UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

[X]QUARTERLY REPORT PURSUANTTO SECTION 13OR 15(D)OFTHE SECURITIES EXCHANGE ACTOF 1934
  FORTHE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007MARCH 31, 2008

OR

 

[    ]TRANSITION REPORT PURSUANTTO SECTION 13OR 15(D)OFTHE SECURITIES EXCHANGE ACTOF 1934FORTHE TRANSITION PERIOD FROM            TO            

Commission file number 000-24389

VASCO Data Security International, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

DELAWARE 36-4169320

(State or Other Jurisdiction of


Incorporation or Organization)

 

(I.R.S. Employer


Identification No.)

1901 South Meyers Road, Suite 210

Oakbrook Terrace, Illinois 60181

(Address of Principal Executive Offices)(Zip Code)

(630) 932-8844

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.            xYes            ¨No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (seeor a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).Act.

¨ Large accelerated filer                    x Accelerated filer                                ¨ Non-accelerated filer

Large accelerated filer¨Accelerated filerx
Non-accelerated filer¨ (do not check if smaller reporting company)Smaller reporting company¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                                                                      ¨ Yes            x No

There were 37,204,82937,254,581 shares of Common Stock, $.001 par value per share, outstanding at October 31, 2007.April 30, 2008.


VASCO Data Security International, Inc.

Form 10-Q

For The Quarterly Period Ended September 30, 2007March 31, 2008

Table of Contents

 

PART I. FINANCIAL INFORMATION

  Page No.

Item 1.

  Financial Statements  
  Condensed Consolidated Balance Sheets as of September 30, 2007March 31, 2008 (Unaudited) and December 31, 20062007  3
  Condensed Consolidated Statements of Operations (Unaudited) for the three month period ended March 31, 2008 and nine month periods ended September 30, 2007 and 2006  4
  Consolidated Statements of Comprehensive Income (Unaudited) for the three month period ended March 31, 2008 and nine month periods ended September 30, 2007 and 2006  5
  Condensed Consolidated Statements of Cash Flows (Unaudited) for the ninethree months ended September 30,March 31, 2008 and 2007 and 2006  6
  Notes to Consolidated Financial Statements (Unaudited)  7

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations  1415

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk  2423

Item 4.

  Controls and Procedures  2423

PART II. OTHER INFORMATION

  

Item 6.

  Exhibits  2524

SIGNATURES

  2625

EXHIBIT INDEX

  2726

 


This report may contain trademarks of VASCO Data Security International, Inc. and its subsidiaries, some of which are registered, including VASCO, AccessKey, VACMan Server and VACMan/CryptaPak, AuthentiCard and Digipass.

2


VASCO Data Security International, Inc.

Condensed Consolidated Balance Sheets

(In thousands)in thousands, except per share data)

 

  September 30,
2007
 December 31,
2006
   March 31,
2008
 December 31,
2007
 

ASSETS

   (unaudited)    (unaudited) 

Current assets:

      

Cash and equivalents

  $40,042  $14,768   $47,815  $38,833 

Accounts receivable, net of allowance for doubtful accounts

   18,015   19,617    21,320   25,721 

Inventories, net

   6,670   4,275 

Inventories

   8,418   7,076 

Prepaid expenses

   1,167   1,295    1,756   1,712 

Foreign sales tax receivable

   3,136   967    6,002   4,919 

Deferred income taxes

   767   375    224   476 

Other current assets

   308   23    216   180 
              

Total current assets

   70,105   41,320    85,751   78,917 

Property and equipment:

      

Furniture and fixtures

   2,822   2,273    3,519   3,124 

Office equipment

   3,012   2,395    3,851   3,341 
              

Total property

   5,834   4,668 
   7,370   6,465 

Accumulated depreciation

   (3,954)  (3,246)   (4,830)  (4,325)
              

Property and equipment, net

   1,880   1,422    2,540   2,140 

Goodwill, net of accummulated amortization

   13,957   12,685 

Goodwill, net of accumulated amortization

   15,362   14,319 

Intangible assets, net of accumulated amortization

   2,500   3,013    2,164   2,295 

Other assets, net of accumulated amortization

   3,381   4,206    3,292   3,005 
              

Total assets

  $91,823  $62,646   $109,109  $100,676 
              

LIABILITIES AND STOCKHOLDERS’ EQUITY

      

Current liabilities:

      

Bank borrowing

  $3,320  $2,154 

Accounts payable

   5,333   7,579    6,760   7,757 

Deferred revenue

   5,234   5,608 

Accrued wages and payroll taxes

   4,726   3,176    5,288   5,330 

Income taxes payable

   2,553   1,396    4,843   4,008 

Deferred revenue

   3,920   2,081 

Current deferred income taxes

   96   125 

Other accrued expenses

   3,523   2,751    3,564   3,776 

Current deferred compensation

   1,095   -   
              

Total current liabilities

   23,471   19,262    26,784   26,479 

Deferred warranty revenues

   336   302 

Long-term compensation plan

   898   356 

Long-term deferred taxes

   529   520 

Deferred warranty

   268   309 

Accrued compensation

   462   1,281 

Deferred revenue

   697   457 

Deferred tax liability

   577   611 
              

Total liabilities

   25,234   20,440    28,788   29,137 
              

Stockholders’ equity :

      

Common stock, $.001 par value - 75,000,000 shares authorized:

   

37,195,727 shares issued and outstanding at September 30, 2007,

36,546,289 shares issued and outstanding at December 31, 2006

   37   37 

Common stock, $.001 par value - 75,000 shares authorized;

   

37,254 and 37,205 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively

   37   37 

Additional paid-in capital

   64,372   61,251    65,179   64,734 

Accumulated deficit

   (2,707)  (20,398)

Accumulated other comprehensive income - Cumulative translation adjustment

   4,887   1,316 

Accumulated income

   5,461   565 

Accumulated other comprehensive income

   9,644   6,203 
              

Total stockholders’ equity

   66,589   42,206    80,321   71,539 
              

Total liabilities and stockholders’ equity

  $91,823  $62,646   $109,109  $100,676 
              

See accompanying notes to consolidated financial statements.

3


VASCO Data Security International, Inc.

Condensed Consolidated Statements of Operations

(Inin thousands, except per share data)

(Unaudited)(unaudited)

 

  Three months ended
September 30,
 Nine months ended
September 30,
   Three months ended
March 31,
 
  2007 2006 2007 2006   2008  2007 

Net revenue

  $29,977  $18,707  $88,824  $50,909   $28,928  $26,405 

Cost of goods sold

   10,009   5,922   30,639   16,811    8,889   8,875 
                    

Gross profit

   19,968   12,785   58,185   34,098    20,039   17,530 

Operating costs:

         

Sales and marketing

   6,246   4,570   18,995   13,013    7,700   6,090 

Research and development

   2,553   1,446   6,552   3,624    2,691   1,923 

General and administrative

   2,666   1,624   7,302   5,164    3,535   2,387 

Amortization of purchased intangible assets

   250   169   761   339    272   258 
                    

Total operating costs

   11,715   7,809   33,610   22,140    14,198   10,658 
                    

Operating income

   8,253   4,976   24,575   11,958    5,841   6,872 

Impairment of Secured Services, Inc. (SSI) investment

   -     -     -     (600)

Interest income (expense)

   192   (58)  330   16 

Other income (expense)

   (289)  27   (334)  135 

Interest income, net

   257   58 

Other income (expense), net

   261   (37)
                    

Income before income taxes

   8,156   4,945   24,571   11,509    6,359   6,893 

Provision for income taxes

   2,284   1,658   6,880   4,018    1,463   1,930 
                    

Net income

  $5,872  $3,287  $17,691  $7,491   $4,896  $4,963 
                    

Basic net income per share

  $0.16  $0.09  $0.48  $0.21 

Diluted net income per share

  $0.15  $0.09  $0.46  $0.20 

Weighted average shares outstanding:

     

Net income per share:

    

Basic

   37,013   36,251   36,820   36,190   $0.13  $0.14 
                    

Diluted

   38,387   37,712   38,207   37,701   $0.13  $0.13 
                    

Weighted average common shares outstanding:

    

Basic

   37,109   36,564 
       

Diluted

   38,308   38,001 
       

See accompanying notes to consolidated financial statements.

4


VASCO Data Security International, Inc.

Consolidated Statements of Comprehensive Income

(Inin thousands)

(Unaudited)(unaudited)

 

  Three months ended
September 30,
  Nine months ended
September 30,
  Three months ended
March 31,
  2007  2006  2007  2006  2008  2007

Net Income

  $5,872  $3,287  $17,691  $7,491

Net income

  $4,896  $4,963

Other comprehensive income - Cumulative translation adjustment

   2,498   177   3,571   1,030   3,441   338
                  

Comprehensive income

  $8,370  $3,464  $21,262  $8,521  $8,337  $5,301
                  

See accompanying notes to consolidated financial statements.

5


VASCO Data Security International, Inc.

Condensed Consolidated Statements of Cash FlowFlows

(Inin thousands)

(Unaudited)(unaudited)

 

  Nine months ended September 30,   Three months ended March 31, 
  2007 2006   2008 2007 

Cash flows from operating activities:

      

Net income

  $17,691  $7,491   $4,896  $4,963 

Adjustments to reconcile net income to net cash provided by operating activities:

      

Impairment of SSI investment

   -     600 

Depreciation and amortization

   2,263   698    919   719 

Deferred tax benefit

   (258)  (246)

Deferred tax expense (benefit)

   253   (7)

Non-cash compensation

   1,469   1,166    670   443 

Changes in assets and liabilities:

      

Accounts receivable, net

   2,665   (529)   5,547   (3,396)

Inventories, net

   (1,891)  (932)

Inventories

   (1,330)  (1,393)

Prepaid expenses

   208   169    46   (175)

Foreign sales tax receivable

   (1,935)  84    (1,052)  82 

Other assets

   (300)  253    (503)  (73)

Accounts payable

   (2,633)  (1,562)   (1,132)  (103)

Income taxes payable

   953   965    584   1,738 

Deferred revenue

   1,591   (409)   (475)  727 

Accrued wages and payroll taxes

   1,228   (432)   (364)  (43)

Accrued expenses

   612   30    (334)  300 

Long term deferred revenue

   210   -   

Deferred warranty

   34   41    (41)  (41)
              

Net cash provided by operations

   21,697   7,387    7,894   3,741 
              

Cash flows from investing activities:

      

Business acquisitions

   -     (1,912)

Additions to property and equipment

   (727)  (382)   (470)  (309)

Additions to goodwill and intangibles

   (249)  (51)   -     (203)

Reduction in restricted cash

   -     181 

Payments received on SSI note receivable

   -     220 
              

Net cash used in investing activities

   (976)  (1,944)   (470)  (512)
              

Cash flows from financing activities:

      

Proceeds/(repayment) from bank borrowing

   1,166   (94)

Proceeds from bank borrowing

   -     983 

Proceeds from exercise of stock options and warrants

   2,195   447    52   1,001 
              

Net cash provided by financing activities

   3,361   353    52   1,984 

Effect of exchange rates on cash

   1,192   728    1,506   (22)

Net increase in cash

   25,274   6,524    8,982   5,191 

Cash and equivalents, beginning of year

   14,768   16,962    38,833   14,768 
              

Cash and equivalents, end of period

  $40,042  $23,486   $47,815  $19,959 
              

See accompanying notes to consolidated financial statements.

6


VASCO Data Security International, Inc.

Notes to Condensed Consolidated Financial Statements

(All amounts are in thousands, except per share data)

(Unaudited)

Unless otherwise noted, references in this Quarterly Report on Form 10-Q 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 security products and services which manage and protect against unauthorized access to computer systems of corporate and government customers. VASCO has operations in Austria, Australia, Belgium, Brazil, China, Japan, the Netherlands, Singapore, the United States (U.S.) and Switzerland.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of VASCO Data Security International, Inc. and its subsidiaries and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2006.2007.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the results of the interim periods presented. All significant intercompany accounts and transactions have been eliminated. The operating results for the interim periods presented are not necessarily indicative of the results expected for a full year.

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.

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. Our actualActual 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. Revenue and expenses are translated at average exchange rates prevailing during the year.

7


Translation adjustments arising from differences in exchange rates are charged or credited to Other Comprehensive Income. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations.

Revenue Recognition

The company recognizesWe recognize revenue in accordance with AICPA Statement of Position (SOP) 97-2 and SEC Staff Accounting Bulletin (SAB) 104. We recognize revenueRevenue 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.

Hardware Revenue and License Fees: We record revenueRevenue from the sale of computer security hardware or the license of software licensesis recorded upon shipment or delivery or, if an acceptance period is allowed, at the timelater of shipment or customer acceptance. No significant obligations or contingencies exist with regard to delivery, customer acceptance or rights of return at the time we recognize revenue.revenue is recognized.

Maintenance and Support Agreements: Maintenance agreements generally call for us to provide software updates to customers. Support agreements generally call for us to provide technical support and software updates to our customers. Revenue on technical support and software update rights is deferred and recognized ratably over the term of the support agreement.

Consulting and Education Services: We provide consulting and education services to our customers. We recognize revenueRevenue from such services is recognized during the period in which the services are performed.

Multiple-Element Arrangements:We allocate revenue to the various elements of multiple-element salesthe arrangements based on the estimated fair value of each deliverable as required by SOP 97-2 and Emerging Issues Task Force (EITF) Issue No. 00-21. The fair value for each element is based on the price charged when that element is sold separately, price lists, renewal rates and other methods. When discounts are given in a multiple-element arrangement, includes discounts, a proportionate amount of the discount is applied to each element based on theeach element’s fair value without regard to the discount. The estimated fair value of undelivered elements is deferred and recorded as revenue when

services are performed or products are delivered. For sales arrangements in which vendor-specificvendor specific objective evidence (VSOE) of fair value is not established, revenue for all elements is deferred and amortized over the life of the arrangement.

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 our 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 Equivalents

The company classifies as cash and equivalents amounts on deposit in banks and cash invested temporarily in various instruments with maturities of three months or less at time of purchase.

8


Accounts Receivable and Allowance for Doubtful Accounts

The credit-worthiness of customers is reviewed prior to shipment. A reasonable expectation of collection is a requirement for revenue recognition. Verification of credit and/or the establishment of credit limits are part of the new customer contract administration process. Adjustment of credit limits for existing customers may result from the monthly review of outstanding accounts receivable. The company records trade accounts receivable at invoice values, which are generally equal to fair value.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments for goods and services. The company analyzes 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. The company analyzes 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 software prior to the determination of technological feasibility, are expensed as incurred on a project-by-project basis.

Software Development Costs

VASCO capitalizesWe capitalize software development costs in accordance with Statement of Financial Accounting Standards (SFAS) No. 86,Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise 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 bearsbear 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.years, including the period being reported on. In the first quarter of 2008, we capitalized $491 for instructional software (see note 5). No amounts were capitalized in the first quarter of 2007.

9


Income Taxes

We account for income taxes under the asset and liability method. We recognize deferredDeferred 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.

VASCO monitors itsWe monitor our potential income tax exposure itemsexposures as required by Financial Accounting Standards Board (FASB) Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an interpretationInterpretation of FASB Statement No. 109.109.

We have significant net operating loss carryforwards in the U.S. and other countries which are available to reduce our potentialthe liability on future taxable income. We have established aA valuation reserve has been provided to offset most of these future benefits because we have not determined that their realization is more likely than not.

Fair Value of Financial Instruments

At March 31, 2008 and December 31, 2007, our financial instruments were accounts receivable, notes 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. The fair values of the financial instruments were not materially different from their carrying amounts at March 31, 2008 and December 31, 2007.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective in fiscal years beginning after November 15, 2007. Delayed application is permitted for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008. We adopted SFAS No. 157 on January 1, 2008 for financial assets and financial liabilities and have chosen to delay the adoption for nonfinancial assets and nonfinancial liabilities until January 1, 2009. We do not believe that the final adoption of this pronouncement will have a material effect on our results of operations or financial position.

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

VASCO accountsWe account for goodwill and other indefinite-lived intangible assets in accordance with SFAS No. 142,Goodwill and Other Intangible Assets. This statement replaced the requirements to amortizeIndefinite-lived intangible assets with indefinite lives and goodwill with a requirement for an impairment test. SFAS 142 also established accounting guidelines for identifiable intangible assets, which include customer lists, proprietary technology and other intangible assets. Intangible assets other than patents with definite lives are amortized over thetheir useful life of the asset,lives, generally three to seven

years for proprietary technology. Patents are amortized over the life of the patent, generally 20 years in the U.S.

10


We assess the impairment of goodwill and intangible assets with indefinite lives each year-end or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our last review during December 2006. 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.

When we determine that the carrying value of intangibles and goodwill or other intangible assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment is measured by the excess of the carrying amount of the asset over its fair value as determined by an estimate of discounted future cash flows.

Note 2 - AcquisitionsStock-Based Compensation

On October 25, 2006,Our stock-based employee compensation plan (the VASCO acquired Unified Threat Management specialist Able N.V.Data Security International, Inc. 1997 Stock Compensation Plan, as Amended and Restated) is accounted for under SFAS 123(R), Stock-Based Compensation. This statement requires us to estimate the fair value of Mechelen, Belgium (Able). VASCO acquired allstock options granted to employees, directors and others and to record compensation expense equal to the estimated fair value. The fair value of stock options at the date of grant is estimated using the Black-Scholes option pricing model, with the expected life adjusted to reflect the effect of post-vesting restrictions. This compensation expense is recorded on a straight-line basis over the vesting period of the stock of Able, in exchange for cash consideration of5,000 (equivalent to $6,300 at the historical exchange rate).options.

TheDeferred Warranty

Our standard practice is to provide a warranty on our authenticators for one or two years, depending on the country in which it is sold, after the date of purchase. Customers may purchase price included1,250 (equivalentextended warranties covering periods from one to $1,570 atthree years after the historical exchange rate) which is subject tostandard warranty period. We defer the revenue associated with the extended warranty and recognize it into income on a bank guaranty and may be returned to us in whole or in part if the seller terminates his employment with us before the fourth anniversary of the acquisition date. As required by EITF 95-8,Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination, we recorded this portion of the purchase price as deemed compensation in other assets, to be amortizedstraight-line basis over the required employmentextended warranty period.

On May 11, 2006, VASCO acquired all of We have historically experienced minimal actual claims over the issued and outstanding shares of Logico Smart Card Solutions GmbH and Logico Smartcard Solutions Vertriebs, GmbH (collectively, “Logico”) for an aggregate purchase price of $2,368. This includes a cash payment of1,236 (equivalent to $1,578 at the historical exchange rate) made at the time of purchase, previously acquired software rights with a net cost of $174 and estimated direct transaction costs of $416. In the first quarter this year, a payment of $200 was recorded as additional goodwill for the completion of certain performance requirements.warranty period.

The following summarized unaudited pro forma financial information for the three and nine months ended September 30, 2006, is based on the actual performance of VASCO and the businesses acquired from Logico and Able and assumes the acquisitions occurred January 1, 2006. These results are not necessarily indicative of the results that would have occurred if the acquisition had actually been completed on January 1, 2006, nor are they necessarily indicative of future consolidated results.

   

Three months
ended
September 30,

2006

  

Nine months

ended
September 30,

2006

Net revenue

  $19,185  $52,514

Net income

   3,296   6,705

Basic net income per share

   0.09   0.19

Diluted net income per share

   0.09   0.18

Note 32 – Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable represents the balance due on credit sales made to customers. The allowance for doubtful accounts is an estimate of losses that may result from customers’ inability to make payment on their outstanding balances. The $481 reduction in the allowance for the nine months ended September 30, 2007, was attributable to payments received and the write-off of amounts previously reserved.balances:

 

  

September 30,

2007

 

December 31,

2006

   March 31,
2008
 December 31,
2007
 

Accounts receivable

  $18,246  $20,329   $21,707  $26,173 

Allowance for doubtful accounts

   (231)  (712)   (387)  (452)
              

Accounts receivable, net

  $18,015  $19,617   $21,320  $25,721 
              

Note 43 - 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)FIFO method.

11


Inventories are comprised of the following:

 

  

September 30,

2007

  

December 31,

2006

  March 31,
2008
  December 31,
2007

Component parts

  $4,240  $2,450  $5,038  $3,876

Work-in-process and finished goods

   2,430   1,825   3,380   3,200
            

Total

  $6,670  $4,275  $8,418  $7,076
            

Note 54 – Goodwill and Other Intangibles

The following table summarizes intangible assets and goodwill activity for the ninethree months ended September 30, 2007:March 31, 2008:

 

   Capitalized
technology
  Patents &
trademarks
  Total
Intangible
assets
  Goodwill

Net balance at December 31, 2006

  $2,880  $133  $3,013  $12,685

Additions

   -   46   46   203

Net translation gain

   202   -   202   1,069

Amortization expense

   (755)  (6)  (761)  -
                

Net balance at September 30, 2007

  $2,327  $173  $2,500  $13,957
                

The additional goodwill primarily reflects the contingent payment earned under the terms of the Logico acquisition.

   Capitalized
technology
  Patents &
trademarks
  Total
Intangible
assets
  Goodwill

Net balance at December 31, 2007

  $2,125  $170  $2,295  $14,319

Net translation gain

   141   -     141   1,043

Amortization expense

   (269)  (3)  (272)  -  
                

Net balance at March 31, 2008

  $1,997  $167  $2,164  $15,362
                

Note 65 – Other Assets - Long Term

Other assets is comprised mostly of two components: instructional video software and deemed compensation. The cost of the software was capitalized in accordance with SFAS 86,Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.MarketedThis cost will beand is being amortized on a straight line basis over a three year life, or pro rata based on actual sales as a percentage of expected sales, whichever is larger. In the first quarter 2008, $491 of additional investment in the development of instructional videos was capitalized; amortization will commence once the project is complete.

Deemed compensation represents the long-term portion of the Able acquisition price which is contingent upon the seller’s continued employment with the company for a four year period.period ending October 2010. As of

September 30, March 31, 2008, the amount to be amortized over the next twelve months was $493 and has been included in prepaid expense. As of December 31, 2007, the amount to be amortized over the next twelve months was $418 and has been included in prepaid expense. As of December 31, 2006, the amount to be amortized over the next twelve months was $412.$459.

Amortization of the instructional software and deemed compensation is included in sales and marketing expense. Amortization of deferred tax assets is charged to income tax expense. The following table summarizes other long-term assets for the ninethree months ended September 30, 2007:March 31, 2008:

 

  Instructional
software
 Deemed
compen-
sation
 Deferred
tax assets
 Other
assets
 

Total other

assets

   Instructional
software
 Deemed
compensation
 Deferred
tax
assets
 Other
assets
 Total other
assets
 

Net balance at December 31, 2006

  $2,380  $1,168  $465  $193  $4,206 

Net balance at December 31, 2007

  $1,797  $843  $215  $150  $3,005 

Additions/(reductions)

   63   -   -   (77)  (14)   491   -     (3)  (18)  470 

Net translation gain

   155   74   38   2   269    116   54     170 

Amortized/expensed

   (630)  (314)  (136)  -   (1,080)   (237)  (116)  -     -     (353)
                                

Net balance at September 30, 2007

  $1,968  $928  $367  $118  $3,381 

Net balance at March 31, 2008

  $2,167  $781  $212  $132  $3,292 
                                

12


Note 7 – Bank Borrowings

VASCO maintains an overdraft agreement with Fortis Banque. Under terms of the agreement, we can borrow an amount equal to 80% of our Belgian subsidiary’s eligible accounts receivable up to a maximum of 3,500 U.S. Dollars or Euros. Borrowings in Euros accrue interest at an annual rate of 5.7% and borrowings in U.S. Dollars accrue interest at an annual rate equal to the average monthly prime rate as published daily by Reuters. We are obligated to pay a quarterly commitment fee of 0.125%. As of September 30, 2007, borrowings under the agreement totaled $3,320. The assets, excluding inventory, of our Belgian subsidiary secure our obligations under the agreement and, while it has no specific termination date, the agreement can be terminated by either party upon thirty (30) days notice. The agreement is governed by the General Lending Conditions for Corporate Customers, registered in Brussels, Belgium on December 20, 2001.

Note 86 – Income Taxes

In July 2006, the FASB issued Interpretation No. 48. The company adopted Interpretation 48 effective January 1, 2007. The interpretation set a “more likely than not” criterion for recognizing the tax benefit of uncertain tax positions; it established measurement criteria for tax benefits and it established certain new disclosure requirements.

The company’s primary tax jurisdictions and the last year for which tax returns have been cleared, either by audit or by statutory lapse, are presented in the table below. VASCO Data Security is abbreviated as “VDS.”:

Tax Jurisdiction

Subsidiary

Year

Belgium

VDS NV2004

Belgium

VDS Europe NV2005

United States

VDS Inc.2004

Singapore

VDS Asia Pacific2004

Netherlands

VDS BV2001

Australia

VDS Pty. Ltd.2003

We had no unrecognized tax benefits and no accrued interest or penalties at January 1, 2007 or at September 30, 2007.March 31, 2008. Our policy is to record interest and penalties on income taxes as income tax expense. A valuation reserve has been provided, however, to offset most of the future tax benefits because we have not determined that their realization is more likely than not.

At December 31, 2006, the Company2007, we had U.S. net operating loss carryforwards of $23,798 and foreign net operating loss carryforwards of $7,829. Such losses are$27,533. Of this amount, $21,246 is available to offset future taxable income in the respective jurisdictions. Theseincome. The remainder represents tax benefits have been recognized, but are offset by

valuation reserves.deductions for employee stock option gains which would be credited to paid-in capital. The U.S. loss carryforwards expire in varying amounts beginning in 2018 and continuing through 2023.2027. In addition, if certain substantial changes in the Company’scompany’s ownership arewere deemed to have occurred, there would be an annual limitation on the amount of the U.S. carryforwards that could be utilized.

At December 31, 2007, we also had foreign loss carryforwards of $7,789. The foreign loss carryforwards have no expiration dates. TheIncluded in the foreign loss carryforwards include $3,042 which was obtainedamount is $2,950 of tax losses acquired in the acquisition of Logico acquisition and, if utilized,Smart Card Solutions (Logico). Utilization of these loss carryforwards would not reduce incomefuture tax expense, but would reduce deferred tax assets or goodwill instead.created in the acquisition. Goodwill for the Logico acquisition was reduced by $85 in 2007.

Note 97 – Stock Compensation Plan

We awarded 9069 shares of restricted stock in the first quarter of 20072008 under ourthe VASCO Data Security International, Inc. 1997 Stock Compensation Plan, including 45as Amended and Restated, consisting of 39 issued shares and 4530 shares subject to future performance criteria.criteria which have not been issued. The market value of the restricted shares was $1,340$1,503 at the date of grant and will be amortized over their respective vesting periods, which range from one to four years.

The following table details the non-cash compensation expense incurred in the three and nine months ended September 30, 2007March 31, 2008 and 2006:2007:

 

  Three months
ended September 30,
  

Nine months

ended September 30,

  Three months
ended March 31,
  2007  2006  2007  2006  2008  2007

Stock options

  $80  $175  $250  $501  $70  $94

Restricted stock

   223   159   677   423   323   231

Long-term incentive plan

   261   121   542   242   277   119
                  

Total non-cash compensation

  $564  $455  $1,469  $1,166  $670  $444
                  

13


Note 108 – Common Stock and Earnings per Share

The following table summarizes the activity of VASCO’s common stock for the ninethree months ended September 30, 2007:March 31, 2008:

 

  Common stock issued  Common stock issued
  Number of
shares
  Value of
shares
  Number of
shares
  Value of
shares

Exercise of options

  570  $2,073  10  $52

Exercise of warrants

  35   121

Restricted stock awards

  45   672  39   857

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. The details of the earnings per share calculations for the three and nine month periods ended September 30,March 31, 2008 and 2007 and 2006 follow:

   Three months
ended March 31,
   2008  2007

Net income

  $4,896  $4,963
        

Weighted average common shares outstanding

    

Basic

   37,109   36,564

Incremental shares with dilutive effect:

    

Stock options

   1,081   1,308

Restricted stock awards

   56   67

Warrants

   62   62
        

Dilutive

   38,308   38,001
        

Net income per share

    

Basic

  $0.13  $0.14

Dilutive

  $0.13  $0.13

14

   

Three months

ended September 30,

  

Nine months

ended September 30,

   2007  2006  2007  2006

Net Income

  $5,872  $3,287  $17,691  $7,491
                

Weighted average common shares outstanding

        

Basic

   37,013   36,251   36,820   36,190

Incremental shares with dilutive effect:

        

Stock options

   1,210   1,197   1,243   1,256

Restricted stock awards

   95   182   78   171

Warrants

   69   82   66   84
                

Dilutive

   38,387   37,712   38,207   37,701
                

Net income per share

        

Basic

  $0.16  $0.09  $0.48  $0.21

Dilutive

  $0.15  $0.09  $0.46  $0.20


Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations (In

thousands, except headcount)headcount, ratios, time periods and percents)

Unless otherwise noted, references in this Quarterly Report on Form 10-Q to “VASCO,” “company,” “we,” “our,” and “us” refer to VASCO Data Security International, Inc. and its subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, 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 and Section 27A of the Securities Act of 1933 concerning, among other things, the prospects of, and developments and business strategies for, VASCO and our operations, including the development and marketing of certain new products and the anticipated future growth in certain markets in which we currently market and sell our products or anticipate selling and marketing our products 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” and “goal” 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 risks, uncertainties and other factors have been described in greater detail in VASCO’s Annual Report on Form 10-K for the fiscal year ended December 31, 20062007 filed with the Securities and Exchange Commission, and include, but are not limited to, (a) risks of general market conditions, including currency fluctuations, (b) risks inherent to the computer and network security industry, including rapidly changing technology, evolving industry standards, increasing numbers of patent infringement claims, changes in customer requirements, price competitive bidding, changing government regulations and (c) 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. Thus, the results that we actually achieve may differ materially from any anticipated results included in, or implied by these statements.

General

The following discussion is based upon our consolidated results of operations for the three and nine months ended September 30,March 31, 2008 and 2007 and 2006 (percentages in the discussion may be rounded to the closest full percentage point) and should be read in conjunction with our consolidated financial statements included elsewhere in this Form 10-Q and our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission.

We design, develop, market and support 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 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”), most of which incorporate an electronic signature capability, which guarantees the integrity of electronic transactions and data transmissions. 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 Digipass units comply with the Initiative for Open Authentication (OATH). As evidenced by our current customer base, our products are purchased by companies 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 banking, our customer banks’ corporate and retail customers.

15


Our target market is any business process that uses some form of electronic interface 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.

Comparison of Results for the Three and Nine Months Ended September 30,March 31, 2008 and 2007 and 2006

Industry Growth:We believe that, while there are no accurate measurements of the total industry’s size, the industry growth rate is increasing and will continue to grow at a significant rate into the foreseeable future. Growth is being driven by new government regulations, growing awareness of the impact of identity theft 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 those countries, 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 sell products currently. 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. During difficult economic periods, our customers often delay the rollout of existing applications and defer purchase decisions related to the implementation of our products in new applications. We did note a general slowdown in the approval processes of our customers within the banking market in the first quarter of 2008.

Currency Fluctuations: In the thirdfirst quarter of 20072008 and 2006,2007, approximately 92% and 94%91%, respectively, of our revenue was generated outside the United States. For both the nine months ended September 30, 2007 and 2006, approximately 91% was generated outside of the United States.

In addition, approximately 76%73% and 72% of our operating expenses in both the thirdfirst quarter of 2008 and 2007, and 2006,respectively, were incurred outside of the United States. For the first nine months ended September 30, 2007 and 2006, approximately 74% and 75%, respectively, of our operating expenses were incurred outside of the United States.States

Changes in currency exchange rates, especially from the Euro to U.S. Dollar, can have a significant impact on revenue and expenses. In general, to minimize the net impact of currency fluctuations, we attempt to denominate our billings in a currency such that it would provide a hedge against the operating expenses being incurred in that currency. Over the past few quarters our revenue in Euros has grown faster than our expenses denominated in Euros, which has resulted in our operating income being exposed to changes in currency exchange rates (see below for the net impact). We expect that changes in currency rates may also impact our future results if we are unable to match amounts of revenue with our operating expenses in the same currency.

The U.S. Dollar weakened approximately 7% and 8%12% against the Euro for the quarter and nine months ended September 30, 2007, respectively,March 31, 2008, as compared to the same period in 2006.2007. The U.S. Dollar weakened approximately 10% and 8%13% against the Australian Dollar for the quarter and nine months ended September 30, 2007, respectively,March 31, 2008, as compared to the same periodsperiod in 2006.2007. We estimate that the weakening of the U.S. Dollar versus these two currencies in 2008 compared to 2007 resulted in an increase in revenue of approximately $1,670 and $3,856$2,036 for the quarter and nine months ended September 30, 2007, respectively, compared to the same periods in 2006March 31, 2008, and an increase in operating expenses of approximately $587 and $1,893$1,225 for the quarter and nine months ended

September 30, 2007, respectively, compared to the same periods in 2006. March 31, 2008.

The financial position and results of operations of many of our foreign subsidiaries are generally 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. Translation

16


adjustments arising from differences in exchange rates are included as a separate component of stockholders’ equity. Revenue and expenses are translated at average exchange rates prevailing during the period. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations. Foreign exchange transaction lossesgains aggregating $296$341 in the thirdfirst quarter of 2008 compare to losses for the first quarter of 2007 compare to gains for the third quarter of 2006 of $23. For the nine months ended September 30, 2007, transaction losses of $540 compare to gains of $41 for the nine months ended September 30, 2006.$84. Transaction gains and losses are included in other non-operating income (expense).

To minimize the impact of changes in transaction gains and losses, we implemented a foreign exchange hedging program in the third quarter of 2005. Under the program, our Belgian subsidiary borrows U.S. Dollars in an amount that is generally equal to its net U.S. Dollar asset position. The U.S. Dollars borrowed are converted to Euros and invested in short-term instruments. The borrowings under this program have not been designated as a foreign currency hedge as that term is defined in FASB Statement 133,Accounting for Derivative Instruments and Hedging Activities. As a result of the start-up of our Swiss operations, we will re-evaluate our approach to hedging our exposed currency positions in the fourth quarter of 2007.

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, includingwhich for our purposes includes sales in Canada; 3) Asia Pacific Rim;Pacific; and 4) Other Countries, including Australia, Latin America and Central Asia. The breakdown of revenue for the three and nine months ended September 30,March 31, 2008 and 2007 and 2006 in each of our major geographic areas was as follows:

 

  Europe,
Middle East,
Africa
 

United

States

 Asia
Pacific
 Other
Countries
 Total   Europe,
Middle East,
Africa
 United
States
 Asia
Pacific
 Other
Countries (a)
 Total 

Three months ended September 30:

 

    

Three months ended March 31:

Three months ended March 31:

 

    

Total Revenue:

            

2008

  $19,460  $2,396  $3,151  $3,921  $28,928 

2007

  $19,686  $2,437  $4,776  $3,078  $29,977    16,201   2,462   2,780   4,962   26,405 

2006

   10,811   1,165   1,694   5,037   18,707 

Percent of Total:

            

2008

   67%  8%  11%  14%  100%

2007

   66%  8%  16%  10%  100%   61%  9%  11%  19%  100%

2006

   58%  6%  9%  27%  100%

Nine months ended September 30:

      

Total Revenue:

      

2007

  $57,155  $7,545  $11,858  $12,266  $88,824 

2006

   31,692   4,576   3,854   10,787   50,909 

Percent of Total:

      

2007

   64%  9%  13%  14%  100%

2006

   62%  9%  8%  21%  100%

(a)Amounts for 2007 include amounts reclassified from Asia Pacific to Other Countries to be consistent with the presentation in 2008.

Total revenue in the thirdfirst quarter of 20072008 increased $11,270,$2,523, or 60%10%, over the thirdfirst quarter of 2006.2007. The increase was primarily attributable to an increase in the volume of products shipped and higher revenue resulting from the weakening of the U.S. Dollar as compared to the Euro, as previously noted.

We believe that thenoted, and an increase in product volume is attributedrelated to non-hardware revenue.

The increase in non-hardware product volume reflects our strategy to increase recurring software-related revenue. Non-hardware revenue, which includes software, maintenance, support, customization, warranty and other services increased from 15% of revenue in the increased strengthfirst quarter of our product line, growth2007 to 20% of revenue in our distribution channel and increased awarenessthe first quarter of the need for strong authentication to combat identity theft. We have expanded the capabilities of our core host system software, VACMAN, and increased the number of products, hardware and software, available to our customers. Once our customers have implemented the VACMAN software, they can customize their authentication processes by selecting from our broad line of hardware and software authentication products in order to match the appropriate level of authentication security with their perceived level of risk.2008.

Revenue generated in Europe, Middle East, Africa (EMEA) during the thirdfirst quarter was $8,875,$3,259, or 82%20%, higher than the thirdfirst quarter of 2006. 2007. The increase was primarily attributable to the weakening of the U.S. Dollar as compared to the Euro and an increase in product volume related to non-hardware revenue.

Revenue generated in the United States during the thirdfirst quarter was $1,272,$66, or 109% higher than the third quarter of 2006. Revenue generated in the Asia Pacific region during the third quarter was $3,082, or 181% higher than the third quarter of 2006. Revenue generated from other countries during the third quarter was $1,959, or 39%3%, lower than the thirdfirst quarter of 2006. The period-over-period increase in revenue in all of the primary geographic areas was primarily related to the aforementioned increase in volume. The decrease in other regions was due to a decline in volume. The other countries generally represent areas where the markets for strong user authentication are less developed and, as a result, we expect the sales volume in those areas to be more inconsistent. The increase2007. Revenue in the United States was less thandeclined primarily in other regionsthe banking market and is due, in part, to the fact that the U.S. banking market continues to defer the decision to implement strong authentication for users of its retail Internet banking services. We believe that we are well positioned to meet the needs of the U.S. market when banks decide to deploy strong user authentication to their retail banking customers.

Total revenue for the nine months ended September 30, 2007 increased $37,915, or 74% over the first nine months of 2006. The increase in revenue was attributable to the same factors noted above for the changes in the third quarter. Revenue for the nine months ended September 30, 2007 generated in EMEA was $25,463, or 80% higher than the third quarter of 2006, revenue generated in the United States was $2,969, or 65% higher than the third quarter of 2006, revenue generated in the Asia Pacific region during the first quarter was $8,004,$371, or 208%13%, higher than the thirdfirst quarter and revenueof 2007. The increase was primarily attributable to an increase in product volume.

17


Revenue generated from other countries during the first quarter was $1,479,$1,041, or 14% higher21%, lower than the thirdfirst quarter of 2006.2007. The decrease in other regions was due to a decline in product volume. The “other countries” region represents areas where the markets for strong user authentication are less developed and, as a result, we expect the sales volume in those areas to be more inconsistent.

For the first ninethree months of 2007,2008, our top ten customers accounted for approximately 47% of total revenue as compared to 54% of total revenue in the first ninethree months of 2006.2007.

Revenue by Target Market:Revenue is generated currently from two primary markets, banking/finance (Banking) and Enterprise Security (formerly referred to as Corporate Network Access)“Enterprise Security”, through the use of both direct and indirect sales channels. The Enterprise Security market includes corporations, business-to-business (B2B), business-to-consumer (B2C), e-commerce, e-government and various other vertical application markets that are not related to banking or finance. The breakdown of revenue between the two primary markets is as follows:

 

   Banking  Enterprise
Security
  Total 

Three months ended September 30:

 

Total Revenue:

    

2007

  $23,969  $6,008  $29,977 

2006

   16,092   2,615   18,707 

Percent of Total:

    

2007

   80%  20%  100%

2006

   86%  14%  100%

Nine months ended September 30:

 

Total Revenue:

    

2007

  $74,861  $13,963  $88,824 

2006

   43,406   7,503   50,909 

Percent of Total:

    

2007

   84%  16%  100%

2006

   85%  15%  100%

   Banking  Enterprise
Security
  Total 

Three months ended March 31:

 

Total Revenue:

    

2008

  $23,081  $5,847  $28,928 

2007

   22,442   3,963   26,405 

Percent of Total:

    

2008

   80%  20%  100%

2007

   85%  15%  100%

Revenue in the thirdfirst quarter of 20072008 from the Banking market increased $7,877,$639, or 49%3%, over the thirdfirst quarter of 20062007 and revenue from the Enterprise Security market increased $3,393,$1,884, or 130% in the same period. Revenue for the first nine months of 2007 from the Banking market increased $31,455, or 72%48%, compared to the first nine months of 2006, and revenue from the Enterprise Security market increased $6,460, or 86% in the same period. The increase in revenue in each of the markets is attributable to the factors noted above. The strength in the Enterprise Security market was attributable in part to increased sales volume from Original Equipment Manufacturer (OEM) customers, other large volume orders and sales of appliance-related products. Sales to OEM customers and other large volume orders both of which have gross margins that, due to our volume-pricing methodologies, are lower than the margins realized on sales to small and medium sizedmedium-sized businesses. We expect to continue to invest in the development of the channel as well as to continue to invest in developing products for the channel.

Enterprise Security revenue currently includes revenue generated in the e-commerce market. We expect that the e-commerce market will be an important source of future revenue for us as our products will not only provide a higher level of security for purchases made over the Internet; they can also help protect our customers’ revenue stream by making it more difficult for subscribers to our customers’ Internet services to share passwords.

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Gross Profit and Operating Expenses

The following table sets forth, for the periods indicated, certain consolidated financial data as a percentage of revenue for the three and nine months ended September 30, 2007March 31, 2008 and 2006:2007:

 

  Three months ended Nine months ended   Three months ended 
  September 30, September 30,   March 31, 
  2007 2006 2007 2006   2008 2007 

Revenue

  100.0% 100.0% 100.0% 100.0%

Net revenues

  100.0% 100.0%

Cost of goods sold

  33.4  31.7  34.5  33.0   30.7% 33.6%
                    

Gross profit

  66.6  68.3  65.5  67.0   69.3% 66.4%

Operating costs:

        

Sales and marketing

  20.8  24.4  21.4  25.6   26.6% 23.1%

Research and development

  8.5  7.7  7.4  7.1   9.3% 7.3%

General and administrative

  8.9  8.7  8.2  10.1   12.2% 9.0%

Amortization of intangible assets

  0.9  0.9  0.8  0.7 

Amortization of purchased intangible assets

  1.0% 1.0%
                    

Total operating costs

  39.1  41.7  37.8  43.5   49.1% 40.4%
    ��               

Operating income

  27.5  26.6  27.7  23.5   20.2% 26.0%

Interest income (expense)

  0.6  (0.3) 0.4  -   

Impairment of SSI investment

  -    -    -    (1.2)

Other income (expense), net

  (1.0) 0.1  (0.4) 0.3 

Interest income

  0.9% 0.2%

Other income (expense)

  0.9% -0.1%
                    

Income before income taxes

  27.1  26.4  27.7  22.6   22.0% 26.1%

Provision for income taxes

  7.6  8.8  7.8  7.9   5.1% 7.3%
                    

Net income

  19.5  17.6  19.9  14.7   16.9% 18.8%
                    

Gross Profit

Consolidated gross profit for the quarter ended September 30, 2007March 31, 2008 was $19,968,$20,039, an increase of $7,183,$2,509, or 56%14%, from the quarter ended September 30, 2006.March 31, 2007. Gross profit as a percentage of revenue was approximately 66.6%69% for the quarter ended September 30, 2007,March 31, 2008, as compared to 68.3%66% for the quarter ended September 30, 2006.March 31, 2007. The decreaseincrease in gross profit as a percentage of revenue for the thirdfirst quarter of 20072008 compared to 20062007 primarily reflects: (a)reflects the positive impact of currency, an increase in card readers sold, both in absolute dollars andnon-hardware related revenue as a percentage of total sales; (b)revenue and a decreasechange in the selling pricemix of the

readers resulting from larger quantities being sold and competitive pricing pressures; and (c)our revenue, with a decline in the gross profit of the Enterprise Security market resulting from volume price discounts as noted above. The decline in gross margins from these three factors was partially offset by: (a) an increase in thehigher percentage of the businessrevenue coming from the Enterprise Security market; (b) an increase in the percentagemarket.

The majority of the business coming from non-hardware products; (c) a reduction in the average per unit cost of product sold; and (d) the strengthening of the Euro compared to the U.S. Dollar. Our non-hardware revenues were 14% of total revenue for the third quarter of 2007 and compares to 8% of revenue for the third quarter of 2006.

Consolidated gross profit for the nine months ended September 30, 2007 was $58,185, an increase of $24,087, or 71%, from the comparable period in 2006. Gross profit as a percentage of revenue was 65.5% for the first nine months of 2007, as compared to 67.0% for the comparable period in 2006. The decrease in the gross profit as a percentage of revenue is generally consistent with the factors noted above. Our non-hardware revenue was 14% of total revenue for the first nine months of 2007 as compared to 11% of total revenue for the first nine months of 2006.

Ourour inventory purchases of inventory are denominated in U.S. Dollars. Also, as previously noted, our sales are denominated in Euros act as a hedge to offsetvarious currencies including the effects of currency fluctuations on operating expenses.Euro and Australian dollar. As the U.S. Dollar has weakened when compared to the Euro and Australian Dollar in the same periods in the prior year, revenue from sales made in Euros and Australian Dollars increased, as measured in U.S. Dollars, without the corresponding increase in cost of goods sold. The impact from changes in currency rates as noted above are estimated to behave increased revenue by approximately $1,670$2,036 for the quarter and $3,856 for the nine months ended September 30, 2007.March 31, 2008. Had the currency exchange rates in 20072008 been equal to the rates in 2006,2007, the gross profit rate would have been approximately 2.0 percentage points and 1.6 percentage points lower0.5% higher for the three and nine months ended September 30, 2007, respectively,March 31, 2008, than the comparable periodsperiod in 2006.2007.

Our non-hardware revenue was 20% of total revenue for the first quarter of 2008 and compares to 15% of total revenue for the first quarter of 2007. As noted above, the increase in non-hardware product volume reflects our strategy to increase recurring software-related revenue.

Operating Expenses

Our operating expenses are generally based on anticipated revenue levels and the majority of such expenses are fixed.fixed over short periods of time. As a result, small variations in the amount of revenue recognized in any given quarter could cause significant variations in the quarter-to-quarter comparisons of either the absolute amounts of operating income or operating income as a percentage of revenue.

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Sales and Marketing Expenses

Consolidated sales and marketing expenses for the quarter ended September 30, 2007March 31, 2008 were $6,246,$7,700, an increase of $1,676,$1,610, or 37%26%, from the thirdfirst quarter of 2006.2007. This increase in sales and marketing expenses is primarily related to increased direct headcount, the cost of agents in countries where we do not have a direct sales presence, increased sales-related travel, increased non-cash compensation amortization of instructional software and deemed compensation and the impact of a weaker U.S. Dollar compared to the Euro. The results for the quarter also reflected the reclass of expenses from sales and marketing to research and development of $257. The average full-time sales and marketing employee headcount was 120 in the third quarter of 2007 compared to 89 in the third quarter of 2006.

Consolidated sales and marketing expenses for the nine months ended September 30, 2007 were $18,995, an increase of $5,982, or 46%, from the same period of 2006. In addition to the factors noted above for the comparison of the third quarter, the increase in expense was attributable to increased marketing expense. Average full-time sales and marketing employee headcount138 in the first nine monthsquarter of 2007 was 111,2008, compared to 85103 in the first nine monthsquarter of 2006.2007.

Research and Development Expenses

Consolidated research and development expenses for the quarter ended September 30, 2007March 31, 2008 were $2,553,$2,691, an increase of $1,107,$768, or 77%40%, from the thirdfirst quarter of 2006.2007. This increase was primarily due to increased compensation-related expenses the reclassification of expenses from sales and marketing as noted above and the weaker U.S. Dollar compared to the Euro and Australian Dollar. Our acquisitions of Logico in May 2006 and Able in October 2006 have been the primary sources of increased headcount and compensation-related expenses. Average full-time research and development employee headcount in the thirdfirst quarter of 20072008 was 70,74, compared to 4866 in the thirdfirst quarter of 2006.

Consolidated research and development costs for the nine months ended September 30, 2007 were $6,552, an increase of $2,928, or 81%, from the same period of 2006. This increase was related to the same factors noted for the third quarter above. Average full-time research and development employee headcount for the first nine months in 2007 was 68 compared to 40 in the same period of 2006.2007.

General and Administrative Expenses

Consolidated general and administrative expenses for the quarter ended September 30, 2007March 31, 2008 were $2,666,$3,535, an increase of $1,042,$1,148, or 64%48%, from the thirdfirst quarter of 2006.2007. This increase was primarily due to increased compensation expenses, increased professional fees and the weaker U.S. Dollar compared to the Euro. The increase in compensation expense is due in part to the start up ofadditional headcount in the Swiss office and the addition of headcount in that office. Average full-time general and administrative employee headcount in the thirdfirst quarter of 20072008 was 26,32, compared to 2024 in the thirdfirst quarter of 2006.

Consolidated general and administrative expenses for the nine months ended September 30, 2007 were $7,302, an increase of $2,138, or 41%, from the same period of 2006. In addition to the factors noted above for the comparison of the third quarter, the increase in expense was attributable to reduction in the provision for bad debt as amounts were recovered in 2007 for provisions made in 2006. Average full-time general and administrative employee headcount for the first nine months in 2007 was 25 compared to 19 in the same period of 2006.2007.

Amortization of Intangible Assets

Amortization of intangible assets for the thirdfirst quarter and first nine months of 20072008 increased $81 and $422, respectively,$14 over the comparable periods of 2006.period in 2007. The increase was primarily related to the amortizationeffects of the weakening dollar as the majority of our intangible assets resulting from the acquisitions of Logico and Ableare denominated in 2006.

Impairment of Investment in SSI

In the first quarter of 2006, we determined that our investment in Secured Services, Inc. (SSI) had been impaired. In the second quarter of 2006 we recovered a portion of the investment that had been impaired. The charge taken in the first quarter of 2006 represented the full amount of the remaining investment we had in SSI as of that date. There have been no further adjustments related to our investment in SSI since the third quarter of 2006.Euros.

Interest Income

Consolidated net interest income was $192$257 in the thirdfirst quarter of 20072008 as compared to expenseincome of $58 in the thirdfirst quarter of 2006. For the nine months ended September 30, interest income was $330 in 2007 compared to $16 in the same period of 2006.2007. The increase in interest income in both periods is primarily attributable to income on higher average invested cash balances.

Other Income (Expense), Net

Other income primarily includes exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries’ functional currencies and subsidies received from foreign governments in support of our export business in those countries.currencies. Other expenseincome for the thirdfirst quarter of 20072008 was $289$261 and compares to other incomeexpense of $27 for the third quarter of 2006. Other expense$37 for the first nine monthsquarter of 2007 was $334 compared to other income2007. Exchange gains of $135$341 in the first nine monthsquarter of 2006. The reductions in income2008 compare to exchange losses of $84 in the three and nine-month periods reflect an increase in exchange losses related to U.S. Dollar positions that were not fully hedged infirst quarter of 2007.

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Income Taxes

Income tax expense for the thirdfirst quarter of 20072008 was $2,284, an increase$1,463, a decrease of $626$467 from the thirdfirst quarter of 2006.2007. The increasedecrease in tax expense is attributable to higherlower pre-tax income partially offset byand a lower effective tax rate. The effective tax rate was 28% for the third quarter of 2007 and compares to 33.5% for the third quarter of 2006.

Income tax expense23% for the first nine monthsquarter of 2007 was $6,880, an increase of $2,862 from the same period in 2006. The increase in tax expense reflects the tax on increased earnings, partially offset by a lower effective tax rate. The effective tax rate was2008 and compares to 28% for the first nine monthsquarter of 2007 and compares to 34.9% for the first nine months of 2006. The estimated effective tax rate for the first nine months of 2006 was 33.2%, but was increased for the effect of the impairment charge related to SSI, which was considered to be a one-time expense item with no corresponding tax benefit.2007.

The effective tax rate for both periods reflects our estimate of our full-year tax rate at the end of each respective period. The reduction in the tax rate reportedis primarily attributable to the benefits expected from the new strategy implemented in 2007 is lower thanrelated to the rate reported in 2006 as our estimatecompany’s ownership of the full-year tax rate in 2007 reflects increased earnings in Switzerland, which are taxed at a lower statutory rate and increased earnings in the United States, which will be offset by the use of tax loss carryforwards.its intellectual properties.

At December 31, 2006,2007, we had U.S. net operating loss carryforwards of $23,798 and foreign net operating loss carryforwards of $7,829. Such losses are$27,533. Of this amount, $21,246 is available to offset future taxable income in the respective jurisdictions. Theseincome. The remainder represents tax benefits have been recognized, but are offset by valuation reserves.deductions for employee stock option gains which would be credited to paid-in capital. The U.S. loss carryforwards expire in varying amounts beginning in 2018 and continuing through 2023.2027. In addition, if certain substantial changes in the Company’scompany’s ownership arewere deemed to have occurred, there would be an annual limitation on the amount of the U.S. carryforwards that could be utilized.

At December 31, 2007, we also had foreign loss carryforwards of $7,789. The foreign loss carryforwards have no expiration dates. TheIncluded in the foreign loss carryforwards include $3,042 which was obtainedamount is $2,950 of tax losses acquired in the Logico acquisition and, if utilized,of Logico. Utilization of these loss carryforwards would not reduce incomefuture tax expense, but would reduce deferred tax assets or goodwill instead.created in the acquisition. Goodwill for the Logico acquisition was reduced by $85 in 2007.

Liquidity and Capital Resources

Our net cash balance (total cash less loans payable to banks) was $36,722$47,815 at September 30, 2007,March 31, 2008, an increase of $10,693,$8,982, or 41% from $26,029 at June 30, 2007, and an increase of $24,108, or 191%23%, from $12,614$38,833 at December 31, 2006.

2007. At September 30, 2007,March 31, 2008, we had working capital of $46,634,$58,967, an increase of $8,810,$6,529, or 23%12%, from $37,824$52,438 reported at June 30, 2007, and an increase of $24,576, or 111% from $22,058 at December 31, 2006.2007. The increase in cash and working capital was primarily related to positive earnings before interest, taxes, depreciation and amortization (EBITDA).

Days sales outstanding (DSO) in net accounts receivable decreased to 55 days at September 30, 2007 from 67 days at June 30,March 31, 2008 from 76 days at December 31, 2007. DaysThe decrease in DSO was primarily related to the timing of when sales outstanding in receivables decreasedwere made in the third quarter of 2007 primarily due to the fact that revenue was realized more evenly in the third quarter of 2007 than in the second quarter.

EBITDA from continuing operations for the three and nine months ended September 30,March 31, 2008 and 2007 were $8,743was $7,021 and $26,504,$7,554, respectively, and reflect an increasea decrease of $3,424,$533, or 64% and $14,313, or 117% over amounts for the same periods of the prior year.7.1%. A reconciliation of EBITDA to net income for the three month period ended March 31, 2008 and nine-month periods ended September 30, 2007 and 2006 follows:

 

  Three Months
Ended March 31,
 
  Three months ended
September 30,
 Nine months ended
September 30,
   2008 2007 
  2007 2006 2007 2006   (in thousands) 
  (unaudited) (unaudited)   (unaudited) 

EBITDA

  $8,743  $5,319  $26,504  $12,191   $7,021  $7,554 

Interest income, net

   192   (58)  330   16    257   58 

Provision for income taxes

   (2,284)  (1,658)  (6,880)  (4,018)   (1,463)  (1,930)

Depreciaton and amortization

   (779)  (316)  (2,263)  (698)

Depreciation and amortization

   (919)  (719)
                    

Net income

  $5,872  $3,287  $17,691  $7,491   $4,896  $4,963 
                    

EBITDA is a non-GAAP financial measure within the meaning of applicable U.S. Securities and Exchange Commission rules and regulations. We use EBITDA as a measure of performance, a simplified tool for use in communicating our performance to investors and analysts and for

21


comparisons to other companies within our industry. As a performance measure, we believe that EBITDA presents a view of our operating results that is most closely related to serving our customers. By excluding interest, taxes, depreciation and amortization we are able to evaluate performance without considering decisions that, in most cases, are not directly related to meeting our customers’ requirements and were either made in prior periods (e.g., depreciation and amortization), or deal with the structure or financing of the business (e.g., interest) or reflect the application of regulations that are outside of the control of our management team (e.g., taxes). Similarly, we find that the comparison of our results to those of our competitors is facilitated when we do not need to consider the impact of those items on our competitors’ results.

EBITDA should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with accounting principles generally accepted in the United States (U.S. GAAP).States. While we believe that EBITDA, as defined above, is useful within the context described above, it is in fact incomplete and not a measure that should be used to evaluate our full performance or our prospects. Such an evaluation needs to consider all of the complexities associated with our business including, but not limited to, how past actions are affecting current results and how they may affect future results, how we have chosen to finance the business and how regulations and the other aforementioned items affect the final amounts that are or will be available to shareholders as a return on their investment. Net income determined in accordance with U.S. GAAP is the most complete measure available today to evaluate all elements of our performance. Similarly, our Consolidated StatementsStatement of Cash Flows, providewhich will be filed as part of our annual report on Form 10-K, provides the full accounting for how we have decided to use resources provided to us from our customers, lenders and shareholders.

At September 30, 2007,March 31, 2008, we had an overdraft agreement in place with Fortis Bank, wherein we could borrow up to 3,500 Euros or U.S. Dollars. We borrow against this line of credit as part of our hedging program as noted previously. Based on receivable balances as of September 30, 2007March 31, 2008 and the amount of borrowings outstanding under the line, to support our hedging program, $180$3,500 of the overdraft agreement was available to us for borrowing at September 30, 2007.March 31, 2008.

We believe that our current cash balances, credit available under our existing overdraft agreement, the anticipated cash generated from operations, and deposits that will be received in future quarters on orders of our products will be sufficient to meet our anticipated cash needs over the next 12 months.

There is substantial risk, however, that we may not be able to achieve our revenue and cash goals. If we do not achieve those goals, we may need to significantly reduce our workforce, sell certain 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.

For additional information related to risks, refer to Certain Factors noted in Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.2007.

Recently Issued Accounting Pronouncements

There were no recently issued accounting pronouncements that are deemed likely to have a significant impact on our financial position or results of operations.

22


Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in our market risk during the ninethree months ended September 30, 2007.March 31, 2008. For additional information, refer to “Item 7A. Quantitative and Qualitative Disclosures about Market Risk”, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.2007.

Item 4. Controls and Procedures

We maintain a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed by us in this Quarterly Report on Form 10-Q and in other reports required to be filed under the Securities Exchange Act of 1934, (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission for such filings. As required by Rule 13a-15(b) under the Exchange Act, our management, under the direction of our Chief Executive Officer and Chief Financial Officer, reviewed and performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of September 30, 2007.March 31, 2008. Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer, along with the other members of our management, have determined that as of September 30, 2007,March 31, 2008, the disclosure controls and procedures were and are effective as designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act relating to us and our consolidated subsidiaries would be accumulated and communicated to them, as appropriate, to allow timely disclosures regarding required disclosures.

There were no changes in our internal control over financial reporting (as that term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2007March 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

23


PART II. OTHER INFORMATION

Item 6.Exhibits.

Item 6. Exhibits.

Exhibit 31.1 - Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

Exhibit 31.2 - Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007May 9, 2008

Exhibit 32.1 - Section 1350 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

Exhibit 32.2 - Section 1350 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

24


SIGNATURES

Pursuant to the requirements 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 November 7, 2007.May 9, 2008.

 

VASCO Data Security International, Inc.

/s/ T. Kendall Hunt

T. Kendall Hunt
Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer)

/s/ Clifford K. Bown

Clifford K. Bown
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)

25


EXHIBIT INDEX

Exhibit 31.1 - Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

Exhibit 31.2 - Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

Exhibit 32.1 - Section 1350 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

Exhibit 32.2 - Section 1350 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 7, 2007.May 9, 2008.

 

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