purchase or license hardware or software authenticators that are distributed to the users of their systems or applications. Our on-premise model is ideally suited to instances where the application owner needs to control all critical aspects of security, which is often the case where there is either a high transaction value or a high frequency of use. Under our traditional approach, the client devices can generally only be used with one host system application.
Banking
Enterprise VPN Access
Enterprise Single Sign-on
2. Our in-the-cloud services model includes two product offerings that use the same operational platform:
a) DIGIPASS as a Service (“DPaaS”) is our cloud-based service offering that was announced in October 2010 with a focus on the needs of customers in the Enterprise and Application Security market. By using our DPaaS authentication platform, business customers can deploy two-factor authentication more quickly and incur less upfront costs when compared to an on-premise solution. DPaaS is targeted towards B2B and B2E applications (e.g., employees of companies logging into third party applications operated in the cloud or accessing corporate data and resources stored in the cloud).
b) MYDIGIPASS (“MDP”) is our cloud-based service offering that was announced in April 2012 with a focus on the needs of B2B and B2C. MDP facilitates password management while adding an additional level of security to the login procedure. By using our MDP platform, consumers using B2C applications have convenient access to these applications with increased security. The MDP platform may also provide benefits for eGovernment and eID applications by providing authentication for citizens that are accessing government applications online.
MYDIGIPASS Security in the Cloud
Detailed Product Descriptions:
VACMAN Controller
The VACMAN product line incorporates a range of strong authentication utilities and solutions designed to allow organizations to add DIGIPASS strong authentication into their existing networks and applications.
In order to provide the greatest flexibility, without compromising functionality or security, VACMAN solutions are designed to integrate with most popular hardware and software. Once integrated, the VACMAN components become largely transparent to the users, minimizing rollout and support issues.
VACMAN is the backbone of VASCO’s product strategy towards the banking and e-commerce markets. VACMAN encompasses all four authentication technologies (passwords, dynamic password technologies, certificates, and biometrics) and allows our customers to use any combination of those technologies simultaneously. VACMAN is natively embedded in or compatible with the solutions of over 100 VASCO solution partners.
Designed by specialists in system access security, VACMAN makes it easy to administer a high level of access control and allows our customers to match the level of authentication security used with their perceived risk for each user of their application. Our customer simply adds a field to his or her existing user database, describing the authentication technology used and, if applicable, the unique DIGIPASS assigned to the end user of their application. VACMAN takes it from there, automatically authenticating the logon request using the security sequence the user specifies, whether it’s a one-time password using either response-only or a challenge/response authentication scheme or an electronic signature.
VACMAN allows the user the freedom to provide secure remote access to virtually any type of application. VACMAN is a library requiring only a few days to implement in most systems and supports all DIGIPASS functionality. Once linked to an application, VACMAN automatically handles login requests from any user authorized to have a DIGIPASS.
IDENTIKEY Authentication Server
IDENTIKEY Authentication Server is an off-the-shelf centralized authentication server that supports the deployment, use, and administration of DIGIPASS strong user authentication. IDENTIKEY is based on VASCO’s core VACMAN technology.
IDENTIKEY Authentication Server is available in a Banking Edition and three versions for the Enterprise and Application Security market that can be easily upgraded.
The Banking Edition provides robust protection against man-in-the-middle (MITM) attacks, the highest security, and verified fit into existing PCI-DSS environments without reducing compliancy. This version includes:
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RADIUS functionality,
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Web filter support for access to in-house applications (OWA, RDWA, CWI, Receiver),
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Two-Factor Authentication for protection of access to internet banking applications,
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e-signature for validation of financial transactions, and
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Licenses for up to seven servers.
The three versions available to the Enterprise and Application Security market include:
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The Standard Edition includes Remote Authentication Dial In User Service (“RADIUS”) functionality for a single licensed server. It targets small and medium-sized business (“SMB”) wanting to secure their remote access infrastructure at the lowest total cost of ownership.
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The Gold Edition offers web filters to secure Outlook Web Access (“OWA”) and Citrix Web Interface (CWI”), additional to the RADIUS support. This version includes licenses for a primary and a back-up server. It is an ideal solution for SMBs that want to offer more functionality and assure availability for their employees.
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The Enterprise Edition is our most comprehensive solution, offering:
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RADIUS for remote access to the corporate network,
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Web filter support for access to in-house applications (OWA, CWI),
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Simple Object Access Protocol (“SOAP”) for protection of internet based business applications (e.g. portals, extranet, e-commerce websites, partner services, etc.), and
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Licenses for up to seven servers.
The Enterprise Edition is the optimum solution for SMBs that want to secure more than remote access by using the same DIGIPASS device to secure additional applications at little to no extra cost. It also addresses the need of large enterprises to set up a pool of replication servers to share the authentication load and assure high-availability, especially when securing an increased number of customers and partners who use web-hosted applications.
IDENTIKEY Appliance and IDENTIKEY Virtual Appliance
IDENTIKEY Appliance is a standalone authentication solution that offers strong two-factor authentication for remote access to a corporate network or to web-based in-house business applications. It comes in a standard 19 inch rack mountable “slim fit” design. The appliance verifies DIGIPASS/IDENTIKEY authentication requests from RADIUS clients and web filters and can easily be integrated with any infrastructure. It features a web based administration interface as well as an auditing and reporting console.
IDENTIKEY Virtual Appliance is a virtualized authentication appliance that secures remote access to corporate networks and web-based applications.
IDENTIKEY Federation Server
IDENTIKEY Federation Server is a server appliance that provides an identity and access management platform. It is used to validate user credentials across multiple applications and disparate networks. The solution validates users and creates an identity ticket enabling web single sign-on for different applications across organizational boundaries. IDENTIKEY Federation Server works as an Identity Provider within the local organization, but can also delegate authentication requests (for unknown users) to other Identity Providers. In a Federated Model, IDENTIKEY Federation Server not only delegates but also receives authentication requests from other Identity Providers, when local users want to access applications from other organizations within the same federated infrastructure.
Cloud Services (DPaaS and MDP)
In October of 2010, we launched our DIGIPASS as a Service security platform. Our initial DPaaS offering was directed at providing strong authentication for B2B and B2E applications. B2B applications are applications between two organizations that have an on-going relationship of some type. An example could be a manufacturer that has a web site through which a customer regularly purchases its products. VASCO’s DPaaS platform could be used to strongly authenticate the purchaser to prevent fraudulent activities. B2E applications are applications which have been outsourced by an organization. These could be sales reporting and forecasting applications, payroll and 401(k) plan administration applications, human resource applications, etc. that are operated in the cloud.
We launched MYDIGIPASS (“MDP”) in April 2012. MDP is directed at the B2B and B2C market. Our goal is to have the user securely access multiple applications with only one DIGIPASS. We believe that with this approach, we can bring two-factor authentication to a large number of online applications.
The combination of our core business line and service offering brings a large number of online applications within VASCO’s reach. While revenues generated from DPaaS and MDP to date have been minimal, we believe DPaaS/MDP has potential for future growth as it will make two-factor authentication more affordable and readily available to users and applications markets. We believe that this combination provides VASCO with a viable position in the market, giving us the opportunity to target web application owners and offer their end users convenience and security.
DIGIPASS Hardware Authenticators
We offer a wide variety of DIGIPASS authenticators, each of which has its own distinct characteristics to meet the needs of our customers. All models of the DIGIPASS family are designed to work together so that our customers can switch their users’ devices without requiring any changes to their existing infrastructure. Our hardware DIGIPASS models range from simple one-button devices to devices that include more secure technologies such as PKI.
With the acquisition of Cronto, VASCO has also added visual cryptography to its product portfolio. Sensitive transaction data are captured in a cryptogram that consists of a matrix of colored dots. By scanning the image with a hardware or software authenticator, the data contained in the cryptogram is decrypted and the transaction details are presented to the user for verification providing a highly secure method of visual transaction signing with maximum user convenience.
During 2014, we launched Bluetooth-enabled authentication and digital signature solutions that bring our high level of security to the increasing number of users of tablets and smart phones that have no USB port. VASCO’s Bluetooth Smart devices create an immediate virtual secure connection between the authenticator and the mobile device using a Bluetooth Smart connection,
Many DIGIPASS authenticators also combine the benefits of traditional password authenticators (authentication and digital signatures) with smart card readers. Together, they bring portability to smart cards and allow the use of secure time-based algorithms.
DIGIPASS hardware technology is designed to support authentication and digital signatures for applications running on desktop PCs, laptops, tablets, and smart phones.
DIGIPASS Software Authenticators
Our DIGIPASS Software authenticators are designed to provide our customers with increased security for access to their networks and applications without having to carry a standalone hardware device.
Many of our DIGIPASS Software authenticator models also balance the need for stronger mobile application security with the demands for user convenience by delivering comprehensive, built-in security for mobile applications, combined with a frictionless, “hands-free” authentication and e-signing experience for mobile users.
DIGIPASS for Apps is a software development kit that contains a library APIs (application programming interface) that allows application developers to add important security features to their mobile applications such as secure storage, secure communication channel, secure provisioning, device binding capabilities, jailbreak detection, rootkit detection, geolocation, IP address detection, and other security features. DIGIPASS for Mobile offers a similar set of security features as a downloadable mobile application.
Developer Tools:
In additional to serving as a software authenticator, DIGIPASS for Apps is a comprehensive software development kit (SDK) that allows application developers to natively integrate application security such as two-factor authentication and electronic signing into mobile applications. Through a complete library of APIs, application developers can extend and strengthen application security, deliver enhanced convenience to their application users, and streamline application deployment and lifecycle management processes.
Intellectual Property and Proprietary Rights and Licenses
We rely on a combination of patent, copyright, trademark and trade secret laws, as well as employee and third-party non-disclosure agreements to protect our proprietary rights. In particular, we hold several patents in the U.S. and in other countries, which cover multiple aspects of our technology. These patents expire between 2021 and 2033. In addition to the issued patents, we also have several patents pending in the U.S., Europe and other countries. The majority of our issued and pending patents cover our DIGIPASS family and other authentication related technology. We believe these patents to be valuable property rights and we rely on the strength of our patents and on trade secret law to protect our intellectual property rights. To the extent that we believe our patents are being infringed upon, we intend to assert vigorously our patent protection rights, including but not limited to, pursuing all available legal remedies.
Research and Development
Our research and development efforts historically have been, and will continue to be, concentrated on product enhancement, new technology development, and related new product introductions. We employ a team of full-time engineers and, from time to time, also engage independent engineering firms to conduct non-strategic research and development efforts on our behalf. For fiscal years ended December 31, 2014, 2013, and 2012, we incurred expenses of $19.5 million, $21.3 million, and $18.8 million, respectively, for research and development.
Production
Our security hardware DIGIPASS products are manufactured by third party manufacturers pursuant to purchase orders that we issue. Our hardware DIGIPASS products are made primarily from commercially available electronic components purchased globally. Our software products, including software versions of our DIGIPASS products are produced in-house.
Hardware DIGIPASS products utilize commercially available programmable microprocessors purchased from several suppliers. The microprocessors are the only components of our security authenticators that are not commodity items readily available on the open market. Some programmed microprocessors are single sourced. Orders of microprocessors generally require a lead-time of 12-16 weeks. We attempt to maintain a sufficient inventory of all parts to handle short-term increases in orders.
Large orders that would significantly deplete our inventory are typically required to be placed with more than 12 weeks of lead-time, allowing us to make appropriate arrangements with our suppliers. During 2013, we purchased a multi-year supply of certain microprocessors scheduled to be discontinued by a manufacturer. While we can re-engineer our products to use other processors when notified that a processor will no longer be produced, we believe that it is generally more cost effective to carry a multi-year supply than to re-engineer the product.
We purchase the microprocessors and arrange for shipment to third parties for assembly and testing in accordance with our design specifications. The majority of our DIGIPASS products are manufactured by four independent vendors domiciled in Hong Kong and Macau with production facilities in mainland China. Purchases from these companies are made on a volume purchase order basis. Equipment designed to test product at the point of assembly is supplied by us and periodic visits are made by our personnel for purposes of quality assurance, assembly process review and supplier relations.
Competition
The market for computer and network security solutions is very competitive and, like most technology-driven markets, is subject to rapid change and constantly evolving products and services. Our main competitors are Gemalto and RSA Security, a subsidiary of EMC Corporation. There are many other companies, such as Kobil Systems, SafeNet (acquired by Gemalto in 2014), Symantec, and Entrust that offer competing authentication hardware, software and services that range from simple locking mechanisms to sophisticated encryption technologies. In addition to these companies, we face competition from many small authentication solution providers many of whom offer new technologies and niche solutions such as biometric or behavioral analysis. We believe that competition in this market is likely to intensify as a result of increasing demand for security products. Visibility of global competitors and their planned actions has diminished over the last several years as some of our competitors have been acquired by larger corporations (e.g., EMC’s acquisition of RSA in 2006) or private equity firms (e.g., Entrust, acquired by Thoma Bravo in 2009 and subsequently sold to Datacard Group in 2013).
We believe that the principal competitive factors affecting the market for computer and network security products include the strength and effectiveness of the solution, technical features, ease of use, quality/reliability, customer service and support, name recognition, customer base, distribution channels, and the total cost of ownership of the authentication solution. Although we believe that our products currently compete favorably with respect to such factors, other than name recognition in certain markets, there can be no assurance that we can maintain our competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical, and other competitive resources.
Some of our present and potential competitors have significantly greater financial, technical, marketing, purchasing, and other resources than we do, and as a result, may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the development, promotion and sale of products, or to deliver competitive products at a lower end-user price. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. It is possible that new competitors or alliances may emerge and rapidly acquire significant market share. Accordingly, we have forged, and will continue to forge, our own partnerships to offer a broader range of products and capabilities to the market.
Our products are designed to allow authorized users access to a computing environment or application, in some cases using patented technology, as a replacement for or supplement to a static password. Although certain of our security token technologies are patented, there are other organizations that offer token-type password generators incorporating challenge-response or response-only approaches that employ different technological solutions and compete with us for market share.
Sales and Marketing
Our security solutions are sold worldwide through our direct sales force, as well as through distributors, resellers and systems integrators. Our traditional security solutions are sold through our direct sales force, as well as through approximately 52 distributors, their reseller networks and systems integrators. A sales staff of 102 coordinates our sales activity through both our sales channels and those of our strategic partners making direct sales calls either alone or with the sales personnel of our partners. Our sales staff also provides product education seminars to sales and technical personnel of vendors and distributors with whom we have working relationships and to potential end-users of our products.
VASCO secures and trains its channel. Over 1,200 staff members of our channel partners have become VASCO certified.
Our sales force is able to offer each customer a choice of an on-site implementation using our traditional on-premise model or a cloud implementation using our services platform.
Our DPaaS solution is sold primarily by our direct sales force calling on Enterprise and Application Security customers.
Our MDP solution is also sold primarily by our direct sales force and marketed to application owners. We will work with the application owners to develop marketing programs that will encourage users of the application to access that application through our services platform.
Part of our expanded selling effort includes approaching our existing strategic partners to find additional applications for our security products. In addition, our marketing plan calls for the identification of new business opportunities that may require enhanced security over the transmission of electronic data or transactions where we do not currently market our products. Our efforts also include various activities to increase market awareness of the MDP/DPaaS solutions as well as preparation and dissemination of white papers explaining how our security products can add value or otherwise be beneficial.
Customers and Markets
Customers for our products include some of the world’s most recognized names: HSBC, Rabobank, Belfius, Sumitomo Mitsui Banking Corporation, BNP-Paribas Fortis, Swedbank, The Bank of Tokyo-Mitsubishi, Citibank, and Commonwealth Bank of Australia.
Our top 10 customers contributed 46%, 40%, and 37%, in 2014, 2013, and 2012, respectively, of total worldwide revenue. In 2014, 2013, and 2012, HSBC contributed approximately 11%, 18%, and 10%, of our worldwide revenue, respectively. In addition, in 2014, Rabobank contributed 12% of our worldwide revenue.
A significant portion of our sales is denominated in foreign currencies and changes in exchange rates impact results of operations. To mitigate exposure to risks associated with fluctuations in currency exchange rates, we attempt to denominate an amount of billings in a currency such that it would provide a hedge against operating expenses being incurred in that currency. For additional information regarding how currency fluctuations can affect our business, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures about Market Risk.”
We experience seasonality in our business. Historically, these seasonal trends are most notable in the summer months, particularly in Europe, when many businesses defer purchase decisions; however, given the relatively small size of our business, the timing of any one or more large orders may temper or offset this seasonality.
We organize our sales group and report our results in two vertical markets:
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Banking, which includes Financial Institutions: Traditionally our largest market where we believe that there are substantial opportunities for future growth.
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Enterprise and Application Security: A significant market that includes:
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Businesses seeking secure internal and remote network access: We sell to this market primarily through distributors and resellers. Our strategy is to leverage products developed for the Banking market by selling them to businesses. We believe that our strength in this segment is largely related to selling remote access products to both SME (small and medium enterprises) as well as large corporations.
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Other application-specific markets: Our products are being used in a significant number of 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.
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E-commerce: Both business-to-business and business-to-consumer e-commerce are becoming ever more important for us.
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E-government: Our revenue in this market is still small, but we are ready to take advantage of the market’s evolution.
Our channel partners are critical to our success in selling to businesses in the Enterprise and Application Security markets. We serve this market exclusively via our two-tier indirect sales channel. We invest in and support our channel with marketing and public relations actions. Distributors and resellers get the tools they need to be successful, such as campaigns, case studies, marketing funds and more. We train employees of our resellers and distributors on-site and in our offices. In addition, we have developed online video training software that allows us to train people worldwide, resulting in cost- and time-saving benefits.
We expect that sales into the application security market, other than businesses, will be on a direct sale basis. We plan to add sales and marketing staff to help increase revenues from each of these targeted areas.
Backlog
Our backlog at December 31, 2014 was approximately $113 million compared to $42 million at December 31, 2013. We anticipate that substantially all of the backlog at the end of 2014 will be shipped in 2015. We do not believe that the specific amount of backlog at any point in time is indicative of the trends in our markets or the expected results of our business. Given the relatively small size of our business and the large size of potential orders, the backlog number can change significantly with the receipt of a new order or modification of an existing order, for example, shipment timing.
Financial Information Relating to Foreign and Domestic Operations
For financial information regarding VASCO, see our Consolidated Financial Statements and the related Notes, which are included in this Annual Report on Form 10-K. We have a single reportable segment for all our products and operations. See Note 12 in the Notes to Consolidated Financial Statements for a breakdown of revenue and long-lived assets between U.S. and foreign operations.
Employees
As of December 31, 2014, we had 371 total employees, which included 350 full-time employees. Of the total employees, 38 were located in the U.S., 305 in EMEA (Europe, the Middle East and Africa), 19 in the Asia Pacific Rim countries and 9 in other countries, including Australia, Latin America, India and Central Asia. Of the total employees, 179 were involved in sales, marketing, operations and customer support, 136 in research and development and 56 in general and administration.
Item 1A
Item 1A - Risk Factors
RISK FACTORS
You should carefully consider the following risk factors, which we consider the most significant, as well as other information contained in this Annual Report on Form 10-K. In addition, there are a number of less significant and other general risk factors that could affect our future results. If any of the events described in the risk factors were to occur, our business, financial condition or operating results could be materially and adversely affected. We have grouped our Risk Factors under captions that we believe describe various categories of potential risk. For the reader’s convenience, we have not duplicated risk factors that could be considered to be included in more than one category.
Risks Related to Our Business
A significant portion of our sales are to a limited number of customers. The loss of substantial sales to any one of them could have an adverse effect on revenues and profits.
We derive a substantial portion of our revenue from a limited number of customers, most of which are European or Asian headquartered banks. The loss of substantial sales to any one of them could adversely affect our operations and results. In fiscal 2014, 2013, and 2012, our top 10 largest customers contributed 46%, 40%, and 37%, respectively, of total worldwide revenue. In fiscal 2014, 2013, and 2012, HSBC contributed approximately 11%, 18%, and 10%, respectively, of total worldwide revenue. In addition, in 2014, Rabobank contributed 12% of total revenue principally due to an order for card readers incorporating our CrontoSign technology which began shipping in the third quarter of 2014 and scheduled to be completed by the third quarter of 2015.
HSBC has no long term contractual commitment to purchase products or services from us. HSBC and its affiliates only make purchase commitments pursuant to individual purchase orders placed with us from time to time, which are subject to our acceptance. The general commercial framework that applies to such purchases by HSBC may be terminated by HSBC at any time, without cause, on 90 days’ notice to us without payment of any termination charge by HSBC.
The return of a worldwide recession and/or an increase in the concern over the European sovereign debt crisis may further impact our business.
Our business is subject to economic conditions that may fluctuate in the major markets in which we operate. Factors that could cause economic conditions to fluctuate include, without limitation, recession, inflation, deflation, higher interest borrowing rates, higher levels of unemployment, higher consumer debt levels, general weakness in retail or commercial markets and changes in consumer or business purchasing power or preferences.
While it appears that circumstances that led to the sovereign debt crisis have abated, many significant economic issues have not been addressed fully. As a result, we expect that Europe will continue to face difficult economic conditions in 2015. If global economic and financial market conditions remain uncertain and/or weak for an extended period of time, any of the following factors, among others, could have a material adverse effect on our financial condition and results of operations:
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slower consumer or business spending may result in reduced demand for our products, reduced orders from customers for our products, order cancellations, lower revenues, increased inventories, and lower gross margins;
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continued volatility in the global markets and fluctuations in exchange rates for foreign currencies and contracts or purchase orders in foreign currencies could negatively impact our reported financial results and condition;
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continued volatility in the prices for commodities and raw materials we use in our products could have a material adverse effect on our costs, gross margins, and ultimately our profitability;
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if our customers experience declining revenues, or experience difficulty obtaining financing in the capital and credit markets to purchase our products, this could result in reduced orders for our products, order cancellations, inability of customers to timely meet their payment obligations to us, extended payment terms, higher accounts receivable, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense;
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in the event of a contraction of our sales, dated inventory may result in a need for increased obsolescence reserves;
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a severe financial difficulty experienced by our customers may cause them to become insolvent or cease business operations, which could reduce the availability of our products to consumers; and
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any difficulty or inability on the part of manufacturers of our products or other participants in our supply chain in obtaining sufficient financing to purchase raw materials or to finance general working capital needs may result in delays or non-delivery of shipments of our products.
While we believe that many of the effects of the recession and credit crisis have abated, we are unable to predict potential future economic conditions, disruptions in the sovereign debt markets or other financial markets, the Euro Monetary Union or the European Union, or the effect of any such disruption or disruptions on our business and results of operations, but the consequences may be materially adverse. We believe that our business in the Banking market in Europe would be impacted most directly by any such disruption and that the consequences may be materially adverse, as approximately 64% of our consolidated revenues originated in the EMEA region in 2014.
Disruptions in markets or the European Union may affect our liquidity and capital resources.
We believe our financial resources and current borrowing arrangements are adequate to meet our operating needs. However, difficult economic conditions existing on a worldwide basis today may require us to modify our business plans. Disruptions in the sovereign debt markets or other financial markets, the Euro Monetary Union or the European Union, could materially adversely affect our liquidity and capital resources and expose us to additional currency fluctuation risk.
Furthermore, in the current economic environment there is a risk that customers may delay their orders until the economic conditions improve further. If a significant number of orders are delayed for an indefinite period of time, our revenue and cash receipts may not be sufficient to meet the operating needs of the business. If this is the case, we may need to significantly reduce our workforce, sell certain of our assets, enter into strategic relationships or business combinations, discontinue some or all of our operations, or take other similar restructuring actions. While we expect that these actions would result in a reduction of recurring costs, they also may result in a reduction of recurring revenue and cash receipts. It is also likely that we would incur substantial non-recurring costs to implement one or more of these restructuring actions.
We have a long operating history, but only a modest accumulated profit.
Although we have reported net income of $33.5, $11.1 million, and $15.6 million for the years ended December 31, 2014, 2013, and 2012, respectively, our retained earnings were only $125.9 million at December 31, 2014. Over our 22 year operating history, we have operated at a loss for many of those years. In the current uncertain economic environment, it may be difficult for us to sustain our recent levels of profitability.
We derive revenue from a limited number of products and do not have a broadly-diversified product base.
Substantially all of our revenue is derived from the sale of authentication products. We also anticipate that a substantial portion of our future revenue, if any, will also be derived from these products and related services. If the sale of these products and services is impeded for any reason and we have not diversified our product offerings, our business and results of operations would be negatively impacted.
The sales cycle for our products and technology is long, and we may incur substantial expenses for sales that do not occur when anticipated.
The sales cycle for our products, which is the period of time between the identification of a potential customer and completion of the sale, is typically lengthy and subject to a number of significant risks over which we have little control. If revenue falls significantly below anticipated levels, our business would be seriously harmed.
A typical sales cycle in the Banking market is often six months or more. Larger Banking transactions may take up to 18 months or more. Purchasing decisions for our products and systems may be subject to delays due to many factors that are not within our control, such as:
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The time required for a prospective customer to recognize the need for our products;
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The significant expense of many data security products and network systems;
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Customers’ internal budgeting processes; and
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Internal procedures customers may require for the approval of large purchases.
As our operating expenses are based on anticipated revenue levels, a small fluctuation in the timing of sales can cause our operating results to vary significantly between periods.
We have a great dependence on a limited number of suppliers and the loss of their manufacturing capability could materially impact our operations.
In the event that the supply of components or finished products is interrupted or relations with any of our principal vendors is terminated, there could be increased costs and considerable delay in finding suitable replacement sources to manufacture our products. The majority of our products are manufactured by four independent vendors domiciled in Hong Kong and Macau. Our hardware DIGIPASSES are assembled at facilities in mainland China. The importation of these products from China exposes us to the possibility of product supply disruption and increased costs in the event of changes in the policies of the Chinese government, political unrest or unstable economic conditions in China or developments in the United States that are adverse to trade, including enactment of protectionist legislation.
We order processors well in advance of expected use and produce finished goods prior to the receipt of customer orders. If orders are not received, we could suffer losses related to the write down or write off of inventory that cannot be sold at full value.
In an attempt to minimize the risk of not having an adequate supply of component parts to meet demand, especially in situations where we have been notified that key processors will no longer be manufactured, we purchase multiple years’ supply of processors based on internal forecasts of demand. In addition, to meet customers’ demands for accelerated delivery of product, we produce finished product for existing customers before we receive the order from the customer. Should our forecasts of future demand be inaccurate or if we produce product that is never ordered, we could incur substantial losses related to the write down or write off of our inventory.
Our customers have the ability to reschedule their deliveries.
Prior to 2009, a major portion of our business was scheduled by our customers under purchase orders which called for multiple shipments over the course of 12 months. Typically, these were firm orders with specific requests for shipments on specified dates. Historically, a customer may have requested that a shipment be accelerated and delivered earlier than scheduled or, conversely, delayed and delivered later than originally scheduled, or in rare cases, cancelled. In 2009 and in 2010, we experienced instances in which customers delayed delivery shipments or placed smaller orders covering shorter periods of time. Subsequent to 2010, many of our larger customers returned to order patterns more similar to their earlier historical patterns. However, in the future, they may delay shipments or order small quantities covering shorter periods of time. Our results may differ substantially from period to period based on orders delivered in that period.
Our success depends on establishing and maintaining strategic relationships with other companies to develop, market, and distribute our technology and products and, in some cases, to incorporate our technology into their products.
Part of our business strategy is to enter into strategic alliances and other cooperative arrangements with other companies in our industry. We currently are involved in cooperative efforts with respect to the incorporation of our products into products of others, research and development efforts, marketing efforts and reseller arrangements. None of these relationships are exclusive, and some of our strategic partners also have cooperative relationships with certain of our competitors. If we are unable to enter cooperative arrangements in the future or if we lose any of our current strategic or cooperative relationships, our business could be harmed. We do not control the time and resources devoted to such activities by parties with whom we have relationships. In addition, we may not have the resources available to satisfy our commitments, which may adversely affect these relationships. These relationships may not continue, may not be commercially successful, or may require our expenditure of significant financial, personnel and administrative resources from time to time. Further, certain of our products and services compete with the products and services of our strategic partners.
We may not be able to maintain effective product distribution channels, which could result in decreased revenue.
We rely on both our direct sales force and an indirect channel distribution strategy for the sale and marketing of our products. We may be unable to attract distributors, resellers and integrators, as planned, that can market our products effectively and provide timely and cost-effective customer support and service. There is also a risk that some or all of our distributors, resellers or integrators may be acquired, may change their business models or may go out of business, any of which could have an adverse effect on our business. Further, our distributors, integrators and resellers may carry competing lines of products. The loss of important sales personnel, distributors, integrators or resellers could adversely affect us.
We depend on our key personnel for the success of our business and the loss of one or more of our key personnel could have an adverse effect on our ability to manage our business or could be negatively perceived in the capital markets.
Our success and our ability to manage our business depend, in large part, upon the efforts and continued service of our senior management team. The loss of one or more of our key personnel could have a material adverse effect on our business and operations. It could be difficult for us to find replacements for our key personnel, as competition for such personnel is intense. Further, such a loss could be negatively perceived in the capital markets, which could reduce the market value of our securities. Our Chief Financial Officer has announced his intention to retire and we must hire a successor.
If we fail to continue to attract and retain qualified personnel, our business may be harmed.
Our future success depends upon our ability to continue to attract and retain highly qualified scientific, technical, sales and managerial personnel. Competition for such personnel is intense and there can be no assurance that we can attract other highly qualified personnel in the future. If we cannot retain or are unable to hire such key personnel, our business, financial condition and results of operations could be significantly adversely affected.
Changes in our effective tax rate may have an adverse effect on our results of operations.
Our future effective tax rates may be adversely affected by a number of factors including the distribution of income among the various countries in which we operate, changes in the valuation of our deferred tax assets, increases in expenses not deductible for tax purposes, including the impairment of goodwill in connection with acquisitions, changes in share-based compensation expense, and changes in tax laws or the interpretation of such tax laws and changes in generally accepted accounting principles. Any significant increase in our future effective tax rates could adversely impact net income for future periods.
Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions.
Significant judgment is required in determining our provision for income taxes and other taxes such as sales and VAT taxes. There are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany agreements to purchase intellectual properties, allocate revenue and allocate costs, each of which could ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is reasonable, we cannot be certain that the final tax authority review of these matters will not differ materially from what is reflected in our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.
Any acquisitions we make could disrupt our business and harm our financial condition or results.
We may make investments in complementary companies, products or technologies. Should we do so, our failure to successfully structure or manage future acquisitions could seriously harm our financial condition or operating results. The expected benefits of any acquisition may not be realized. In the event of any future purchases, we will face additional financial and operational risks, including:
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Difficulty in assimilating the operations, technology and personnel of acquired companies;
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Disruption in our business because of the allocation of resources to consummate these transactions and the diversion of management’s attention from our existing business;
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Difficulty in retaining key technical and managerial personnel from acquired companies;
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Dilution of our stockholders, if we issue equity to fund these transactions;
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Reduced liquidity, increased debt and higher amortization expenses;
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Assumption of operating losses, increased expenses and liabilities;
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Our relationships with existing employees, customers and business partners may be weakened or terminated as a result of these transactions;
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Discovery of unanticipated issues and liabilities;
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Failure to meet expected returns; and
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Failure to cause acquired financial reporting and internal control processes to be compliant with requirements applicable to companies subject to SEC reporting.
Reported revenue may fluctuate widely due to the interpretation or application of accounting rules.
Our sales arrangements often include multiple elements, including hardware, software and maintenance. The accounting rules for such arrangements are complex and subject to change from time to time. Small changes in circumstances could cause wide deviations in the timing of reported revenue.
Indemnity provisions in various agreements potentially expose us to substantial liability for intellectual property infringement and other losses.
Our agreements with customers, solution partners and channel partners include indemnification provisions under which we agree to indemnify them for losses suffered or incurred as a result of claims of intellectual property infringement and, in some cases, for damages caused by us to property or persons. Large indemnity payments could harm our business, operating results and financial condition.
Risks Related to the Market
We face significant competition and if we lose or fail to gain market share our financial results will suffer.
The market for computer and network security products and services is highly competitive. Our competitors include organizations that provide computer and network security products based upon approaches similar to and different from those that we employ. Many of our competitors have significantly greater financial, marketing, technical and other competitive resources than we do. As a result, our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products.
A decrease of average selling prices for our products and services could adversely affect our business.
The average selling prices for our solution offerings may decline as a result of competitive pricing pressures or a change in our mix of products, software and services. In addition, competition continues to increase in the market segments in which we participate and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Furthermore, we anticipate that the average selling prices and gross profits for our products will decrease over product life cycles. To maintain or realize higher prices and gross margins, we must continue to develop and introduce new products and services that incorporate new technologies or increased functionality. If we experience pricing pressures or fail to develop new products, our revenue and gross margins could decline, which could harm our business, financial condition and results of operations.
We may need additional capital in the future and our failure to obtain capital would interfere with our growth strategy.
Our ability to obtain financing will depend on a number of factors, including market conditions, our operating performance and investor interest. These factors may make the timing, amount, terms and conditions of any financing unattractive. They may also result in our incurring additional indebtedness or accepting stockholder dilution. If adequate funds are not available or are not available on acceptable terms, we may have to forego strategic acquisitions or investments, defer our product development activities, or delay the introduction of new products.
We experience variations in quarterly operating results and sales are subject to seasonality, both of which may result in a volatile stock price.
In the future, as in the past, our quarterly operating results may vary significantly, resulting in a volatile stock price. Factors affecting our operating results include:
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The level of competition;
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The size, timing, cancellation or rescheduling of significant orders;
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New product announcements or introductions by competitors;
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Technological changes in the market for data security products including the adoption of new technologies and standards;
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Changes in pricing by competitors;
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Our ability to develop, introduce and market new products and product enhancements on a timely basis, if at all;
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Component costs and availability;
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Our success in expanding our sales and marketing programs;
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Market acceptance of new products and product enhancements;
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Changes in foreign currency exchange rates; and
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General economic conditions in the countries in which we operate.
We also experience seasonality in all markets. These seasonal trends are most notable in the summer months, particularly in Europe, when many businesses defer purchase decisions.
Our stock price may be volatile for reasons other than variations in our quarterly operating results.
The market price of our common stock may fluctuate significantly in response to factors, some of which are beyond our control, including the following:
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Actual or anticipated fluctuations in our quarterly or annual operating results;
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Differences between actual operating results and results estimated by analysts that follow our stock and provide estimates of our results to the market;
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Differences between guidance relative to financial results, if given, and actual results;
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Changes in market valuations of other technology companies;
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Announcements by us or our competitors of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
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Additions or departures of key personnel;
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Future sales of common stock;
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Trading volume fluctuations; and
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Reactions by investors to uncertainties in the world economy and financial markets.
A small group of persons control a substantial amount of our common stock and could delay or prevent a change of control.
Our Board of Directors, our officers and their immediate families and related entities beneficially own approximately 26%, with Mr. T. Kendall Hunt beneficially owning approximately 23%, of the outstanding shares of our common stock. As the Chairman of the Board of Directors, Chief Executive Officer and our largest stockholder, Mr. Hunt may exercise substantial control over our future direction and operation and such concentration of control may have the effect of discouraging, delaying or preventing a change in control and may also have an adverse effect on the market price of our common stock.
Certain provisions of our charter and of Delaware law make a takeover of our company more difficult.
Our corporate charter and Delaware law contain provisions, such as a class of authorized but unissued preferred stock which may be issued by our board without stockholder approval that might enable our management to resist a takeover of our company. Delaware law also limits business combinations with interested stockholders. These provisions might discourage, delay or prevent a change in control or a change in our management. These provisions could also discourage proxy contests, and make it more difficult for you and other stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.
Future issuances of blank check preferred stock may reduce voting power of common stock and may have anti-takeover effects that could prevent a change in control.
Our corporate charter authorizes the issuance of up to 500,000 shares of preferred stock with such designations, rights, powers and preferences as may be determined from time to time by our Board of Directors, including such dividend, liquidation, conversion, voting or other rights, powers and preferences as may be determined from time to time by the Board of Directors without further stockholder approval. The issuance of preferred stock could adversely affect the voting power or other rights of the holders of common stock. In addition, the authorized shares of preferred stock and common stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control.
Risks Related to Technology and Intellectual Property
Technological changes occur rapidly in our industry and our development of new products is critical to maintain our revenue.
The introduction by our competitors of products embodying new technologies and the emergence of new industry standards could render our existing products obsolete and unmarketable. Our future revenue growth and operating profit will depend in part upon our ability to enhance our current products and develop innovative products to distinguish ourselves from the competition and to meet customers’ changing needs in the data security industry. We cannot assure you that security-related product developments and technology innovations by others will not adversely affect our competitive position or that we will be able to successfully anticipate or adapt to changing technology, industry standards or customer requirements on a timely basis.
Our business could be negatively impacted by cyber security incidents and other disruptions.
Our use of technology is increasing and is critical in three primary areas of our business:
1. Software and information systems that we use to help us run our business more efficiently and cost effectively;
2. The products we have traditionally sold and continue to sell to our customers for integration into their software applications contain technology that incorporates the use of secret numbers and encryption technology; and
3. Products and services providing security through our servers (or in the cloud from our customers’ perspective).
A cyber incident in any of these areas of our business could disrupt our ability to take orders or deliver product to our customers, cause us to suffer significant monetary and other losses and significant reputational harm, or substantially impair our ability to grow the business. We expect that there are likely to be hacking attempts intended to impede the performance of our products, disrupt our services and harm our reputation as a company, as the processes used by computer hackers to access or sabotage technology products, services and networks are rapidly evolving in sophistication.
In July 2011, we experienced a cyber incident related to DigiNotar B.V. See Part I. Item 3 - Legal Proceedings, Part II. Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 3 to our consolidated financial statements for a description of the hacking incident at DigiNotar B.V., the termination of DigiNotar B.V’s registration as a certification service provider and DigiNotar B.V.’s bankruptcy. See Part I. Item 3 - Legal Proceedings for a description of legal proceedings related to the cyber security incident at DigiNotar B.V. We may incur additional losses from discontinued operations resulting from these events as a result of unanticipated costs associated with DigiNotar B.V.’s bankruptcy and potential claims that may arise in connection with the hacking incidents.
Our products contain third-party, open-source software and failure to comply with the terms of the underlying open-source software licenses could restrict our ability to sell our products or otherwise result in claims of infringement.
Our products are distributed with software programs licensed to us by third-party authors under “open-source” licenses, which may include the GNU General Public License, the GNU Lesser Public License, the BSD License and the Apache License. These open-source software programs include, without limitation, Linux, Apache, Openssl, IPTables, Tcpdump, Postfix, Cyrus, Perl, Squid ,Snort, Ruby, Rails, PostgreSQL, MongoDB and Puppet. These third-party, open-source programs are typically licensed to us for no fee and the underlying license agreements generally require us to make available to users the source code for such programs, as well as the source code for any modifications or derivative works we create based on these third-party, open-source software programs.
We do not believe that we have created any modifications or derivative works to, an extended version of, or works based on, any open-source software programs referenced above. We include instructions to users on how to obtain copies of the relevant open-source code and licenses.
We do not provide end users a copy of the source code to our proprietary software because we believe that the manner in which our proprietary software is aligned or communicates with the relevant open-source programs does not create a modification, derivative work or extended version of, or a work based on, that open-source program requiring the distribution of our proprietary source code.
Our ability to commercialize our products by incorporating third-party, open-source software may be restricted because, among other reasons:
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the terms of open-source license agreements are unclear and subject to varying interpretations, which could result in unforeseen obligations regarding our proprietary products or claims of infringement;
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it may be difficult to determine the developers of open-source software and whether such licensed software infringes another party’s intellectual property rights;
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competitors will have greater access to information by obtaining these open source products, which may help them develop competitive products; and
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open-source software potentially increases customer support costs because licensees can modify the software and potentially introduce errors.
We must continue to attract and retain highly skilled technical personnel for our research and development department.
The market for highly skilled technicians in Europe, Asia, Australia and the United States is highly competitive. If we fail to attract, train, assimilate and retain qualified technical personnel for our research and development department, we will experience delays in introductions of new or modified products, loss of clients and market share and a reduction in revenue.
We cannot be certain that our research and development activities will be successful.
While management is committed to enhancing our current product offerings and introducing new products, we cannot be certain that our research and development activities will be successful. Furthermore, we may not have sufficient financial resources to identify and develop new technologies and bring new products to market in a timely and cost effective manner, and we cannot ensure that any such products will be commercially successful if and when they are introduced.
We depend significantly upon our proprietary technology and intellectual property and the loss of or the successful challenge to our proprietary rights could require us to redesign our products or require us to enter into royalty or licensing agreements, any of which could reduce revenue and increase our operating costs.
We currently rely on a combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection, and generally enter into confidentiality and nondisclosure agreements with our employees and with key vendors and suppliers.
There has been substantial litigation in the technology industry regarding intellectual property rights, and we may have to litigate to protect our proprietary technology.
We expect that companies in the computer and information security market will increasingly be subject to infringement claims as the number of products and competitors increases. Any such claims or litigation may be time-consuming and costly, cause product shipment delays, require us to redesign our products or require us to enter into royalty or licensing agreements, harm our reputation, cause our customers to use our competitors’ products or divert the efforts and attention of our management and technical personnel from normal business operations, any of which could reduce revenue and increase our operating costs.
Our patents may not provide us with competitive advantages.
We hold several patents in the United States and in other countries, which cover multiple aspects of our technology. The majority of our patents cover the DIGIPASS product line. These patents expire between 2021 and 2033. We do not believe that patents expiring in 2015 will affect revenues, profitability, or increase competition. In addition to the issued patents, we also have several patents pending in the United States, Europe and other countries. There can be no assurance that we will continue to develop proprietary products or technologies that are patentable, that any issued patent will provide us with any competitive advantages or will not be challenged by third parties, or that patents of others will not hinder our competitive advantage. Although certain of our security token technologies are patented, there are other organizations that offer token-type password generators incorporating challenge-response or response-only approaches that employ different technological solutions and compete with us for market share.
We are subject to warranty and product liability risks.
A malfunction of or design defect in our products which results in a breach of a customer’s data security could result in tort or warranty claims against us. We seek to reduce the risk of these losses by attempting to negotiate warranty disclaimers and liability limitation clauses in our sales agreements. However, these measures may ultimately prove ineffective in limiting our liability for damages. We do not presently maintain product liability insurance for these types of claims.
In addition to any monetary liability for the failure of our products, an actual or perceived breach of network or data security at one of our customers could adversely affect the market’s perception of us and our products, and could have an adverse effect on our reputation and the demand for our products. Similarly, an actual or perceived breach of network or data security within our own systems could damage our reputation and have an adverse effect on the demand for our products.
There is significant government regulation of technology exports and to the extent we cannot meet the requirements of the regulations we may be prohibited from exporting some of our products, which could negatively impact our revenue.
Our international sales and operations are subject to risks such as the imposition of government controls, new or changed export license requirements, restrictions on the export of critical technology, trade
restrictions and changes in tariffs. If we become unable to obtain foreign regulatory approvals on a timely basis our business in those countries would no longer exist and our revenue would decrease dramatically. Certain of our products are subject to export controls under U.S. law. The list of products and countries for which export approval is required, and the regulatory policies with respect thereto may be revised from time to time and our inability to obtain required approvals under these regulations could materially and adversely affect our ability to make international sales.
We employ cryptographic technology in our authentication products that uses complex mathematical formulations to establish network security systems.
Many of our products are based on cryptographic technology. With cryptographic technology, a user is given a key that is required to encrypt and decode messages. The security afforded by this technology depends on the integrity of a user’s key and in part on the application of algorithms, which are advanced mathematical factoring equations. These codes may eventually be broken or become subject to government regulation regarding their use, which would render our technology and products less effective. The occurrence of any one of the following could result in a decline in demand for our technology and products:
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Any significant advance in techniques for attacking cryptographic systems, including the development of an easy factoring method or faster, more powerful computers;
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Publicity of the successful decoding of cryptographic messages or the misappropriation of keys; and
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Increased government regulation limiting the use, scope or strength of cryptography.
Risks Related to International Operations
We face a number of risks associated with our international operations, any or all of which could result in a disruption in our business and a decrease in our revenue.
In 2014, approximately 94% of our revenue and approximately 75% of our operating expenses were generated/incurred outside of the U.S. In 2013, approximately 93% of our revenue and approximately 82% of our operating expenses were generated/incurred outside of the U.S. A severe economic decline in any of our major foreign markets could adversely affect our results of operations and financial condition.
In addition to exposures to changes in the economic conditions of our major foreign markets, we are subject to a number of risks any or all of which could result in a disruption in our business and a decrease in our revenue. These include:
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Inconsistent regulations and unexpected changes in regulatory requirements;
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Export controls relating to our technology;
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Difficulties and costs of staffing and managing international operations;
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Potentially adverse tax consequences;
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Wage and price controls;
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Uncertain protection for intellectual property rights;
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Imposition of trade barriers;
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Differing technology standards;
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Uncertain demand for electronic commerce;
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Linguistic and cultural differences;
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Political instability; and
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Social unrest.
We are subject to foreign exchange risks, and improper management of that risk could result in large cash losses.
Because a significant number of our principal customers are located outside the United States, we expect that international sales will continue to generate a significant portion of our total revenue. We are subject to foreign exchange risks because the majority of our product costs are denominated in U.S. Dollars, whereas a significant portion of the sales and expenses of our foreign operating subsidiaries are denominated in various foreign currencies. A decrease in the value of any of these foreign currencies relative to the U.S. Dollar could affect the profitability in U.S. Dollars of our products sold in these markets. We do not currently hold forward exchange contracts to exchange foreign currencies for U.S. Dollars to offset currency rate fluctuations.
We must comply with governmental regulations setting environmental standards.
Governmental regulations setting environmental standards influence the design, components or operation of our products. New regulations and changes to current regulations are always possible and, in some jurisdictions, regulations may be introduced with little or no time to bring related products into compliance with these regulations. Our failure to comply with these regulations may prevent us from selling our products in a certain country. In addition, these regulations may increase our cost of supplying the products by forcing us to redesign existing products or to use more expensive designs or components. In these cases, we may experience unexpected disruptions in our ability to supply customers with products, or we may incur unexpected costs or operational complexities to bring products into compliance. This could have an adverse effect on our revenues, gross profit margins and results of operations and increase the volatility of our financial results.
Over the last several years, we have become subject to the Restriction on the Use of Hazardous Substances Directive 2002/95/EC (also known as the “RoHS Directive”) and the Waste Electrical and Electronic Equipment Directive (also known as the “WEEE Directive”). These directives restrict the distribution of products containing certain substances, including lead, within applicable geographies and require a manufacturer or importer to recycle products containing those substances.
These directives affect the worldwide electronics and electronics components industries as a whole. If we or our customers fail to comply with such laws and regulations, we could incur liabilities and fines and our operations could be suspended.
We or our suppliers may be impacted by new regulations related to climate change.
In addition to the European environmental regulations noted above, we or our suppliers may become subject to new laws enacted with regards to climate change. In the event that new laws are enacted or current laws are modified in countries in which we or our suppliers operate, our flow of product may be impacted and/or the costs of handling the potential waste associated with our products may increase dramatically, either of which could result in a significant negative impact on our ability to operate or operate profitably.
The effects of new regulations relating to conflict minerals may adversely affect our business.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of certain minerals and derivatives ( collectively “Conflict Minerals”) which may originate from the conflict zones of the Democratic Republic of Congo (DRC) and adjoining countries (collectively, “Covered Countries”). As a result, in August 2012 the SEC established annual disclosure and reporting requirements for companies using Conflict Minerals in their products, including
products manufactured by third parties. Like many electronic devices, our products contain Conflict Minerals and are subject to the disclosure and reporting requirements. Compliance with these rules also requires due diligence including country of origin inquiries to determine the sources of Conflict Minerals used in our products.
We filed our first annual report in May 2014 related to products manufactured in calendar 2013. We reported that we determined we had no reason to believe Conflict Minerals used in our products may have originated in Covered Countries.
We may incur costs associated with complying with these disclosure requirements. These requirements may affect pricing, sourcing and availability of Conflict Minerals used to produce our devices. We may be unable to verify the origin of all Conflict Minerals in our products. We may encounter challenges with customers and stakeholders if we are unable to certify that our products are conflict free.
U.S. investors may have difficulties in making claims for any breach of their rights as holders of shares because some of our assets and executives are not located in the United States.
Several of our executives and key employees are residents of foreign countries, and a substantial portion of our assets and those of some of our executives and key employees are located in foreign countries. As a result, it may not be possible for investors to effect service of process on those persons located in foreign countries, or to enforce judgments against some of our executives and key employees based upon the securities or other laws of jurisdictions in those foreign countries.
Our business in countries with a history of corruption and transactions with foreign governments increase the risks associated with our international activities.
We are subject to the U.S. Foreign Corrupt Practices Act (FCPA), and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. and other business entities for the purpose of obtaining or retaining business. We have operations, deal with and make sales to governmental or quasi-governmental customers in countries known to experience corruption, particularly certain countries in the Middle East, Africa, East Asia and South America, and further expansion of our international selling efforts may involve additional regions. Our activities in these countries create the risk of unauthorized payments or offers of payments by one of our employees, consultants, sales agents or channel partners that could be in violation of various laws, including the FCPA and the U.K. Bribery Act, even though these parties are not always subject to our control. Violations of the FCPA may result in severe criminal or civil sanctions, including suspension or debarment from U.S. government contracting, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. Violations of the U.K. Bribery Act may result in severe criminal or civil sanctions and we may be subject to other liabilities which could negatively affect our business operating results and financial condition.
Item 1B
Item 1B - Unresolved Staff Comments
None.
Item 2
Item 2 - Properties
Our corporate headquarters is located in Oakbrook Terrace, Illinois. Our international headquarters is in Zurich, Switzerland. Our European operational headquarters is located near Brussels, Belgium. We conduct sales and marketing, research and development and customer support activities from our operational headquarters. Also in Belgium are our logistics facility in Mollem, and an operations facility in Mechelen. In the Netherlands, we have two research and development facilities, one of which also houses a sales office. Additionally, we have research and development facilities in Cambridge, United Kingdom, Bordeaux, France and Vienna, Austria.
We have sales offices near Boston, Massachusetts, Sydney, Australia, Singapore, Beijing, China, Tokyo, Japan, Mumbai, India, Sao Paulo, Brazil, Dubai, and London, United Kingdom, and conduct sales activities through liaison offices and agents in Palo Alto, California, Shanghai, China, Germany, Turkey, Mexico, and Colombia.
All of our properties are leased and we believe that these facilities are adequate for our present growth plans.
Item 3
Item 3 - Legal Proceedings
On January 10, 2011, we purchased our wholly-owned subsidiary, DigiNotar B.V., a private company organized and existing in The Netherlands from the shareholders (“Sellers”). On September 19, 2011, DigiNotar B.V. filed a bankruptcy petition under Article 4 of the Dutch Bankruptcy Act in the Haarlem District Court, The Netherlands. On September 20, 2011, the court declared DigiNotar B.V. bankrupt and appointed a bankruptcy trustee and a bankruptcy judge to manage all affairs of DigiNotar B.V. through the bankruptcy process. The trustee took over management of DigiNotar B.V.’s business activities and is responsible for the administration and liquidation of DigiNotar B.V. In connection with the bankruptcy of DigiNotar B.V., subsequent to September 20, 2011, a number of claims and counter-claims have been filed with the courts in The Netherlands (collectively, the “Court”) related to discontinued assets and discontinued liabilities and other available remedies.
On July 30, 2014, the Court issued a judgment in the DigiNotar case in favor of VASCO for 4,108 ($5,176 at an exchange rate of 1.26 U.S. Dollars per Euro) plus interest related to the Sellers’ failure to achieve earn-out targets established in the purchase agreement, breach of certain representations and warranties under the share purchase agreement and reimbursement of certain costs incurred by VASCO as a result of such breach. The judgment was subject to additional legal proceedings.
In November 2014, all matters with the Sellers related to the sale and bankruptcy of DigiNotar B.V. were settled for 2,263 ($2,854 at an exchange rate of 1.26 U.S. Dollars per Euro). The funds were applied first in full satisfaction of the previously recorded contingent consideration due from escrow included in assets of discontinued operations and the remainder of $1,088 recorded as income from discontinued operations net of tax of $108.
In January 2015, we received a notice of potential claim by the trustee against all of the individuals who served as Directors of DigiNotar, both before and after our acquisition of DigiNotar. T. Kendall Hunt, Jan Valcke, and Clifford K. Bown were the Directors of DigiNotar following its purchase by VASCO. The basis for the potential claim from the trustee appears to be based primarily on the same arguments that VASCO presented in its case against the sellers, which were adjudicated in VASCO’s favor. The trustee has invited the directors (both former and new) to respond to the preliminary conclusion before he makes a decision to file a claim. While we believe that we have strong defenses against the claim, we have also notified our provider of director and officer insurance should a claim be filed and we do not expect the resolution of the potential claim to have a material adverse effect on our business, financial condition or results of operations. VASCO is indemnifying Messrs. Hunt, Valcke, and Bown for this matter.
We are from time to time involved in litigation incidental to the conduct of our business. We are not currently a party to any lawsuit or proceeding which, in the opinion of management, is likely to have a material adverse effect on our business, financial condition or results of operations.
Item 4
Item 4 - Mine Safety Disclosures
Not applicable.
PART II
Item 5
Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock, par value $0.001 per share, trades on the NASDAQ Capital Market under the symbol VDSI.
The following table sets forth the range of high and low daily closing prices of our common stock on the NASDAQ Capital Market for the past two years.
On February 27, 2015, there were 85 registered holders and approximately 27,000 street name holders of the company’s common stock.
We have not paid any dividends on our common stock since incorporation. The declaration and payment of dividends will be at the sole discretion of the Board of Directors and subject to certain limitations under the General Corporation Law of the State of Delaware. The timing, amount and form of dividends, if any, will depend, among other things, on the company’s results of operations, financial condition, cash requirements, plans for expansion and other factors deemed relevant by the Board of Directors. The company intends to retain any future earnings for use in its business and therefore does not anticipate paying any cash dividends in the foreseeable future.
Recent Sales of Unregistered Securities
None
Issuer Purchases of Equity Securities
None
Stock Performance Graph
The Stock Performance Graph below compares the cumulative total return through December 31, 2014, assuming reinvestment of dividends, by an investor who invested $100.00 on December 31, 2009, in each of (i) our common stock, (ii) the Russell 2000 index, (iii) the Standard Industrial Code Index 3577 - Computer Peripheral Equipment, NEC and (iv) a comparable industry (the peer group) index selected by the company. The peer group for this purpose consists of: Actuate Corporation, Broadsoft, Inc., Callidus Software Inc., CommVault Systems, Inc., FireEye, Inc., Fortinet, Inc., Guidance Software, Inc., Imperva, Inc., Interactive Intelligence Group, Inc., Monotype Imaging Holdings, Inc., Progress Software Corporation, Proofpoint, Inc., PROS Holdings, Inc., QAD Inc., Qualys, Inc., and Seachange International, Inc. The stock price performance shown on the graph below is not necessarily indicative of future price performance.
Item 6
Item 6 - Selected Financial Data (in thousands, except per share data)
Item 7
Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
(in thousands, except head count, ratios, time periods and percents)
Unless otherwise noted, references in this Annual Report on Form 10-K to “VASCO”, “company”, “we”, “our”, and “us” refer to VASCO Data Security International, Inc. and its subsidiaries.
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K, including Management’s Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures About Market Risk contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended and Section 27A of the Securities Act of 1933, as amended concerning, among other things, our expectations regarding the prospects of, and developments and business strategies for, VASCO and our operations, including the development and marketing of certain new products and services and the anticipated future growth in certain markets in which we currently market and sell our products and services or anticipate selling and marketing our products or services in the future. These forward-looking statements (1) are identified by use of terms and phrases such as “expect”, “believe”, “will”, “anticipate”, “emerging”, “intend”, “plan”, “could”, “may”, “estimate”, “should”, “objective”, “goal”, “possible”, “potential”, “projected” and similar words and expressions, but such words and phrases are not the exclusive means of identifying them, and (2) are subject to risks and uncertainties and represent our present expectations or beliefs concerning future events. VASCO cautions that the forward-looking statements are qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These additional risks, uncertainties and other factors have been described in greater detail in this Annual Report on Form 10-K and include, but are not limited to, (a) risks specific to VASCO, including, demand for our products and services, competition from more established firms and others, pressures on price levels and our historical dependence on relatively few products, certain suppliers and certain key customers, (b) risks inherent to the computer and network security industry, including rapidly changing technology, evolving industry standards, increasingly sophisticated hacking attempts, increasing numbers of patent infringement claims, changes in customer requirements, price competitive bidding, and changing government regulations, and (c) risks of general market conditions, including currency fluctuations and the uncertainties resulting from turmoil in world economic and financial markets. Thus, the results that we actually achieve may differ materially from any anticipated results included in, or implied by these statements. Except for our ongoing obligations to disclose material information as required by the U.S. federal securities laws, we do not have any obligations or intention to release publicly any revisions to any forward-looking statements to reflect events or circumstances in the future or to reflect the occurrence of unanticipated events.
General
The following discussion is based upon our consolidated results of operations for the years ended December 31, 2014, 2013, and 2012 (percentages in the discussion, except for returns on average net cash balances, are rounded to the closest full percentage point) and should be read in conjunction with our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
We design, develop, market and support both propriety and open standards-based hardware and software security systems that manage and secure access to information assets. We also design, develop, market, and support patented strong user authentication products and services for e-business and e-commerce. Our products enable secure financial transactions to be made over private enterprise networks and public networks, such as the Internet. Our strong user authentication is delivered via our hardware and software DIGIPASS security products (collectively “DIGIPASSES”, many of which incorporate an electronic and digital signature capability, which further protects the integrity of electronic transactions and data transmissions. Many of our software DIGIPASSES are focused on the mobile platform and can be downloaded directly to mobile devices, such as DIGIPASS for Mobile, while others are integrated directly into mobile applications (using DIGIPASS for Apps) that are downloaded onto mobile devices. Some of our DIGIPASSES are compliant with the Europay
MasterCard Visa (“EMV”) standard and are compatible with MasterCard’s and VISA’s Chip Authentication Program (“CAP”). Some of our DIGIPASSES comply with the Initiative for Open Authentication (“OATH”). As evidenced by our current customer base, most of our products are purchased by businesses and, depending on the business application, are distributed to either their employees or their customers. Those customers may be other businesses or, as an example in the case of Internet and mobile banking, our customer banks’ corporate and retail customers. Our target market is any business process that uses some form of electronic interface, particularly the Internet, where the owner of that process is at risk if unauthorized users can gain access to its process and either obtain proprietary information or execute transactions that are not authorized. Our products can not only increase the security associated with accessing the business process, thereby reducing the losses from unauthorized access, but also, in many cases, can reduce the cost of the process itself by automating activities that were previously performed manually.
We offer our products either through: (a) a product sales and licensing model or (b) through our services platform, which includes our cloud-based service offering, DIGIPASS as a Service (“DPaaS”) or MYDIGIPASS (“MDP”) or together (“DPaaS/MDP”). Our product license and sales model is expected to be used in situations where the application owner wants to control all of the critical aspects of the authentication process. We expect that our services platform will be used by: (a) companies lacking technical resources or expertise to implement a full authentication process or preferring to focus their primary attention on other aspects of their business rather than on the authentication process or (b) companies that want to verify identities through our platform or (c) consumers that are aware of the dangers posed by identity theft.
In May 2013, we acquired Cronto Limited, a provider of secure visual transaction authentication solutions for online banking. Using the patented Cronto technology, customers can establish a secure optical communication channel with their client and display the details of a transaction in an encrypted graphical cryptogram consisting of a matrix of colored dots, which are displayed on the end user’s screen. Account holders can simply “scan” the image with our device to verify the transaction details and respond with an electronic signature, if needed.
In May 2014, we acquired Risk IDS, a provider of risk-based authentication solutions to the global banking community. Risk-based authentication provides a more flexible process of authentication to ensure higher risk profiles result in stronger challenges. It allows the application to request additional credentials when the risk level is higher. Contextual information that may be used in risk-based authentication includes user location, device characteristics, transaction amount, and other factors. This method is designed to provide the appropriate level of security depending on the identified risks for a particular transaction or user.
Industry Growth: We do not believe that there are any accurate measurements of the total industry’s size or the industry’s growth rate. We believe, however, that the industry using our product sales and licensing model will grow at a significant rate as the use of the internet increases and the awareness of the risks of using the internet become more prevalent among application owners. We also believe that a market will develop for our cloud-based service offering and grow at a significant rate as business owners and consumers become more aware of the risks involved in conducting business over the internet. We expect that growth will be driven by new government regulations, growing awareness of the impact of cyber-crime, and the growth in commerce that is transacted electronically. The issues driving the growth are global issues and the rate of adoption in each country is a function of that country’s culture, the competitive position of businesses operating in that country, the country’s overall economic conditions and the degree to which businesses and consumers within the country use technology.
Economic Conditions: Our revenue may vary significantly with changes in the economic conditions in the countries in which we currently sell products. With our current concentration of revenue in Europe and specifically in the banking/finance vertical market, significant changes in the economic outlook for the European Banking market may have a significant effect on our revenue.
There continues to be significant global economic uncertainty, including Europe, our most important market. While the European Union and European Central Bank continue to implement new programs to adapt to changing economic conditions in the region, Europe continues to struggle with sovereign debt issues and, in most recent months, a currency, primarily the Euro, that has weakened against the U.S. Dollar and other currencies. As a result, we expect that Europe will continue to face difficult economic conditions in 2015. We believe that the current economic conditions in Europe may limit our growth opportunities in the Enterprise and Application Security market, but do not expect that the economic conditions will have a significant impact on the Banking market. Should the sovereign debt issue escalate, especially to the point that a country defaults on its debt or the European Union, or Euro Monetary Union, either disbands or is re-formulated, we expect that the resulting economic difficulties would have a major negative impact on the global economy, not just the economies of Western Europe, and our business.
Cybersecurity: Our use of technology is increasing and is critical in three primary areas of our business:
1. Software and information systems that we use to help us run our business more efficiently and cost effectively;
2. The products we have traditionally sold and continue to sell to our customers for integration into their software applications contain technology that incorporates the use of secret numbers and encryption technology; and
3. New products and services that we introduced to the market, such as DPaaS/MDP, are focused on processing information through our servers (or in the cloud from our customers’ perspective).
We believe that the risks and consequences of potential incidents in each of the above areas are different.
In the case of the information systems we use to help us run our business, we believe that an incident could disrupt our ability to take orders or deliver product to our customers, but such a delay in these activities would not have a material impact on our overall results. To minimize this risk, we actively use various forms of security and monitor the use of our systems regularly to detect potential incidents as soon as possible.
In the case of products that we have traditionally sold, we believe that the risk of a potential cyber incident is minimal. We offer our customers the ability to either create the secret numbers themselves or have us create the numbers on their behalf. When asked to create the numbers, we do so in a secure environment with limited physical access and store the numbers on a system that is not connected to any other network, including other VASCO networks, and similarly, is not connected to the internet.
In the case of our new products and services, which involve the active daily processing of the secret numbers on our servers or servers managed by others in a hosted environment, we believe a cyber incident could have a material impact on our future business. We also believe that these products may be more susceptible to cyber attacks than our traditional products since it involves the active processing of transactions using the secret numbers. While we do not have a significant amount of revenue from these products today, we believe that these products have the potential to provide substantial future growth. A cyber incident involving these products in the future could substantially impair our ability to grow the business and we could suffer significant monetary and other losses and significant reputational harm.
To minimize the risk, we review our security procedures on a regular basis. Our reviews include the processes and software programs we are currently using as well as new forms of cyber incidents and new or updated software programs that may be available in the market that would help mitigate the risk of incidents. While we do not insure against cyber incidents today, we would likely review insurance policies related to our new product offering in the future. Overall, we expect the cost of securing our networks will increase in future periods, whether through increased staff, systems or insurance coverage.
While we did not experience any cyber incident in 2014, 2013 or 2012 that had a significant impact on our business, it is possible that we could experience an incident in 2015 or future years, which could result in unanticipated costs.
See Part I, Item 3 - Legal Proceedings for a description of legal proceedings related to the cyber security incident in 2011.
Income Taxes: Our effective tax rate reflects our global structure related to the ownership of our intellectual property (“IP”). All our IP is owned by two subsidiaries, one in the U.S. and one in Switzerland. These two subsidiaries have entered into agreements with most of the other VASCO entities under which those other entities provide services to our U.S. and Swiss subsidiaries on either a percentage of revenue or on a cost plus basis or both. Under this structure, the earnings of our service provider subsidiaries are relatively constant. These service provider companies tend to be in jurisdictions with higher effective tax rates. Fluctuations in earnings tend to flow to the U.S. company and Swiss company. Earnings flowing to the U.S. company are expected to be taxed at a rate of 35% to 40%, while earnings flowing to the Swiss company are expected to be taxed at a rate ranging from 8% to 12%.
With the majority of our revenues being generated outside of the U.S., our consolidated effective tax rate is strongly influenced by the effective tax rate of our foreign operations. Changes in the effective rate related to foreign operations reflect changes in the geographic mix of where the earnings are realized and the tax rates in each of the countries in which it is earned. The statutory tax rate for the primary foreign tax jurisdictions ranges from 8% to 35%.
The geographic mix of earnings of our foreign subsidiaries will primarily depend on the level of our service provider subsidiaries’ pretax income, which is recorded as an expense by the U.S. and Swiss subsidiaries and the benefit that is realized in Switzerland through the sales of product. The level of pretax income in our service provider subsidiaries is expected to vary based on:
1. the staff, programs and services offered on a yearly basis by the various subsidiaries as determined by management, or
2. the changes in exchange rates related to the currencies in the service provider subsidiaries, or
3. the amount of revenues that the service provider subsidiaries generate.
For items 1 and 2 above, there is a direct impact in the opposite direction on earnings of the U.S. and Swiss entities. Any change from item 3 is generally expected to result in a larger change in income in the U.S. and Swiss entities in the direction of the change (increased revenues expected to result in increased margins/pretax profits and conversely decreased revenues expected to result in decreased margins/pretax profits).
In addition to the provision of services, the intercompany agreements transfer the majority of the business risk to our U.S. and Swiss subsidiaries. As a result, the contracting subsidiaries’ pretax income is reasonably assured while the pretax income of the U.S. and Swiss subsidiaries varies directly with our overall success in the market.
Currency Fluctuations: In 2014, approximately 94% of our revenue and approximately 75% of our operating expenses were generated/incurred outside of the U.S. In 2013, approximately 93% of our revenue and approximately 82% of our operating expenses were generated/incurred outside of the U.S. While the majority of our revenue is generated outside of the U.S., the majority of our revenue is billed in U.S. Dollars. In 2014, approximately 65% of our revenue was denominated in U.S. Dollars, 30% was denominated in Euros and 5% was denominated in other currencies. In 2013, approximately 69% of our revenue was denominated in U.S. Dollars, 26% was denominated in Euros and 4% was denominated in other currencies.
Since a significant portion of our revenues and operating expenses are outside the U.S. and denominated in currencies other than the U.S. Dollar, changes in currency exchange rates, especially the Euro to U.S. Dollar, can have a significant impact on revenue and expenses. To minimize the net impact of currency on operating earnings, we attempt to denominate an amount of billings in a currency such that it would provide a hedge against the operating expenses being incurred in that currency. For the full-year 2014, we estimate that our revenue denominated in Euros of $61,200 compared to operating expenses denominated in Euros of $44,400. For the full-year 2013, we estimate that our revenue denominated in Euros of $40,200 compared to operating expenses denominated in Euros of $42,600.
In 2014 compared to 2013, the U.S. Dollar, on average, weakened approximately 1% against the Euro. We estimate that the net impact of the change in currency rates in 2014 compared to 2013 resulted in a decrease in revenue of approximately $214 and an increase in operating expenses of $261. While the average full-year rate for the U.S. Dollar compared to the Euro was comparable, the U.S. Dollar strengthened approximately 8% in the fourth quarter of 2014 compared to the fourth quarter of 2013. Through the first nine months of 2014 the U.S. Dollar was approximately 3% weaker in 2014 than in 2013 and the cumulative revenue denominated in Euros was approximately $4,700 lower than cumulative operating expenses denominated in Euros. As a result, we estimate that the change in exchange rate through the first nine months of 2014 increased revenues by $1,355 and increased operating expenses by $1,452. In the fourth quarter of 2014, compared to the fourth quarter of 2013, the U.S. Dollar strengthened approximately 8% compared to the Euro. Also, in the fourth quarter of 2014, revenue denominated in Euros was approximately $1,100 higher than the operating expenses denominated in Euros. As a result, we estimate that the change in exchange rate in the fourth quarter decreased revenues by $1,569 and decreased operating expenses by $1,191.
In 2013 compared to 2012, on average, the U.S. Dollar weakened approximately 3% against the Euro. We also estimate that the change in currency rates in 2013 compared to 2012 resulted in an increase in revenue of approximately $708 and an increase in operating expenses of $1,280.
The financial position and the results of operations of most of our foreign subsidiaries, with the exception of our subsidiaries in Switzerland and Singapore, are measured using the local currency as the functional currency. Accordingly, assets and liabilities are translated into U.S. Dollars using current exchange rates as of the balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the year. Translation adjustments arising from differences in exchange rates generated a comprehensive loss of $4,468 in 2014 and a comprehensive gain of $1,906 and $1,677 in 2013 and 2012, respectively. These amounts are included as a separate component of stockholders’ equity. The functional currency for both our subsidiaries in Switzerland and Singapore is the U.S. Dollar.
Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations as other non-operating income/expense. In 2014, 2013, and 2012, we reported foreign exchange transaction losses of $1,382, $624, and $410, respectively.
Revenue
Revenue by Geographic Regions: We classify our sales by customers’ location in four geographic regions: 1) EMEA, which includes Europe, the Middle East and Africa; 2) the United States, which for our purposes includes sales in Canada; 3) Asia Pacific Rim; and 4) Other Countries, including Australia, Latin America and India. The breakdown of revenue in each of our major geographic areas was as follows:
2014 Compared to 2013
Total revenue in 2014 increased $46,490, or 30%, from 2013. The increase in total revenue was primarily attributable to an increase in hardware products sold to the Banking market and non-hardware products sold to both the Banking and Enterprise and Application Security markets. Please see the discussion below under “Revenue by Target Market” for additional information regarding the changes in revenue from the Banking market and the Enterprise and Application Security market.
Revenue generated in EMEA for the full-year 2014 was $33,591, or 35%, higher in 2014 than in 2013. The increase reflected an increase of approximately 39% in revenue from the Banking market and an increase of approximately 20% in revenue from the Enterprise and Application Security market. The increase in revenue in the Banking market was driven by an increase in both hardware products, in large part from card readers that either include our CrontoSign technology or provide a high level of functionality, and non-hardware products, primarily our mobile solutions. Growth in revenue from the Enterprise and Application Security market came from non-hardware products, primarily maintenance.
Revenue generated in the United States for the full-year 2014 was $317, or 3%, higher in 2014 than in 2013. Revenue was approximately 30% higher in the Enterprise and Application Security market and was partially offset by a decline of approximately 13% in the Banking market. In the second half of 2014, HSBC adopted two-factor authentication for its retail internet banking application, but the results from their rollout was not large enough to offset our shortfall in the first half of the year when compared to the same period in 2013. To date, no other large U.S. bank has made a firm commitment to adopt two-factor authentication for their retail internet banking applications.
Revenue generated in Asia Pacific for the full-year 2014 was $15,009, or 55%, higher in 2014 than in 2013. Revenue was approximately 63% higher in the Banking market and 7% lower in the Enterprise and Application Security market when compared to the revenue for full-year 2013. The increase in revenue in the Banking market came primarily from Japan and Hong Kong, in part reflecting the addition of new customers.
Revenue generated in other countries for the full-year 2014 was $2,427, or 12%, lower in 2014 than in 2013. Revenue in other countries was approximately 14% lower in the Banking market and 26% higher in the Enterprise and Application Security market when compared to the revenue for full-year 2013.
Given the relatively small size of the revenue in regions other than EMEA, the results may vary substantially year-to-year on both an absolute and on a percentage basis depending upon the timing of the receipt and delivery of a large new order or the completion of a large rollout. We believe that the variability in results will lessen as we develop a larger base of Banking customers and further develop our distribution channel and direct touch sales model for the Enterprise and Application Security market.
2013 Compared to 2012
Total revenue in 2013 increased $1,018 (or 1%) from 2012. The increase in total revenue was primarily attributable to an increase in non-hardware products sold to the Banking market and the strengthening of the Euro as compared to the U.S. Dollar, partially offset by a decrease in hardware products sold to both the Banking and Enterprise and Application Security markets. Please see the discussion below under “Revenue by Target Market” for additional information regarding the changes in revenue from the Banking market and the Enterprise and Application Security market.
Revenue generated in EMEA for the full-year 2013 was $802 (or 1%) higher in 2013 than in 2012. The increase reflected an increase of approximately 2% in revenue from the Banking market partially offset by a decrease of 3% in revenue from the Enterprise and Application Security market. We estimate that the change in currency rates increased revenues in EMEA by $1,080 compared to 2012. Had currency exchange rates in 2013 remained unchanged from 2012, revenues in EMEA would have been less than 1% lower than in full-year 2012.
Revenue generated in the United States for the full-year 2013 was $638 (or 6%) higher in 2013 than in 2012. Revenue was approximately 9% higher in the Banking market, but flat in the Enterprise and Application Security market when compared to the revenue for full-year 2012. Revenue generated in Asia Pacific for the full-year 2013 was $5,427 (or 17%) lower in 2013 than in 2012. Revenue was approximately 22% lower in the Banking market and 55% higher in the Enterprise and Application Security market when compared to the revenue for full-year 2012. Revenue generated in other countries for the full-year 2013 was $5,005 (or 33%) higher in 2013 than in 2012. Revenue in other countries was approximately 53% higher in the Banking market and 58% lower in the Enterprise and Application Security market when compared to the revenue for full-year 2012. We estimate that the change in currency rates decreased revenues in other countries by $301 compared to 2012 due in large part to the strengthening of the U.S. Dollar compared to the Australian Dollar. Had currency exchange rates in 2013 remained unchanged from 2012, revenues in other countries would have been approximately 35% higher than in full-year 2012.
Revenue by Target Market: Revenue is generated currently from two primary markets, (1) Banking and (2) Enterprise and Application Security, through the use of both direct and indirect sales channels. The Enterprise and Application Security market includes products used by employees of corporations to secure their internal networks (the Enterprise Security market) and business-to-business, business-to-consumer, e-commerce, e-government, e-gaming and other vertical applications (the Application Security market) that are not related to banking or finance. In addition, maintenance and support services associated with all markets are included in the Enterprise and Application Security market results. Management currently views the Enterprise and Application Security market as one market because the same products are sold using the same methods to both groups (i.e., a direct touch model and channel distribution model). Sales to the Enterprise and Application Security market are
generally for smaller quantities and higher prices than sales made to the Banking market. The breakdown of revenue between the two primary markets is as follows:
2014 Compared to 2013
Revenue for the full year 2014 from the Banking market increased $41,292, or 33%, from 2013 and revenue from the Enterprise and Application Security market increased $5,198 or 18% in the same period.
The increase in revenues from the Banking market reflects an increase in both hardware and non-hardware. The increase in hardware revenue resulted primarily from increased sales of our card readers that either include our CrontoSign technology or provide a high level of functionality, such as those that can read both a bank card and a government issued identification card. The increase in non-hardware products primarily reflected an increase in revenue from our mobile solutions, such as DIGIPASS for Mobile or DIGIPASS for Apps, and revenue from license and support revenue related to CrontoSign products.
The increase in revenue from the Enterprise and Application Security market reflects an increase in non-hardware revenue, primarily maintenance and support.
The changes in revenue in both markets reflects the transaction nature of our business where the absolute amount of revenue reported in any given period is a reflection of transactions closed in that period. Also, given the sustainable, repeatable nature of our revenue model, we believe that the growth over a longer period of time reflects the growth in our customer base, which we expect will lead to continued increases in revenues in future years, albeit with uneven growth reported annually. We expect that customers that have purchased our products in prior years will replace those products in future years for several reasons, including but not limited to;
•
upgrading to products that are more convenient for their customers to use and/or provide a higher level of security (e.g., our products with electronic or digital signing capability) to counteract the increasing sophistication of parties attempting to steal their customers’ identities or conduct man-in-the-middle attacks,
•
establishing a competitive advantage in their market place by providing technology that differs from their competitors,
•
expanding the use of our products to provide security over new applications that may be offered by our customers to their application users, and
•
replacing existing products that may have been lost or are reaching the end of their useful lives.
2013 Compared to 2012
Revenue for the full year 2013 from the Banking market increased $2,105 (or 2%) from 2012 and revenue from the Enterprise and Application Security market decreased $1,087 or 4% in the same period.
The increase in the Banking market reflects an increase in non-hardware revenue and the benefit of currency exchange rates partially offset by a decline in revenue from hardware products. The decline in revenue from the Enterprise and Application Security market reflects a decrease in both hardware and non-hardware products sold partially offset by the benefit of currency exchange rates.
Gross Profit and Operating Expenses
The following table sets forth, for the periods indicated, certain consolidated financial data as a percentage of revenue from continuing operations for the years ended December 31, 2014, 2013, and 2012.
Gross Profit
2014 Compared to 2013
Consolidated gross profit for 2014 was $127,766, an increase of $27,895, or 28%, from the $99,871 reported for 2013. Gross profit as a percentage of revenue (“gross profit margin”) was 63% in 2014 compared to 64% in 2013. The decrease in the gross profit margin was primarily attributable to the following factors:
•
an unfavorable mix of products sold, with revenues from the Enterprise and Application Security market decreasing from 18% to 17% of our total revenue, and
•
a decline in the gross margins from hardware products sold in the Banking market.
Gross margin on product sold reflects the specific mix of product and quantities sold in each period. As the size of deals increase, the gross margin generally declines. For 2014, gross margins from product sold in the Banking market was approximately 1.8 percentage points lower than in 2013. Gross margins from product sold in the Enterprise and Application Security market was approximately 0.5 percentage points higher in 2014 compared to 2013.
Revenue from the Enterprise and Application Security market, which generally has gross profit margins that are 20 to 30 percentage points higher than the Banking market, was 17% of our total revenue for the full-year 2014 compared to 18% of our total revenue for the full-year 2013.
The decline in gross margin from product sold in the Banking market is primarily attributable to the increase in card readers sold as a percentage of revenue. Card readers, which generally have gross profit margins that are 15 to 25 percentage points lower than other hardware-related margins due to competitive pricing pressures, were 25% of our total revenue for the full-year 2014 compared to 14% of our revenue for the full-year 2013. In 2014, we experienced increased demand for our card readers that either include our CrontoSign technology or provide a high level of functionality, such as those that can read both a bank card and a government issued identification card.
There were no significant changes for the full-year 2014 compared to the full-year 2013 in other factors that often affect our gross margins as a percentage of revenue. Non-hardware related revenues as a percentage of total revenue were 27% in 2014 compared to 28% in 2013. Write-downs of inventory and non-product costs did not change materially in 2014 compared to 2013. As noted above, the average exchange rates in both years were also comparable.
Our backlog at December 31, 2014 of firm orders scheduled to ship in 2015 includes a significant amount of card readers that include our CrontoSign technology and, as a result, we expect that our consolidated gross margins as a percent of revenue will be lower in 2015 than in 2014. The actual change in gross margin as a percent of revenue for 2015 compared to 2014 will, however, reflect the final mix of product sold in 2015. With our strategy to focus on revenues from non-hardware products, we expect the negative impact of the higher volume of card readers to be offset in part by increased revenues from non-hardware products.
2013 Compared to 2012
Consolidated gross profit for 2013 was $99,871, an increase of $306, or less than 1%, from the $99,565 reported for 2012. Gross profit as a percentage of revenue (“gross profit margin”) was 64% in 2013 compared to 65% in 2012. The decrease in the gross profit margin was primarily attributable to the following factors:
•
an unfavorable mix of products sold, with revenues from the Enterprise and Application Security market decreasing from 19% to 18% of our total revenue, and
•
a decline in the gross margins from hardware products sold in the Banking market, which were
partially offset by
•
an increase in non-hardware revenues as a percentage of total revenues,
•
a reduction in the amount of inventory written down to our estimate of lower of cost or market, and
•
lower non-product costs such as freight and customization costs.
For 2013, gross margin from product sold in the Banking market was approximately 2.1 percentage points lower than in 2012. Gross margins from product sold in the Enterprise and Application Security market was approximately 0.2 percentage points higher in 2013 compared to 2012.
We experienced an increase in the gross profit margin in 2013 due to an increase in non-hardware related revenues. Non-hardware revenue as a percentage of total revenue was approximately 28% in 2013 compared to 24% in 2012. The amount of non-hardware revenue increased by approximately 15% in 2013 compared to 2012. Non-hardware revenue can have a gross profit margin that is approximately 20 to 30 percentage points higher than hardware-related revenue, depending on the model and quantity of the hardware units sold.
We monitor our inventory levels on a regular basis and write down the value of selected inventory items to their expected net realizable value when it appears that the value of the item may not be realized through
the ultimate sale of a finished product. The total amount of the inventory write down was approximately $1,095 for the full-year 2013 compared to $2,176 for full-year 2012. Going forward, we believe that similar adjustments may be needed reflecting the risk associated with making estimates of future demand and buying inventory to meet that demand on a recurring basis.
The cost of shipping our products to customers was lower in 2013 than in 2012. We continue to work with our customers to plan deliveries in such a way that we can minimize our freight costs, typically by using a non-expedited shipment process such as by sea rather than by air. We estimate that the reduction in shipping costs increased our gross margin as a percent of revenue by approximately 0.4 percentage points.
Changes in currency exchange rates had a positive impact on our gross profit margins in 2013. The majority of our inventory purchases are denominated in U.S. Dollars. As previously noted, our sales are denominated in various currencies, including the Euro and Australian Dollar. As the U.S. Dollar strengthened in 2013 when compared to the Euro in 2012, revenue as measured in U.S. Dollars increased from sales made in Euros, without a corresponding decrease in cost of goods sold. The impact from changes in currency rates, as noted above, is estimated to have increased revenue and gross margin by approximately $708 for the full year 2013. Had the currency rates in 2013 been equal to the rates in 2012, the gross profit margin would have been approximately 0.2 percentage points lower for the year ended December 31, 2013.
Operating Expenses
Our operating expenses are generally based on anticipated revenue levels and the majority of such expenses are fixed over short periods of time. As a result, small variations in the amount of revenue recognized in any given period could cause significant variations in the period-to-period comparisons of either the absolute amounts of operating income or operating income as a percentage of revenue. There are three primary factors that impact our operating expenses: our headcount levels, our stock-based incentive plan compensation expenses and the impact of changes in foreign exchange rates.
Generally, the most significant factor driving our operating expenses is our headcount. Direct compensation and benefit plan expenses generally represent between 55% and 65% of our operating expenses. In addition, a number of other expense categories are directly related to headcount. We attempt to manage our headcount within the context of the economic environments in which we operate and the investments that we believe we need to make to help ensure that our infrastructure is able to support future growth and ensure that our products are competitive. The headcount from continuing operations for 2011 through 2014 is recapped in the following table:
* Average is based on the headcount at the end of five consecutive quarters.
In 2014, we reduced staff in selected areas in an effort to improve profitability in those areas. The targeted reductions were made both in sales and marketing and in research and development. The reduction in sales and marketing was primarily focused on improving the profitability of the Enterprise and Application Security business. The reduction in research and development primarily reflected additional fine tuning related to the shutdown of our engineering operations in Australia and the move of research and development activities previously done in Australia to Austria, as well as reductions related to re-prioritizing projects for our services platform.
For 2015, we expect to increase headcount in all function areas with the largest increases coming in sales and marketing and in research and development. We plan to increase headcount in:
•
Sales in an effort to accelerate the growth of our newer products, such as the mobile applications and the services platform;
•
Marketing to improve the name and brand recognition of the company in all of our markets, and
•
Research and development to continue developing state-of-the art products for all of our markets.
The comparison of operating expenses in both 2014 to 2013 and 2013 to 2012 were impacted by changes to our long-term incentive plan compensation expenses that relate to our performance in each year. For the full-year 2014, 2013 and 2012, operating expenses included $3,250, $2,587 and $3,726, respectively, of expense related to long-term incentive plans. Based on our performance in 2014, long-term incentive awards granted at the beginning of 2014 were earned. In 2013 and 2012, we fell short of our targets and, as a result, long-term incentive awards for those years were not earned. Long-term incentive plan compensation expense includes both cash and stock-based incentives.
Sales and Marketing Expenses
2014 Compared to 2013
Consolidated sales and marketing expenses for the year ended December 31, 2014 were $43,362, an increase of $3,039, or 8%, from $40,323 reported for 2013. This increase in sales and marketing expenses primarily relates to:
•
higher compensation expenses of approximately $3,292 related primarily to incentive compensation payments such as commissions and bonuses, and
•
an increase in purchased services cost of $604, which includes the cost of services provided to us by persons that are not our direct employees, with the increase in cost of such services also primarily related to incentive payments based on our overall performance,
partially offset by
•
reductions in expense in various other accounts, none of which we consider material on a standalone basis.
Our average full-year headcount decreased 1% in 2014 compared to 2013. The average full-time sales, marketing and operations employee headcount was 186 in 2014 compared to 187 in 2013. At year-end 2014, 2013 and 2012, the company employed 179, 193 and 172 sales, marketing and operations employees, respectively.
2013 Compared to 2012
Consolidated sales and marketing expenses for the year ended December 31, 2013 were $40,323, an increase of $2,555, or 7%, from $37,768 reported for 2012. This increase in sales and marketing expenses primarily relates to:
•
higher compensation expenses of approximately $3,621, including the unfavorable impact of changes in currency exchange rates and an increase in average sales and marketing staff in 2013, and
•
expenses of approximately $256 related to Cronto, which was acquired in May 2013,
partially offset by
•
a decrease in long-term incentive compensation expenses of approximately $628.
We estimate that the sales and marketing expenses increased approximately $738 in 2013 primarily as a result of the strengthening of the Euro to the U.S. Dollar.
Our average full year headcount increased 9% in 2013 compared to 2012. The average full-time sales, marketing and operations employee headcount was 187 in 2013 compared to 171 in 2012.
Research and Development Expenses
2014 Compared to 2013
Consolidated research and development costs for the year ended December 31, 2014 were $19,497, a decrease of $1,818, or 9%, from the $21,315 reported for 2013. The decrease in research and development was primarily attributable to:
•
lower compensation expenses of approximately $1,930 as a result of having lower average full-year headcount in 2014 than in 2013 and the fact that expense for the full-year 2013 included redundancy costs of $645 related to the closure of the Brisbane, Australia facility, and
•
lower purchased service costs of approximately $420, primarily related to the completion of work by outside third parties on our services platform,
partially offset by,
•
an increase of approximately $218 associated with having a full-year of operating expenses associated with Cronto Ltd., which was acquired in May of 2013, and
•
approximately $128 of operating expenses associated with Risk IDS, which was acquired in May of 2014.
The average research and development headcount decreased approximately 6% to 137 in 2014 from 145 in 2013. At year-end 2014, 2013 and 2012, we employed 136, 143 and 143 research and development employees, respectively. The reduction in headcount primarily reflected efficiencies gained by completing the consolidation of our research and development operations previously in Brisbane, Australia into Vienna, Austria in the first quarter of 2014 and was partially offset by increases in staff in other locations.
2013 Compared to 2012
Consolidated research and development costs for the year ended December 31, 2013 were $21,315, an increase of $2,521, or 13%, from the $18,794 reported for 2012. The increase in research and development was primarily attributable to:
•
higher compensation expenses of approximately $1,614, including the unfavorable impact of changes in currency exchange rates and an increase in average research and development staff in 2013,
•
redundancy costs associated with the closure of the facility in Brisbane, Australia of $645, and
•
expenses of approximately $391 related to Cronto, which was acquired in May 2013,
partially offset by
•
a decrease in long-term incentive compensation expenses of approximately $221.
We estimate that the research and development expenses increased approximately $264 in 2013 primarily as a result of the strengthening of the Euro to the U.S. Dollar.
The average research and development headcount increased approximately 4% to 145 in 2013 from 140 in 2012. The increase in headcount related to the addition of staff in our offices in Vienna, Austria in order to facilitate the transfer of engineering activities from our operations in Brisbane, Australia and the addition of Research & Development staff at Cronto, which was acquired in May 2013.
General and Administrative Expenses
2014 Compared to 2013
Consolidated general and administrative expenses for the year ended December 31, 2014 were $22,287, an increase of $1,091 or 5%, from the $21,196 reported for 2013. The increase in general and administrative expense was primarily attributable to increases in incentive-based compensation, including $442 of long-term incentive compensation expenses for administrative staff.
The average full-time general and administrative employee headcount decreased approximately 3% to 58 persons in 2014 from 59 persons 2013. At year-end 2014, 2013 and 2012, we employed 56, 60 and 59 general and administrative employees, respectively.
Compared to 2012
Consolidated general and administrative expenses for the year ended December 31, 2013 were $21,196, an increase of $1,125 or 6%, from the $20,071 reported for 2012. The increase in general and administrative expense was primarily attributable to:
•
higher compensation expenses of approximately $1,225, including the unfavorable impact of changes in currency exchange rates, primarily related to an increase in average general and administrative staff in 2013,
partially offset by
•
a decrease in long-term incentive compensation expenses of approximately $290.
We estimate general and administrative expenses increased approximately $278 in 2013 primarily as a result of the strengthening of the Euro to the U.S. Dollar.
The average full-time general and administrative employee headcount increased approximately 5% to 59 persons in 2013 from 56 persons in 2012.
Amortization Expense
2014 Compared to 2013
Amortization expense for 2014 was $4,532, an increase of $1,207, or 36%, from $3,325 reported for 2013. The increase was primarily related to the amortization of intangible assets associated with our acquisition of Cronto Ltd. for twelve months in 2014 compared to 7 months of amortization in 2013.
2013 Compared to 2012
Amortization expense for 2013 was $3,325, an increase of $1,420 or 75% from $1,905 reported for 2012. The increase was primarily related to the amortization of intangible assets associated with our acquisition of Cronto in May 2013.
Interest Income, Net
2014 Compared to 2013
Consolidated net interest income was $118 in 2014 compared to $162 in 2013. The decrease in net interest income reflected a decrease in the average return on invested balances partially offset by an increase in the average net cash balance. Our return on average net cash balances was 0.1% in 2014 compared to 0.2% in 2013. Average net cash and short term investment balances were $117,715 in 2014, an increase of $20,388, or 21%, from $97,327 in 2013. We expect that the rates of return on invested cash will continue to be minimal in 2015.
2013 Compared to 2012
Consolidated net interest income was $162 in 2013 compared to $261 in 2012. The decrease in net interest income reflected a decrease in the average return on invested balances partially offset by an increase in the average net cash balance. Our return on average net cash balances was 0.2% in 2013 compared to 0.3% in 2012. Average net cash balances were $97,327 in 2013, an increase of $4,586 or 5% from $92,741 in 2012.
Other Income (Expense), net
2014 Compared to 2013
Other income (expense), net in 2014 primarily included exchange gains (losses) on transactions that are denominated in currencies other than a subsidiary’s functional currency and subsidies received from foreign governments related to increasing trade in other countries or increasing spending on research and development. Other expense of $286 in 2014 compared to other income of $240 in 2013. The decrease in other income primarily reflects an increase in exchange losses. Exchange losses were $1,382 and $624 in 2014 and 2013, respectively.
2013 Compared to 2012
Other income was $240 in 2013 compared to $409 in 2012. The decrease in other income primarily reflects an increase in exchange losses. Exchange losses were $624 and $410 in 2013 and 2012, respectively.
Income Taxes
2014 Compared to 2013
Income tax expense for 2014 was $5,309, compared to $3,147 in 2013. The effective tax rate in 2014 was 14%, a decrease of 8 percentage points from 22% in 2013. The decrease in the rate in 2014 is primarily attributable to a significant increase in earnings from our foreign operations, the majority of which were taxed at the lower rate in Switzerland versus other higher taxed jurisdictions in Europe.
2013 Compared to 2012
Income tax expense for 2013 was $3,147, compared to $5,468 in 2012. The effective tax rate in 2013 was 22%, a decrease of 3 percentage points from 25% in 2012. The decrease in the rate in 2013 is primarily attributable to the fact that final payments were made by our Swiss and U.S. companies to purchase intellectual property from our other subsidiaries in 2012. As a result, income in higher tax foreign countries was lower in 2013 than in 2012.
Foreign Tax Credit and Loss Carryforwards Available
At December 31, 2014, we had foreign tax credit carryforwards of $5,516. Foreign tax credits of $944 expire in 2015 and the remaining $4,572 expire in 2023 and 2024. We have not provided a valuation reserve for the foreign tax credits because we believe that it is more likely than not that they will be realized.
At December 31, 2014, we also had foreign NOL carryforwards of $4,366 and other foreign deductible carryforwards of $3,568. The foreign NOL carryforwards have no expiration dates and the other deductible carryforwards expire from 2016 to 2021. At December 31, 2014, we had a valuation allowance of $2,378 for certain foreign deferred tax assets and $122 for U.S. state tax NOL. A reduction in the valuation allowance reduces income tax expense in the same period. See Note 7 to the consolidated financial statements for more information on tax loss carryforwards.
Income/Loss from Discontinued Operations
We had income from discontinued operations of $873 in 2014 compared to $180 for the full-year 2013. The income reported in 2014 reflected the settlement of all claims between us and the parties from whom we purchased DigiNotar in 2011. The income reported in 2013 reflected a change in the estimated cost to settle certain liabilities accrued in previous periods.
Note 3 of the consolidated financial statements contains additional information about the discontinued operations. See Part 1, Item 1A - Risk Factors and Part 1, Item 3 - Legal Proceedings for additional information related to DigiNotar B.V.
Liquidity and Capital Resources
At December 31, 2014, we had net cash balances (total cash, cash equivalents and restricted cash less bank borrowings) of $72,441 and short term investments of $64,940. We had no outstanding debt or restricted cash at December 31, 2014.
Short term investments at December 31, 2014, consisting of high quality commercial paper with maturities of less than nine months, were held by our U.S. entities and issued by domestic and foreign corporations.
At December 31, 2014, we held $24,063 of cash in banks in the United States and $48,378 of cash in banks outside of the United States. Of that amount, $47,312 is not subject to significant repatriation restrictions, but would be subject to taxes upon repatriation. We have not provided U.S.tax on unremitted foreign earnings as we consider them to be permanently invested.
Cash provided by operating activities was $38,754 during the year ended December 31, 2014. During 2014, we used $67,800 for investing activities, including net short term investments of $64,940 and $1,453 for additions to property and equipment. Financing activities provided $181, primarily consisting of the tax benefit of stock-based compensation and proceeds from the exercise of stock options.
Cash provided by operating activities was $10,331 during the year ended December 31, 2013. During 2013, we used $20,466 for investing activities, including $19,495 for the purchase of Cronto and $944 for additions to property and equipment. Financing activities provided $2,434, primarily stock option proceeds and tax benefits.
The net effect of 2014 activity resulted in a decrease in net cash of $26,166 and a net cash balance of $72,441 at December 31, 2014, compared to $98,607 at the end of 2013. Our working capital at December 31, 2014 was $161,029, an increase of $36,490 or 29% from $124,539 at December 31, 2013. The change is primarily attributable to the generation of positive cash flow from operations in 2014. Our current ratio was 4.6 to 1.0 at December 31, 2014.
The net effect of 2013 activity resulted in a decrease in net cash of $7,862 and a net cash balance of $98,607 at December 31, 2013, compared to $106,469 at the end of 2012. Our working capital at December 31, 2013 was $124,539, a decrease of $4,948 or 4% from $129,487 at December 31, 2012. The change is primarily attributable to the purchase of Cronto partially offset by the generation of positive cash flow from operations in 2013. Our current ratio was 4.3 to 1.0 at December 31, 2013.
We believe that our financial resources are adequate to meet our operating needs over the next twelve months.
While we believe that our financial resources are adequate to meet our operating needs over the next twelve months, the difficult current economic conditions that exist on a worldwide basis today may require us to
modify our business plans. In the current economic environment there is a risk that customers may delay their orders until the economic conditions stabilize or improve further. If a significant number of orders are delayed for an indefinite period of time, our revenue and cash receipts may not be sufficient to meet the operating needs of the business. If this is the case, we may need to significantly reduce our workforce, sell certain of our assets, enter into strategic relationships or business combinations, discontinue some or all of our operations, or take other similar restructuring actions. While we expect that these actions would result in a reduction of recurring costs, they also may result in a reduction of recurring revenue and cash receipts. It is also likely that we would incur substantial non-recurring costs to implement one or more of these restructuring actions. See our “Risks Related to Our Business” in Item 1A, Risk Factors.
Off-Balance Sheet Arrangements
The company has no off-balance sheet arrangements.
Contractual Obligations
The company has the following contractual obligations:
Purchase obligations are primarily for inventory. As further described in our Critical Accounting Policies, we regularly monitor inventories to ensure they are realizeable at stated values.
The company had $560 of unrecognized tax benefits as of both December 31, 2014 and 2013, which have been set aside in a reserve in accordance with ASC 740-10. These amounts are not included in the above table as the timing of payment of such obligations, if any, is not determinable.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, net realizable value of inventory and intangible assets. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Revenue Recognition
We recognize revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 985-605, Software - Revenue Recognition, ASC 985-605-25, Revenue Recognition - Multiple Element Arrangements and Staff Accounting Bulletin 104.
Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection of the revenue is probable.
In multiple-element arrangements, some of our products are accounted for under the software provisions of ASC 985-605 and others under the provisions that relate to the sale of non-software products.
In our typical multiple-element arrangement, the primary deliverables include:
1. a client component (i.e., an item that is used by the person being authenticated in the form of either a new standalone hardware device or software that is downloaded onto a device the customer already owns),
2. host system software that is installed on the customer’s systems (i.e., software on the host system that verifies the identity of the person being authenticated) or licenses for additional users on the host system software if the host system software had been installed previously, and
3. post contract support (PCS) in the form of maintenance on the host system software or support.
Our multiple-element arrangements may also include other items that are usually delivered prior to the recognition of any revenue and incidental to the overall transaction such as initialization of the hardware device, customization of the hardware device itself or the packaging in which it is delivered, deployment services where we deliver the device to our customer’s end-use customer or employee and, in some limited cases, professional services to assist with the initial implementation of a new customer.
In multiple-element arrangements that include a hardware client device, we allocate the selling price among all elements, delivered and undelivered, based on our internal price lists and the percentage of the selling price of that element, per the price list, to the total of the estimated selling price of all of the elements per the price list. Our internal price lists for both delivered and undelivered elements were determined to be reasonable estimates of the selling price of each element based on a comparison of actual sales made to the price list for each item delivered and to vendor specific objective evidence (VSOE) for undelivered items.
Undelivered elements primarily are PCS. The method by which we determine VSOE has validated that the price lists are reasonable estimates of the selling price for PCS. The estimated selling price of PCS items is based on an established percentage of the user license fee attributable to the specific software and is applied consistently to all PCS arrangements. The percentage we use to establish VSOE, which is also generally consistent with the percentage used in the price list, is developed using the “bell curve method”. This method relies on historical data to show that at least 80% of all our renewals are within 15% of the median renewal percentage rate.
In multiple-element arrangements that include a software client device, we continue to account for each element under the current standards of ASC 985-605 related to software. When software client device and host software are delivered elements, we use the Residual Method (ASC 605-25) for determining the amount of revenue to recognize for token and software licenses if we have VSOE for all of the undelivered elements. Any discount provided to the customer is applied fully to the delivered elements in such an arrangement. VSOE of fair value of PCS agreements is based on customer renewal transactions on a worldwide basis. In sales arrangements where VSOE of fair value has not been established, revenue for all elements is deferred and amortized over the life of the arrangement.
For transactions other than multiple-element arrangements, we recognize revenue as follows:
1. Hardware Revenue and License Fees: Revenue from the sale of computer security hardware or the license of software is recorded upon shipment or, if an acceptance period is allowed, at the latter of shipment or customer acceptance. No significant obligations or contingencies exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized.
2. Maintenance and Support Agreements: Maintenance and support agreements generally call for us to provide software updates and technical support, respectively, to customers. Revenue on maintenance and technical support is deferred and recognized ratably over the term of the applicable maintenance and support agreement.
3. Services: Subscription revenue is recognized ratably over the period in which the service is provided.
4. Consulting and Education Services: We provide consulting and education services to our customers. Revenue from such services is recognized during the period in which the services are performed.
We recognize revenue from sales to distributors and resellers on the same basis as sales made directly to customers. We recognize revenue when there is persuasive evidence that an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection of the revenue is probable.
For large-volume transactions, we may negotiate a specific price that is based on the number of users of the software license or quantities of hardware supplied. The per unit prices for large-volume transactions are generally lower than transactions for smaller quantities and the price differences are commonly referred to as volume-purchase discounts.
All revenue is reported on a net basis, excluding any sales taxes or value added taxes.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments for goods and services. We analyze accounts receivable, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. The allowance is based on a specific review of all significant past-due accounts. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.
Net Realizable Value of Inventory
We write down inventory where it appears that the carrying cost of the inventory may not be recovered through subsequent sale of the inventory. We analyze the quantity of inventory on hand, the quantity sold in the past year, the anticipated sales volume in the form of sales to new customers as well as sales to previous customers, the expected sales price and the cost of making the sale when evaluating the valuation of our inventory. If the sales volume or sales price of a specific model declines significantly, additional write-downs may be required.
Valuation of Goodwill and Other Intangible Assets and Software Development Costs
Impairment of Long-Lived and Intangible Assets:
Definite-lived intangible assets include proprietary technology and other intangible assets. Intangible assets other than patents with definite lives are amortized over the useful life, generally three to seven years for proprietary technology. Patents are amortized over the life of the patent, generally 20 years in the U.S.
Long-lived assets, including property, plant and equipment, definite-lived intangible assets being amortized and capitalized software costs, are reviewed for impairment in accordance with ASC 360-10, Property, Plant and Equipment, whenever events or changes in circumstances indicate that the carrying amount of the long-lived asset may not be recoverable. An impairment loss shall be recognized if the carrying amount of a long-lived asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If it is determined that an impairment loss has occurred, the loss is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value. Long-lived assets held for sale are reported at the lower of carrying value or fair value less cost to sell.
Goodwill and other Intangible Assets:
We account for goodwill and indefinite-lived intangible assets in accordance with ASC 350-20, Intangibles-Goodwill and Other. We assess the impairment of goodwill and intangible assets with indefinite lives each November or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Once identified, the amount of the impairment is computed by comparing the carrying value of the assets to the fair value, which is based on the discounted estimated future cash flows.
We have not recognized any impairment for the years ended December 31, 2014, 2013 or 2012 as the fair value of our reporting unit substantially exceeded the carrying amount.
Income Taxes:
We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect of a change in tax rates on deferred tax assets and liabilities and in income in the period that includes the enactment date.
At December 31, 2014, we had foreign tax credit carryforwards of $5,516 and foreign NOL carryforwards of $4,366. In addition, at December 31, 2014, we had other deductible carryforwards of $3,568. ASC 740-10 requires that valuation allowances be established for deferred tax assets if it is more likely than not that the assets will not be realized. We have provided valuation allowances against certain foreign deferred tax assets. (See Note 7 to the consolidated financial statements for more information regarding the NOL and valuation allowance.)
Also in accordance with ASC 740-10, we have unrecognized tax benefits related to uncertain tax positions. We have identified one exposure concerning cost allocations used in the implementation of our worldwide strategy related to the ownership of our intellectual property for which we had an unrecognized tax benefit of $560 at both December 31, 2014 and 2013, which is an offset to our U.S. deferred tax asset at the end of each respective period.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for
those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in applying such process, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.
ASU 2014-9 is effective for annual periods beginning after December 15, 2016, and interim periods within such annual periods, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, our management believes that the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.
Item 7A
Item 7A - Quantitative and Qualitative Disclosures about Market Risk (In thousands)
Foreign Currency Exchange Risk - In 2014, approximately 94% of our business was conducted outside the United States, primarily in Europe, Latin America and Asia/Pacific. A significant portion of our business operations is transacted in foreign currencies. As a result, we have exposure to foreign exchange fluctuations. We are affected by both foreign currency translation and transaction adjustments. Translation adjustments result from the conversion of the foreign subsidiaries’ balance sheets and income statements to U.S. Dollars at year-end exchange rates and weighted average exchange rates, respectively. Translation adjustments resulting from this process are recorded directly into stockholders’ equity. Transaction adjustments result from currency exchange movements when one of our companies transacts business in a currency that differs from its local currency. These adjustments are recorded as gains or losses in our statements of operations. Our business transactions are spread across numerous countries and currencies. This geographic diversity reduces the risk to our operating results. As noted in Management’s Discussion and Analysis above, we attempt to minimize the net impact of currency on operating earnings by denominating an amount of billings in a currency such that it would provide a hedge against the operating expenses being incurred in that currency.
Interest Rate Risk - We have minimal interest rate risk. We had no debt outstanding at December 31, 2014. Our cash, cash equivalents, and short term investments are invested in short-term instruments at current market rates. If rates were to increase or decrease by one percentage point, the company’s interest income would increase or decrease approximately $1,374 annually.
Impairment Risk - At December 31, 2014, we had goodwill of $22,208 and other intangible assets of $12,819, primarily from acquisitions including Risk IDS in 2014, Cronto in 2013, and other acquisitions prior to 2012. We assess the net realizable value of goodwill at least annually, and the net realizable value of other intangible assets whenever events or circumstances change indicating the carrying value may not be recoverable. For the twelve months ended December 31, 2014, 2013, and 2012, we did not incur any impairments however, we may incur impairment charges in future periods.
Item 8
Item 8 - Financial Statements and Supplementary Data
The information in response to this item is included in our consolidated financial statements, together with the report thereon of KPMG LLP, appearing on pages through of this Form 10-K, and in Item 7 under the heading Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 9
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A
Item 9A - Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, who, respectively, are our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the fiscal quarter ended December 31, 2014. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the fiscal quarter ended December 31, 2014, our disclosure controls and procedures were effective to provide assurance that (i) the information required to be disclosed by us in our reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls
There were no changes in the company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal year ended December 31, 2014, that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
The management of VASCO Data Security International, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all error and all fraud. While our disclosure controls and procedures and internal control over financial reporting are designed
to provide reasonable assurance that their objectives are met, they cannot provide absolute assurance. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. The inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
Notwithstanding the limitations noted above, our principal executive officer and principal financial officer have both concluded that our disclosure controls and procedures and internal control over financial reporting were effective at a reasonable level of assurance as of December 31, 2014.
Our management assessed the effectiveness of its internal control over financial reporting as of December 31, 2014. In making this assessment, it used the criteria based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission on Internal Controls (COSO) - Integrated Framework (2013). Based on our assessments we believe that, as of December 31, 2014, our internal control over financial reporting is effective based on those criteria.
Our independent registered public accounting firm, KPMG LLP, has issued an audit report on the effectiveness of our internal control over financial reporting. This report appears below.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
VASCO Data Security International, Inc.:
We have audited VASCO Data Security International, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). VASCO Data Security International, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, VASCO Data Security International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of VASCO Data Security International, Inc. and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated March 13, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Chicago, Illinois
March 13, 2015
PART III
Item 10
Item 10 - Directors, Executive Officers and Corporate Governance
All information in response to this Item is incorporated by reference to the “Directors and Executive Officers” and “Section 16(a) Beneficial Ownership Compliance” sections of VASCO’s Proxy Statement for the 2015 Annual Meeting of Stockholders.
Item 11
Item 11 - Executive Compensation
The information in response to this Item is incorporated by reference to the “Executive Compensation” section of VASCO’s Proxy Statement for the 2015 Annual Meeting of Stockholders.
Item 12
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information in response to this Item is incorporated by reference to the “Security Ownership of Certain Beneficial Owners, Directors and Management” section of VASCO’s Proxy Statement for the 2015 Annual Meeting of Stockholders.
Item 13
Item 13 - Certain Relationships and Related Transactions, and Director Independence
The information in response to this Item is incorporated by reference to the “Directors and Executive Officers” and “Transactions with Related Persons” sections of VASCO’s Proxy Statement for the 2015 Annual Meeting of Stockholders.
Item 14
Item 14 - Principal Accounting Fees and Services
The information in response to this Item is incorporated by reference to the “Report of the Audit Committee” section of VASCO’s Proxy Statement for the 2015 Annual Meeting of Stockholders.
PART IV
Item 15
Item 15 - Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this Form 10-K.
(1) The following consolidated financial statements and notes thereto, and the related independent auditors’ report, are included on pages through of this Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2014 and 2013
Consolidated Statements of Operations for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012
Notes to Consolidated Financial Statements
(2) The following consolidated financial statement schedule of the company is included on page of this Form 10-K:
Schedule II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because such schedules are not required or the information required has been presented in the aforementioned consolidated financial statements.
(3) The following exhibits are filed with this Form 10-K or incorporated by reference as set forth at the end of the list of exhibits:
* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K.
VASCO Data Security International, Inc. will furnish any of the above exhibits to stockholders upon written request addressed to the Secretary at the address given on the cover page of this Form 10-K. The charge for furnishing copies of the exhibits is $0.25 per page, plus postage.
VASCO Data Security International, Inc.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
All other financial statement schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
VASCO Data Security International, Inc.:
We have audited the accompanying consolidated balance sheets of VASCO Data Security International, Inc. and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited the accompanying consolidated financial statement Schedule II - Valuation and Qualifying Accounts. These consolidated financial statements and the consolidated financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth herein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 13, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Chicago, Illinois
March 13, 2015
VASCO Data Security International, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
See accompanying notes to consolidated financial statements.
VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying notes to consolidated financial statements.
VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except per share data)
Unless otherwise noted, references in this Annual Report on Form 10-K to “VASCO”, “company”, “we”, “our” and “us” refer to VASCO Data Security International, Inc. and its subsidiaries.
Note 1 - Summary of Significant Accounting Policies
Nature of Operations
VASCO Data Security International, Inc. and its wholly owned subsidiaries design, develop, market and support hardware and software security systems that manage and secure access to information assets. VASCO has operations in Austria, Australia, Belgium, Brazil, China, France, India, Japan, The Netherlands, Singapore, Switzerland, the United Arab Emirates, the United Kingdom (U.K)., and the United States (U.S.).
Principles of Consolidation
The consolidated financial statements include the accounts of VASCO Data Security International, Inc. and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
As further described in Note 3, during January 2011 we acquired 100% of the stock of DigiNotar B.V. Effective September 20, 2011, DigiNotar B.V. was declared bankrupt in The Netherlands, transferring effective control over DigiNotar B.V. to the bankruptcy trustee. Accordingly, assets, liabilities and operating activities related to DigiNotar B.V. are reflected as discontinued operations.
Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Foreign Currency Translation and Transactions
The financial position and results of the operations of the majority of the company’s foreign subsidiaries are measured using the local currency as the functional currency. Accordingly, assets and liabilities are translated into U.S. Dollars using current exchange rates as of the balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the year. Translation adjustments arising from differences in exchange rates are charged or credited to other comprehensive income. Losses resulting from foreign currency transactions were $1,382, $624, and $410 in 2014, 2013, and 2012, respectively, and are included in other income (expense) in the consolidated statements of operations.
The financial position and results of our operations in Singapore and Switzerland are measured in U.S. Dollars. For these subsidiaries, gains and losses that result from foreign currency transactions are included in the consolidated statements of operations in other income (expense).
Revenue Recognition
We recognize revenue in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 985-605, Software - Revenue Recognition, ASC 985-605-25, Revenue Recognition - Multiple Element Arrangements and Staff Accounting Bulletin 104.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection of the revenue is probable.
In multiple-element arrangements, some of our products are accounted for under the software provisions of ASC 985-605 and others under the provisions that relate to the sale of non-software products.
In our typical multiple-element arrangement, the primary deliverables include:
1. a client component (i.e., an item that is used by the person being authenticated in the form of either a new standalone hardware device or software that is downloaded onto a device the customer already owns),
2. host system software that is installed on the customer’s systems (i.e., software on the host system that verifies the identity of the person being authenticated) or licenses for additional users on the host system software if the host system software had been installed previously, and
3. post contract support (“PCS”) in the form of maintenance on the host system software or support.
Our multiple-element arrangements may also include other items that are usually delivered prior to the recognition of any revenue and incidental to the overall transaction such as initialization of the hardware device, customization of the hardware device itself or the packaging in which it is delivered, deployment services where we deliver the device to our customer’s end-use customer or employee and, in some limited cases, professional services to assist with the initial implementation of a new customer.
In multiple-element arrangements that include a hardware client device, we allocate the selling price among all elements, delivered and undelivered, based on our internal price lists and the percentage of the selling price of that element, per the price list, to the total of the estimated selling price of all of the elements per the price list. Our internal price lists for both delivered and undelivered elements were determined to be reasonable estimates of the selling price of each element based on a comparison of actual sales made to the price list for each item delivered and to vendor specific objective evidence (VSOE) for undelivered items.
Undelivered elements primarily are PCS. The method by which we determine VSOE has validated that the price lists are reasonable estimates of the selling price for PCS. The estimated selling price of PCS items is based on an established percentage of the user license fee attributable to the specific software and is applied consistently to all PCS arrangements. The percentage we use to establish VSOE, which is also generally consistent with the percentage used in the price list, is developed using the “bell curve method”. This method relies on historical data to show that approximately 80% of renewals are within 15% of the median renewal percentage rate.
In multiple-element arrangements that include a software client device, we account for each element under the standards of ASC 985-605 related to software. When software client devices and host software are delivered elements, we use the Residual Method (ASC 605-25) for determining the amount of revenue to recognize for token and software licenses if we have VSOE for all of the undelivered elements. Any discount provided to the customer is applied fully to the delivered elements in such an arrangement. VSOE of fair value of PCS agreements is based on customer renewal transactions on a worldwide basis. In sales arrangements where VSOE of fair value has not been established, revenue for all elements is deferred and amortized over the life of the arrangement.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
For transactions other than multiple-element arrangements, we recognize revenue as follows:
1. Hardware Revenue and License Fees: Revenue from the sale of computer security hardware or the license of software is recorded upon shipment or, if an acceptance period is allowed, at the latter of shipment or customer acceptance. No significant obligations or contingencies exist with regard to delivery, customer acceptance or rights of return at the time revenue is recognized.
2. Maintenance and Support Agreements: Maintenance and support agreements generally call for us to provide software updates and technical support, respectively, to customers. Revenue on maintenance and technical support is deferred and recognized ratably over the term of the maintenance and support agreement.
3. Services: Revenue is recognized ratably over the period in which the service is provided.
4. Consulting and Education Services: We provide consulting and education services to our customers. Revenue from such services is recognized during the period in which the services are performed.
We recognize revenue from sales to distributors and resellers on the same basis as sales made directly to customers. We recognize revenue when there is persuasive evidence that an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection of the revenue is probable.
For large-volume transactions, we may negotiate a specific price that is based on the number of users of the software license or quantities of hardware supplied. The per unit prices for large-volume transactions are generally lower than transactions for smaller quantities and the price differences are commonly referred to as volume-purchase discounts.
All revenue is reported on a net basis, excluding any sales or value added taxes.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost plus accrued interest, which approximates fair value. Cash equivalents are high-quality short term money market instruments with maturities of three months or less. Cash and cash equivalents are held by a number of U.S. and non-U.S. commercial banks and money market investment funds.
Short Term Investments
Short term investments are stated at cost plus accrued interest, which approximates fair value. Short term investments are high-quality commercial paper and bank certificates of deposit with maturities of twelve months or less.
Accounts Receivable and Allowance for Doubtful Accounts
The credit worthiness of customers is reviewed prior to shipment. A reasonable assurance of collection is a requirement for revenue recognition. Verification of credit and/or the establishment of credit limits are part of the customer contract administration process. Credit limit adjustments for existing customers may result from the periodic review of outstanding accounts receivable. The company records trade accounts receivable at invoice values, which are generally equal to fair value.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments for goods and services. We analyze accounts receivable balances, customer credit-worthiness, current economic trends and changes in our customer payment timing when evaluating the adequacy of the allowance for doubtful accounts. The allowance is based on a specific review of all significant past-due accounts. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
Inventories, consisting principally of hardware and component parts, are stated at the lower of cost or market. Cost is determined using the first-in-first-out (FIFO) method. We write down inventory where it appears that the carrying cost of the inventory may not be recovered through subsequent sale of the inventory. We analyze the quantity of inventory on hand, the quantity sold in the past year, the anticipated sales volume in the form of sales to new customers as well as sales to previous customers, the expected sales price and the cost of making the sale when evaluating the valuation of our inventory. If the sales volume or sales price of a specific model declines significantly, additional write downs may be required.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets ranging from three to seven years. Additions and improvements are capitalized, while expenditures for maintenance and repairs are charged to operations as incurred. Gains or losses resulting from sales or retirements are recorded as incurred, at which time related costs and accumulated depreciation are removed from the accounts.
Research and Development Costs
Costs for research and development, principally the design and development of hardware, and the design and development of software prior to the determination of technological feasibility, are expensed as incurred on a project-by-project basis.
Software Development Costs
We capitalize software development costs in accordance with ASC 985-20, Costs of Software to be Sold, Leased, or Marketed. Research costs and software development costs, prior to the establishment of technological feasibility, determined based upon the creation of a working model, are expensed as incurred. Our software capitalization policy currently defines technological feasibility as a functioning beta test prototype with confirmed manufacturability (a working model), within a reasonably predictable range of costs. Additional criteria include receptive customers, or potential customers, as evidenced by interest expressed in a beta test prototype, at some suggested selling price. Our policy is to amortize capitalized costs by the greater of (a) the ratio that current gross revenue for a product bear to the total of current and anticipated future gross revenue for that product or (b) the straight-line method over the remaining estimated economic life of the product, generally two to five years, including the period being reported on. No software development costs were capitalized in any of the years ending December 31, 2014, 2013, or 2012.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Income Taxes
We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect of a change in tax rates on deferred tax assets and liabilities and in income in the period that includes the enactment date.
We monitor our potential income tax exposures as required by ASC 740-10, Income Taxes.
We have significant net operating loss and other deductible carryforwards in certain foreign jurisdictions available to reduce the liability on future taxable income. A valuation allowance has been provided to offset some of these future benefits because we have not determined that their realization is more likely than not.
Fair Value of Financial Instruments
At December 31, 2014, and 2013, our financial instruments were cash equivalents, short term investments, accounts receivable, accounts payable and accrued liabilities. The estimated fair value of our financial instruments has been determined by using available market information and appropriate valuation methodologies, as defined in ASC 820, Fair Value Measurements and Disclosures. The fair values of the financial instruments were not materially different from their carrying amounts at December 31, 2014 and 2013.
Accounting for Leases
All of our leases are operating leases. Rent expense on facility leases is charged evenly over the life of the lease, regardless of the timing of actual payments.
Goodwill and Other Intangibles
We account for goodwill and indefinite-lived intangible assets in accordance with ASC 350-20. Indefinite-lived intangible assets include customer lists, proprietary technology and other intangible assets. Intangible assets other than patents with definite lives are amortized over the useful life, generally three to seven years for proprietary technology. Patents are amortized over the life of the patent, generally 20 years in the U.S.
We assess the impairment of goodwill and intangible assets with indefinite lives each November or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, and significant negative industry or economic trends. Fair value of our reporting unit is determined using a market approach using our stock price which is a level 1 valuation, as defined by ASC 820-10, Fair Value Measurements and Disclosures. The amount of impairment is computed by comparing the carrying value of the assets to fair value. We did not recognize any impairment for the year ended December 31, 2014 as the fair value of our reporting unit substantially exceeded our carrying amount.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Stock-Based Compensation
We have stock-based employee compensation plans, which are described more fully in Note 9. ASC 718-10, Stock Compensation requires us to estimate the fair value of restricted stock granted to employees, directors and others and to record compensation expense equal to the estimated fair value. Compensation expense is recorded on a straight-line basis over the vesting period.
Warranty
Warranties are provided on the sale of certain of our products and an accrual for estimated future claims is recorded at the time revenue is recognized. We estimate the cost based on past claims experience, sales history and other considerations. We regularly assess the adequacy of our estimates and adjust the amounts as necessary. Our standard practice is to provide a warranty on our hardware products for either a one or two year period after the date of purchase. Customers may purchase extended warranties covering periods from one to four years after the standard warranty period. We defer the revenue associated with the extended warranty and recognize it into income on a straight-line basis over the extended warranty period. We have historically experienced minimal actual claims over the warranty period.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in applying such process, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.
ASU 2014-9 is effective for annual periods beginning after December 15, 2016, and interim periods within such annual periods, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
Note 2 - Inventories
Inventories, consisting principally of hardware and component parts, are stated at the lower of cost or market. Cost is determined using the first-in-first-out (FIFO) method.
Inventory is comprised of the following:
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Note 3 - Discontinued Operations
During 2011, our wholly-owned Dutch subsidiary, DigiNotar B.V., was declared bankrupt. The court-appointed trustee is responsible for the business activities, administration and liquidation of DigiNotar B.V. Accordingly, related assets, liabilities and activities are reflected in discontinued operations.
Income (loss) from discontinued operations, net of tax, for the twelve months ended December 31, 2014, 2013, and 2012 was as follows:
At December 31, 2014 and 2013, remaining assets and liabilities related to DigiNotar have been classified as assets of discontinued operations and liabilities of discontinued operations, respectively, in the consolidated balance sheets and consist of the following:
Assets of discontinued operations and certain portions of liabilities of discontinued operations are denominated in local currencies and are subject to currency fluctuation.
Note 4 - Acquisition of Cronto
To further increase our product offerings, on May 20, 2013, we acquired all of the stock of Cronto Limited, a private company organized and existing in the United Kingdom (“Cronto”), for initial consideration of EUR 15,000 ($19,611 at the exchange rate of 1.31 U.S. Dollars per Euro). The purchase price was subject to verification of certain balances resulting in an additional payment of GBP 358 in June 2013 (approximately $555 at an exchange rate of 1.55 U.S. Dollars per British Pound). Both payments were funded by our existing cash balances.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Consideration was allocated to assets acquired and liabilities assumed based on their respective fair values as of the acquisition date as follows:
In addition to consideration detailed above, the transaction also includes contingent consideration of 2,000 ($2,620 at the exchange rate of 1.31 U.S. Dollars per Euro) subject to orders for Cronto products from new customers during the twenty-four months ended May 20, 2015 to be recorded as earned.
Acquired identifiable intangible assets totaling $13,257 are being amortized over their respective useful lives ranging from two to five years. Goodwill is attributable to expected increased revenues and reduced costs resulting from synergies of combined operations.
The acquisition is not material to our consolidated balance sheet and results of operations. The consolidated financial statements include the operating results of Cronto from the acquisition date.
Note 5 - Goodwill
Goodwill activity for the two years ended December 31, 2014 consisted of the following:
Additions - Cronto refers to goodwill related to the acquisition of Cronto described above.
Certain portions of goodwill are denominated in local currencies and are subject to currency fluctuations.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Note 6 - Intangible Assets
Intangible asset activity for the two years ended December 31, 2014 is detailed in the following table.
Additions - Cronto refers to intangibles acquired in the acquisition of Cronto described above including capitalized technology, trademarks, customer relationships and non-compete agreements.
Certain intangible assets are denominated in local currencies and are subject to currency fluctuations. Expected amortization of the intangible assets for the years ended:
Note 7 - Income Taxes
Income from continuing operations before income taxes was generated in the following jurisdictions. For the year ended December 31, 2014, 2013, and 2012, domestic income excludes taxable intercompany dividend income of $30,650, $30,752, and $0, respectively.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
The provision for income taxes consists of the following:
The U.S. federal corporate tax rate varies with taxable income. For 2014 and 2013, our statutory rate was 35%. Our statutory rate for 2012 was 34%. The differences between the income tax provisions computed using the statutory federal income tax rate and the provisions for income taxes reported in the consolidated statements of operations are as follows:
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Current deferred tax assets and long-term deferred tax liabilities are presented as separate line items in the balance sheet. Long-term deferred tax assets of $6,885 and $6,334 as of December 31, 2014 and 2013, respectively, are included in other assets, net of accumulated amortization. Current deferred tax liabilities as of December 31, 2014 and 2013 of $1,235 and $726, respectively, are included in other accrued liabilities. Deferred income tax balances are comprised of the following:
Current deferred tax assets and liabilities are netted by tax jurisdiction. Similarly, long-term, deferred tax assets and liabilities are netted by tax jurisdiction.
Prior to 2013, we considered unremitted foreign earnings permanently invested and, consequently, did not provide deferred incremental U.S. taxes on them. In 2013, we determined earnings of certain subsidiaries are available for distribution. At December 31, 2014 and 2013, unremitted foreign earnings available for distribution are $19,849 and $46,012, respectively. The deferred tax liability for the incremental U.S. tax to be paid upon remittance as dividends at December 31, 2014 and 2013 was $955 and $380, respectively.
The earnings of certain subsidiaries remain permanently invested. At December 31, 2014 and 2013, total unremitted foreign earnings considered permanently invested are $83,122 and $50,398, respectively.
We utilized U.S. net operating loss (NOL) carryforwards of $10,586 in 2013 including $9,741 related to employee stock options. The stock option tax benefit of $3,318 was credited to additional paid-in capital.
Foreign tax credit carryforwards were $5,516 at December 31, 2014. Foreign tax credits of $944 expire in 2015 and the remaining $4,572 expire in 2023 and 2024. We have not provided a valuation reserve for the foreign tax credits as we believe it is more likely than not they will be realized due to our tax strategy to distribute foreign earnings to utilize foreign tax credits prior to expiration.
At December 31, 2014, we had foreign NOL carryforwards of $4,366 and other foreign deductible carryforwards of $3,568. The foreign NOL carryforwards have no expiration dates and the other deductible
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
carryforwards expire from 2016 to 2021. At December 31, 2014, we had a valuation allowance of $2,378 for certain foreign deferred tax assets and $122 for a U.S. state NOL carryforward.
The net change in the valuation allowance for the years ended December 31, 2014, 2013, and 2012, were increases of $101, $115 and $196, respectively. This valuation allowance will be reviewed on a regular basis and adjustments made as appropriate. In addition to the utilization of NOLs as noted above, the change in the valuation allowance also reflects other factors including, but not limited to, changes in our assessment of our ability to use existing NOLs and other deduction carryforwards, changes in currency rates, and adjustments to reflect differences between the actual returns filed and the estimates we made at financial reporting dates. The company expects to generate adequate taxable income to realize deferred tax assets in foreign jurisdictions where no valuation reserve exists.
We had no accrued interest or penalties for income tax liabilities at December 31, 2014. Our policy is to record interest expense and penalties on income taxes as income tax expense.
ASC 740-10, Accounting for Uncertainty in Income Taxes sets a “more likely than not” criterion for recognizing the tax benefit of uncertain tax positions. We have identified one such exposure concerning cost allocations related to the implementation of our worldwide strategy related to the ownership of our intellectual property for which we had a reserve of $560 at December 31, 2014 and 2013. The reserve is an offset to our U.S. deferred tax asset.
Our primary tax jurisdictions and the earliest tax year subject to audit are presented in the following table.
Note 8 - Deferred Warranty Revenue and Warranty Reserve
Our standard practice is to provide a warranty on our DIGIPASS hardware for one to two years after the date of purchase. Customers may purchase extended warranties covering periods from one to four years after the standard warranty period. We defer the revenue associated with the extended warranty and recognize it into income on a straight-line basis over the extended warranty period. The estimated cost of providing warranty services during the extended warranty period is less than the revenue related to such warranty service.
Deferred warranty revenue at December 31, 2014 will be recognized as revenue as follows:
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
We maintain a reserve for the potential cost of future warranty claims related to products sold and recognized in revenue. The reserve is included in accrued expenses. Activity in the warranty reserve account during the three years ended December 31, 2014 was as follows:
Note 9 - Stock Compensation Plans
In June 2009, our stockholders approved and in June 2014 our stockholders reapproved the VASCO Data Security International, Inc. 2009 Equity Incentive Plan (the “2009 Equity Plan”). The 2009 Equity Plan permits the issuance of awards in a variety of forms, including (1) shares of our common stock, (2) nonqualified and incentive stock options for the purchase of our common stock, (3) stock appreciation rights, (4) deferred stock, (5) other stock-based awards (including restricted shares, performance shares, performance units and other stock unit awards), and (6) cash incentive awards.
Upon approval of the 2009 Equity Plan, our 1997 Stock Compensation Plan, as amended and restated (the “1997 Compensation Plan”) was suspended. No additional awards will be issued under the 1997 Compensation Plan, however, all outstanding awards under the 1997 Compensation Plan were unaffected by the approval of the 2009 Equity Plan. The 1997 Compensation Plan permitted the award of stock compensation in various forms.
The 2009 Equity Plan and the 1997 Compensation Plan were designed and intended to provide performance incentives to employees and non-employee directors, consultants and other key persons of the company. Both plans are administered by the Compensation Committee as appointed by the Board of Directors and are intended to be non-qualified plans.
As of December 31, 2014, the number of shares allowed to be issued under the 2009 Equity Plan was 6,597 shares of the company’s common stock, representing 16.6% of the issued and outstanding shares of the company as of such date.
The following table summarizes compensation expense recorded under the two plans.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Stock Options
We have not granted stock options since 2005. There is no stock option expense for the three years ended December 31, 2014. Options granted had terms of six to ten years and vesting periods of one to five years. The company may issue new shares or treasury shares for option exercises. The following table summarizes option activity for the year ended December 31, 2014. There were no options outstanding at December 31, 2014.
Exercise of options to purchase 20 shares resulted in the issuance of 20 shares.
The intrinsic value of options exercised and the fair value of shares vested over the last three years were:
Time-Based Restricted Stock
Time-based restricted stock awards granted to non-employee directors in 2014 vest on the first anniversary date of the grant. Shares are subject to forfeiture if the service period requirement is not met. Compensation expense equal to the market value of the stock on the grant date is recorded on a straight-line basis over the vesting period as required by ASC 718-10. Compensation expense was $1,316, $1,871, and $1,849 for 2014, 2013, and 2012. The following table summarizes the time-based restricted stock activity for the year ended December 31, 2014:
The unamortized future compensation expense for time-based restricted stock awards was $718 at December 31, 2014.
Performance-Based Restricted Stock
Performance-based restricted stock awards granted to executive officers in 2014 were subject to achievement of one-year and three year performance targets established by the Board of Directors. Earned shares related to one-
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
year performance targets vest annually over four years. Earned shares related to three-year targets vest upon completion of the three-year period. Shares are subject to forfeiture if the service period requirement is not met.
The number of shares to be earned from awards granted in 2014 was152. No shares were earned in 2013 or 2012. Compensation expense, equal to the market value of the stock on the grant date, is recorded on a straight-line basis over the vesting period at the performance level deemed probable, as required by ASC 718-10. Compensation expense in 2014, 2013, and 2012 was $1,083, $600, and $956. Unamortized future compensation expense for performance-based restricted stock was $1,454 at December 31, 2014.
The following table summarizes activity related to unvested performance restricted stock shares during 2014:
At December 31, 2014, total unvested shares consists of 62 earned shares and 254 unearned shares.
Other Long-term Stock Incentive Awards
During 2012 and 2010, other long-term stock incentive awards were granted to key employees, other than named executive officers subject to achievement of performance targets established by the Board of Directors. Awards are designated in U.S. Dollars however, at the option of the Company, may be paid in our common stock. Compensation expense equal to the award level deemed probable is recorded on a straight-line basis over the vesting period as required by ASC 718-10.
For awards granted in 2012, the one-year performance target was not met. Awards granted in 2010 vested at the end of the three-year performance period and were paid in cash during 2013. For the year ended December 31, 2013 and 2012, expense related to the awards granted in 2010 was $16, and $119, respectively.
No long-term stock incentive awards were granted in 2014 or 2013.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Note 10 - Earnings per Common Share
Basic earnings per share is based on the weighted average number of shares outstanding and excludes the dilutive effect of unexercised common stock equivalents. Diluted earnings per share is based on the weighted average number of shares outstanding and includes the dilutive effect of unexercised common stock equivalents to the extent they are not anti-dilutive. A reconciliation of the shares included in the basic and fully diluted earnings per share calculations is as follows:
Note 11 - Employee Benefit Plan
We maintain a defined contribution pension plan for our U.S. employees established pursuant to the provisions of Section 401(k) of the Internal Revenue Code, which provides benefits for eligible employees of the company and allows us to match employee contributions. For the years ended December 31, 2014, 2013, and 2012, we contributed $119, $116, and $111, respectively, to this plan as matching contributions.
We also maintain a pension plan for our Belgian employees, in compliance with Belgian law. The plan is a defined contribution plan, but has a minimum return guarantee under Belgian law. Returns guaranteed by the pension plan administrator are essentially equal to the legal requirement. For the years ended December 31, 2014, 2013, and 2012, the company contributed $697, $655, and $542, respectively, to the plan.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
Note 12 - Geographic, Customer and Supplier Information
We classify our sales by our customers’ locations in four geographic regions: 1) EMEA, which includes Europe, the Middle East and Africa; 2) the United States, which for our purposes includes sales in Canada; 3) Asia Pacific Rim; and 4) Other Countries, including Australia, Latin America and India. Information regarding geographic areas for the years ended December 31, 2014, 2013, and 2012 is as follows:
For the years 2014, 2013, and 2012, our top 10 customers contributed 46%, 40%, and 37%, respectively, of total worldwide revenue. In 2014, 2013 and 2012, one customer accounted for approximately 11%, 18%, and 10%, respectively, of total revenue. In 2014, another customer accounted for approximately 12% of total revenue.
The majority of our products are manufactured by four independent vendors, headquartered in Hong Kong and Macau. Our hardware DIGIPASSES are assembled at facilities in mainland China.
Note 13 - Commitments and Contingencies
The company leases office space and automobiles under operating lease agreements expiring at various times through 2021. Future minimum rental payments required under non-cancelable leases are as follows:
Rent expense under operating leases aggregated $3,061, $3,400, and $3,340 for the year ended December 31, 2014, 2013, and 2012, respectively. Rent expense is recorded on a straight-line basis over the life of the lease agreement.
From time to time, we have been involved in litigation incidental to the conduct of our business. Currently, we are not a party to any lawsuit or proceeding that, in management’s opinion, is likely to have a material adverse effect on its business, financial condition or results of operations.
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(amounts in thousands, except per share data)
We include various types of indemnification clauses in our agreements. These indemnifications may include, but are not limited to, infringement claims related to our intellectual property, direct damages and consequential damages. The type and amount of such indemnifications vary substantially based on our assessment of risk and reward associated with each agreement. We believe the estimated fair value of these indemnification clauses is minimal and there have been no previous indemnification claims, and we cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions. We have no liabilities recorded for these clauses as of December 31, 2014.
Note 14 - Quarterly Results of Operations (unaudited)
The quarterly results of operations are as follows:
Due to rounding in earnings per share, the sum of the quarters may not be equal to the full year.
SCHEDULE II
VASCO DATA SECURITY INTERNATIONAL, INC.
VALUATION AND QUALIFYING ACCOUNTS
Allowance for doubtful accounts for trade receivables
See accompanying independent auditors’ report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 13, 2015.
VASCO Data Security International, Inc.
/s/ T. Kendall Hunt
T. Kendall Hunt
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant in the capacities indicated on March 13, 2015.
POWER OF ATTORNEY
Each of the undersigned, in his capacity as an officer or director, or both, as the case may be, of VASCO Data Security International, Inc. does hereby appoint T. Kendall Hunt, and each of them severally, his true and lawful attorneys or attorney to execute in his name, place and stead, in his capacity as director or officer, or both, as the case may be, this Annual Report on Form 10-K for the fiscal year ended December 31, 2014 and any and all amendments thereto and to file the same with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission. Each of said attorneys shall have power to act hereunder with or without the other attorney and shall have full power and authority to do and perform in the name and on behalf of each of said directors or officers, or both, as the case may be, every act whatsoever requisite or necessary to be done in the premises, as fully and to all intents and purposes as to which each of said officers or directors, or both, as the case may be, might or could do in person, hereby ratifying and confirming all that said attorneys or attorney may lawfully do or cause to be done by virtue hereof.
SIGNATURE
TITLE
/s/ T. Kendall Hunt
T. Kendall Hunt
Chief Executive Officer and Chairman
(Principal Executive Officer)
/s/ Jan Valcke
Jan Valcke
President and Chief Operating Officer
(Principal Operating Officer)
/s/ Clifford K. Bown
Clifford K. Bown
Chief Financial Officer and Secretary
(Principal Financial Officer and Principal Accounting Officer)
/s/ Michael P. Cullinane
Michael P. Cullinane
Director
/s/ Jean K. Holley
Jean K. Holley
Director
/s/ John N. Fox, Jr.
John N. Fox, Jr.
Director
/s/ Matthew Moog
Matthew Moog
Director