VASCO DATA SECURITY INTERNATIONAL INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-24389
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VASCO DATA SECURITY INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)

DELAWARE 36-4169320
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)

1901 SOUTH MEYERS ROAD, SUITE 210 60181
OAKBROOK TERRACE, ILLINOIS (Zip Code)
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(630) 932-8844

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE

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. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of March 13, 2002, 28,263,058 shares of the Company's Common Stock,
$.001 par value per share ("Common Stock"), were outstanding. On that date, the
aggregate market value of voting and non-voting common equity (based upon the
last sale price of the Common Stock as reported on Nasdaq on March 13, 2002)
held by non-affiliates of the registrant was $34,087,818 at $2.99 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement for the Annual Meeting
of Stockholders to be held on July 16, 2002 are to be incorporated by reference
into Part III of this Form 10-K.
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PART I

CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995

This Annual Report on Form 10-K, including "Management's Discussion and
Analysis of Financial Condition and Results of Operations," contains
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 concerning, among other things, the prospects,
developments and business strategies for the Company (as defined) and its
operations, including the development and marketing of certain new products and
the anticipated future growth in certain markets in which the Company currently
markets and sells its products or anticipates selling and marketing its products
in the future. These forward-looking statements (i) are identified by their use
of such terms and phrases as "expected," "expects," "believe," "believes,"
"will," "anticipated," "emerging," "intends," "plans," "could," "may,"
"estimates," "should," "objective" and "goals" and (ii) are subject to risks and
uncertainties and represent the Company's present expectations or beliefs
concerning future events. The Company 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, including (a)
risks of general market conditions, including demand for the Company's products
and services, competition and price levels and the Company's historical
dependence on relatively few products, certain suppliers and certain key
customers, and (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 potential competition
from more established firms and others. Therefore, results actually achieved may
differ materially from expected results included in, or implied by, these
statements.

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL DEVELOPMENT OF BUSINESS

VASCO Data Security International, Inc. was incorporated in 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 and the telephone number at that address is (630)
932-8844. Our principal offices in Europe are located at Koningin Astridlaan
164, B-1780 Wemmel (Belgium) and the telephone number at that address is
32(0)2/456.98.10. Unless otherwise noted, specifically in the section entitled
Management's Discussion and Analysis of Financial Condition and Results of
Operations, references in this prospectus to "VASCO," "company," "we," "our,"
and "us" refer to VASCO Data Security International, Inc., its predecessor,
VASCO Corp., and its subsidiaries.

On March 29, 2001, the Company acquired Identikey Ltd., ("Identikey"), a
privately held international security software company headquartered in
Brisbane, Australia, with operations in the United States, Europe and Australia.
Under the terms of the purchase agreement, more than 90 percent of the
outstanding capital stock of Identikey was exchanged for 366,913 shares of
Company common stock, with potential additional earn-out payments made in the
form of additional shares which are based on defined performance incentives as
specified in the purchase agreement.

The Company, through its operating subsidiaries, designs, develops, markets
and supports open standards-based hardware and software security systems which
manage and secure access to information assets.

FINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES

See Note 10 to VASCO Notes to Consolidated Financial Statements for certain
information about foreign and domestic operations and export sales.

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This report contains the following trademarks of the Company, some of which
are registered: VASCO, AccessKey, VACMan Server and VACMan/CryptaPak,
AuthentiCard and Digipass.

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NARRATIVE DESCRIPTION OF THE BUSINESS

General

We design, develop, market and support security products and services which
manage and secure access to computer systems of corporate and governmental
clients. Additionally, we enable secure financial transactions made over private
enterprise networks and public networks, such as the Internet. We believe that
our software and hardware products provide organizations with strong, flexible,
and effective Internet and enterprise security solutions and they compete
favorably against those of our competitors. Our Digipass product line provides
greater flexibility and a more affordable means than competing products of
authenticating to any network, including the Internet. The Digipass family of
user authentication devices, all of which incorporate an electronic digital
signature capability to guarantee the integrity of electronic transactions and
data transmissions, are commonly referred to as security tokens. 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.

Our security solutions are sold worldwide through our direct sales force,
as well as through distributors, resellers and systems integrators. We currently
have approximately 500 customers in more than 50 countries. Representative
customers of our products include Rabobank Nederland, ABN AMRO Bank, Eterra
Norway, ING Bank, John Hancock, Fortis Bank, Liberty Mutual, Allmerica Financial
Services and the U.S. Government.

Industry Background

The growth in electronic banking and electronic commerce, and the
increasing use and reliance upon proprietary or confidential information by
businesses, government and educational institutions that is remotely accessible
by many users, has made information security a paramount concern. We believe
that enterprises are seeking solutions which will continue to allow them to
expand access to data and financial assets while maintaining network security.

According to International Data Corporation (IDC), the global market for
security products is growing from $4.0 billion in 1999 to over $11.3 billion in
2004, a compound annual growth rate of 23%.

Internet and Enterprise Security. With the advent of personal computers
and distributed information systems in the form of wide area networks,
intranets, local area networks and the Internet, as well as other direct
electronic links, many organizations have implemented applications to enable
their work force and third parties, including vendors, suppliers and customers,
to access and exchange data and perform electronic transactions. As a result of
the increased number of users having direct and remote access to such enterprise
applications, data and financial assets have become increasingly vulnerable to
unauthorized access and misuse.

Individual User Security. In addition to the need for enterprise-wide
security, the proliferation of personal computers, personal digital assistants
and mobile telephones in both the home and office settings, combined with
widespread access to the Internet, have created significant opportunities for
electronic commerce by individual users such as electronic bill payment, home
banking and home shopping.

Fueled by recent and well-publicized incidents including misappropriation
of credit card information and denial of service attacks, there is a growing
perception among many consumers that there is a risk involved in transmitting
information via the Internet. These incidents and this perception may hamper the
development of consumer-based electronic commerce. Accordingly, we believe that
electronic commerce will benefit from the implementation of improved security
measures that accurately identify users and reliably encrypt data transmissions
over the Internet.

Components of Security. Data and financial asset security, and secured
access to and participation in on-line commerce, generally consist of the
following components:

- Encryption: Maintains data privacy by converting information into an
unreadable pattern and allowing only authorized parties to decrypt the
data. Encryption can also maintain data integrity by

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creating digital signatures for transmitted data, enabling the recipient
to check whether the data has been changed since or during transmission.

- Identification and Authentication: Serves as the foundation for other
security mechanisms by verifying that a user is who he or she claims to
be. Identification and authentication mechanisms are often employed with
encryption tools to authenticate users, to determine the proper
encryption key for encrypting/decrypting data, or to enable users to
digitally "sign" or verify the integrity of transmitted data.

- Access Control: Software that provides authentication, authorization,
and accounting functions, controlling a user's access to only that data
or the financial assets which he or she is authorized to access, and
which keep track of a user's activities after access has been granted.

- Administration and Management Tools: Software which sets, implements,
and monitors security policies, the access to which is typically
regulated by access control systems. These tools are extremely important
to the overall effectiveness of a security system.

The most effective security policies employ most, if not all, of the above
components. Most companies, however, only implement a patchwork of these
components, which can result in their security systems being compromised.

The VASCO Solution

To date, most approaches to network security, including Internet security,
have been limited in scope and have failed to address all of the critical
aspects of data security. We believe that an effective enterprise-wide solution
must address and assimilate issues relating to the following:

- speed and ease of implementation, use, and administration;

- reliability;

- interoperability with diverse enterprise environments, existing customer
applications, and the security infrastructure;

- scalability; and

- overall cost of ownership.

Accordingly, we have adopted the following approach to data security:

- In designing our products, we have sought to incorporate all
industry-accepted, open, and non-proprietary protocols. This permits
interoperability between our products and the multiple platforms,
products, and applications widely in use.

- We have designed our products and services to minimize their integration
effort with, and disruption of, existing legacy applications and the
security infrastructure, such as public key infrastructure, known as PKI.
We provide customers with easier implementations and a more rapid means
of implementing security across the enterprise, including the Internet.
With security being a critical enabling technology for on-line business
initiatives, speed and ease of security implementation has become crucial
to an organization's success.

- We design our products and services to have a lower total cost of
security ownership than competing products and services. We have found
that product improvements and tools that lower a customer's total cost of
ownership create differentiating sales and marketing tools, and also help
in the development of a highly loyal customer base that is open to new
solutions that we offer.

As a result of this approach, we believe that we are positioned to be a
leading provider of our open standards-based software and hardware security
solutions.

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VASCO'S STRATEGY

We believe we have one of the most complete lines of security products and
services available in the market today and we intend to become a leading
worldwide provider of these products and services. A key element of our growth
strategy is to demonstrate to an increasing number of distributors, resellers
and systems integrators that, by incorporating our security products into their
own products, they can more effectively differentiate themselves in their
marketplaces and increase the value of their products. In addition, we
demonstrate to our corporate users that our products provide mission critical
security to their internal and external security infrastructures. Following this
aggressive marketing and promotion effort, we work with these resellers and
integrators to support their sales of solutions which include our products.
Also, we plan to expand our direct sales marketing program to new and existing
blue chip customers. Further, we intend to:

Increase Sales and Marketing Efforts Worldwide. We intend to increase
sales of our security products and services in our firmly established European
markets and to aggressively increase our sales and support presence and
marketing efforts in North America, South America, Asia/Pacific, Australia and
the Middle East. We plan to:

- market new services and products to our existing customers by providing
testimonial evidence of user experiences from other customers;

- launch a worldwide marketing campaign to raise awareness of our solutions
among the decision makers in the security products industry;

- form additional strategic relationships with resellers and vendors of
complementary, innovative security products and systems; and

- develop a marketing and sales infrastructure in new markets.

Continue Innovation. We intend to continue to enhance and broaden our line
of security products to meet the changing needs of our existing and potential
customers by:

- building on our core software and hardware security expertise, such as
expanding our technology for use on different platforms (like mobile
phones and personal digital assistants) and incorporating biometrics into
our products;

- acquiring complementary technologies or businesses; and

- developing additional applications for our products in areas which may
include securing the exchange of data in the healthcare field and
providing security for Internet gambling and lottery transactions, among
others.

VASCO'S PRODUCTS

Digipass Product Line

Our Digipass product line, which exists as a family of authentication
devices as well as extensive software libraries, provides a flexible and
affordable means of authenticating users to any network, including the Internet.

Security can be broken into three factors:

- What you have (the Digipass device itself);

- What you know (the PIN code to activate the Digipass); and

- Who you are (biometrics).

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The Digipass family is currently based on the first two factors. We are
developing new technology to incorporate the third factor into the Digipass.
Using the Digipass system, in order to enter a remote system or to digitally
sign data one needs:

- the hardware device (the token) itself so that if you do not physically
have the token, you will not be able to log on to the system; and

- the PIN code for the token so if you do not know the appropriate code the
user will not be able to use the applications stored inside.

Both of these factors help to make sure that a natural person is
authenticating (or signing), instead of a computer or another device. These
factors also enable extremely high portability for security anytime, anywhere
and anyhow.

Digipasses calculate dynamic passwords, also known as one-time passwords to
authenticate users on a computer network and for a variety of other
applications. There are several versions of the Digipass, the DP Desk 3000, DP
Pro 200, DP Go 1, 250, 300, 550, 600, 700, 800 and 850, each of which has its
own distinct characteristics depending on the platform that they use and the
functions they perform. However, the Digipass family is designed to work
together and customers can switch their users' devices without requiring any
changes to the customers' existing infrastructure. In addition, these devices
can be used to calculate digital signatures, also known as electronic signatures
or message authentication codes, to protect electronic transactions and
guarantee the integrity of the contents of these transactions.

In addition, Digipass Desk 3000 is designed to operate on non-VASCO
platforms such as a desktop PC or laptop. With the DP Pro 200, Digipass
technology is brought to personal digital assistants (PDA) while the DP Go 1
does the same for the mobile phones.

Digipass 800 and 850 combine the benefits of both traditional password
tokens (authentication and digital signatures) like Digipass 300 with smartcard
readers. They both bring portability to smart cards and allow secure time-based
algorithms.

A VASCO-secured system has the features needed to secure both today and
tomorrow's IT resources.

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DIGIPASS AT WORK

[GRAPHIC: DIGIPASS INITIALIZATION PROCESS]

The above illustration shows the various steps in the Digipass
initialization process. In the first step, the devices are initialized with
their unique set of secrets and keys per device. These secrets are stored in an
encrypted way on a diskette that is sent to the application owner (for example,
the information technology manager in a company or the security department of a
bank). These floppy disks are one way of safely transporting the Digipass
secrets to the host computer.

The files on the floppy disks will be used to read all the necessary
secrets and other data from the delivered Digipasses into a database. Then the
application owner will assign those Digipass secrets to the end-users. This
assignment is based on the serial number of the Digipass and the identity of the
end-user. The Digipass is then shipped to the end-user together with a manual
and the protected PIN-code on a secure PIN-mailer is sent by a separate
shipment.

Using a Digipass requires a connection to the host (server) computer that
knows the parameters of the end-user's Digipass. Every time the user sends a
dynamic password or digital signature to the host computer, the computer will
retrieve all the necessary information from the database and will check the
validity of the password or signature. After the host has checked the validity
of the dynamic password or signature, it will notify the end-user of the
correctness or incorrectness of the validity check.

Digipass security devices are not terminal dependent and do not require any
specific software platform since they only interact with a person.

Currently, the Digipass is used in many applications, the largest of which
is banking. Different banking applications are:

- corporate banking through direct dial-up, as well as over the Internet
and

- retail banking to secure transactions made through the use of a dial-up
connection with a personal computer, the traditional phone system, the
Internet, and wireless phones and other communication devices such as
personal digital assistants.

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Another significant application for the Digipass is to secure access to
corporate networks for home-based, traveling and other remote users. Finally,
Digipasses are increasingly being used in a variety of e-commerce applications
where the user is part of a pre-defined user group. We intend to expand the use
of the Digipass to other groups of users and applications, including electronic
commerce transactions directed at the general public.

Cryptech Product Line. The Cryptech product line produces encrypted
microprocessor chips. These chips are used to encrypt data for use in ATMs, fax
machines, modems and security servers at high speeds using DES and RSA
algorithms.

VACMAN Product Line

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.

Designed to provide the greatest flexibility, while not compromising on
functionality or security, VACMAN solutions are able 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 Controller

Designed by specialists in "system entry" security, VACMAN Controller makes
it easy to administer a high level of access control. You simply add a field to
your existing user database, describing the unique Digipass token assigned to
the user. VACMAN Controller takes it from there, automatically authenticating
the logon request using the security sequence you specify, whether it's a
one-time password using either Response-Only or a Challenge/Response
authentication scheme or an electronic signature.

VACMAN Controller gives you the freedom to provide secure remote access to
virtually any type of application. VACMAN Controller is a library requiring only
a couple of days to implement in most systems and supports all Digipass
functionality. Once linked to an application, VACMAN Controller automatically
handles login requests from any users you've authorized to have a Digipass
token.

VACMAN RADIUS Middleware

VACMAN RADIUS Middleware brings strong user authentication to existing
RADIUS based environments, while seamlessly integrating with other current
infrastructure technology. Many companies already use RADIUS servers and/or
firewalls to provide a way to centrally manage all remote connections to the
corporate IT infrastructure. VACMAN RADIUS Middleware allows administrators to
positively identify remote users before granting remote access to sensitive
corporate data and applications.

Logically VACMAN RADIUS Middleware is installed between the RADIUS client
(NAS, RAS or firewall) and the existing RADIUS server or servers. Once installed
VACMAN RADIUS Middleware functions transparently, adding strong, two factor,
authentication without otherwise affecting the operation of the server or other
network components.

With a range of automated administration features such as Dynamic User
Registration, automatic assignment of Digipass devices and the ability to bulk
manage users, VACMAN RADIUS Middleware provides transparent strong
authentication without adding significantly to the administration load.

VACMAN Server

VACMAN Server is an integrated, cross platform solution that uses industry
and international standards to provide strong two factor authentication, access
control and audit for remote, local and web-based users. It includes full
support for RADIUS, LAN and Web-based access solutions.

VACMAN Server has three access control modules that are available for
individual or integrated use. Strong authentication is achieved for server based
access control and management on an anywhere, anyhow,

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anytime basis. System access can be achieved independently via each module
(i.e., specific to a functional task) or in concert with each other, making
efficient use of common user authentication administration.

VACMAN Server provides a number of centralized services that are common to
all authentication solutions including secure, web-based administration allowing
administrators the option to administer either locally or remotely, customizable
reporting, delegation of administrative tasks on an organizational basis or by
function, full session monitoring and a full redundancy option for the
authentication server and database.

[VACMAN SERVER FOR RADIUS GRAPHIC]

RADIUS based solutions have generally relied on static user name and
passwords for authentication. Static passwords offer a potential weakness as
they can be trapped, guessed or forced to gain access to an otherwise secure
network. The VACMAN Server for RADIUS (VSR) removes this potential weakness by
adding support for One Time Passwords (OTP) for secure, two factor
authentication using Vasco's Digipass technology. OTP's ensure that all users
are strongly authenticated with information that cannot be re-used or guessed,
eliminating the most common means of defeating security systems.

VACMAN Server for RADIUS compliments an organization's existing security
infrastructure by ensuring that only users who have been strongly authenticated
are granted access to the network. The ability to support industry standards and
run on existing operating systems and hardware platforms provides the
flexibility to support any existing security solution adding value to an
organization's existing investment in people and equipment.

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[VACMAN SERVER FOR NETWORKS GRAPHIC]

Combining strong user authentication and audit for LAN and RADIUS into a
single strong authentication solution, VACMAN Server for Networks provides the
same authentication solution to users regardless of how they access the network
and network resources.

VACMAN Server for Networks has been designed to integrate seamlessly within
existing Windows NT and Windows 2000 based LAN solutions and can generally
function with existing client side network components. The ability to reuse
existing client side network access components provides an organization with the
option of implementing a staged rollout where user numbers are high or users are
scattered around different geographic locations. This also reduces support and
administrative loads as the user only sees minor changes to the logon process.

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[VACMAN SERVER FOR WEB GRAPHIC]

Combining user authentication, authorization and audit into a single strong
authentication solution, VACMAN Server for Web extends established AAA
principles to web based access and also supports the use of One Time Passwords
(OTP) for true, Digipass two factor strong authentication. VACMAN Server for Web
controls user access to individual resources within the protected web site
allowing an organization to finely control what information is accessed, not
only by who, but also when.

With VACMAN Server for Web installed, OTP's can be used to provide secure
access to remote users, through the organization's existing web servers and
firewalls. Once remote access is allowed and corporate processes can be
accessed, additional authentication may be required to validate any transactions
undertaken. VACMAN Server for Web fully supports Digipass electronic signatures
providing non-repudiation for any electronic transaction.

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[VACMAN SERVER CORPORATE LOGO]

VACMAN Server Corporate combines all VACMAN Server modules (RADIUS, LAN and
Web) into a single strong authentication solution for the entire organization.
VACMAN Server Corporate has been designed to integrate seamlessly within
existing access solutions to the network and can generally function with
existing client side network components. The ability to reuse existing client
side network access components provides an organization with the option of
implementing a staged rollout where user numbers are high or users are scattered
around different geographic locations. This also reduces support and
administrative loads as the user only sees minor changes to the logon process.
With the ability to support multiple domains and web servers, a single VACMAN
Server Corporate implementation can secure access to the entire network
regardless of the location of the protected entry points.

VACMAN Server Corporate supports an optional API that allows the
administrator to provide authentication services, manage users and their rights
and integrate VACMAN Server Corporate into existing security and user management
solutions via a consistent, secure programmatic interface, significantly
reducing the management overheads.

Public Key Infrastructure

Many corporations are increasingly relying upon digital certificates to
authenticate and identify users on a network, including the Internet. In
addition, digital certificates are used to transmit data in an encrypted format
over a network. The issuance, revocation, management and policies surrounding
these digital certificates is commonly referred to as public key infrastructure
or PKI. Like any other new comprehensive technology infrastructure, large
companies need to integrate PKI into their legacy and new applications. This
takes time, money, and specialized, hard-to-find personnel. While there may be
significant commercial

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potential for PKI, the process of integrating PKI into other enterprise-wide
applications has proven so difficult that few companies have existing PKI
deployments beyond the pilot stage.

We also have patent pending technology that allows for secure storage of a
digital certificate's private key on a server that can be accessed from any
network using any of our Digipass family of products. The effect of this
technology is that it gives digital certificates the portability of PKI deployed
on smartcards, without the cost or infrastructure development required for
deploying smartcards and their associated smartcard readers.

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 United
States and a corresponding patent in certain European countries, which cover
certain aspects of our technology. The majority of our patents cover our
Digipass family of security tokens. The U.S. patents expire between 2003 and
2010 and the European patent expires in 2008. 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 20 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 the fiscal
years ended December 31, 1999, 2000 and 2001, we expended $3,587,000, $4,369,000
and $4,981,000, respectively, on research and development, representing
approximately 18%, 15% and 19% of consolidated revenues for 1999, 2000 and 2001,
respectively.

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.

PRODUCTION

Our security hardware products are manufactured by third parties pursuant
to purchase orders that we issue. Our hardware products are made primarily from
commercially available electronic components which are purchased globally. Our
software products are produced either in-house or by several outside sources in
North America, Australia and Europe.

The security tokens utilize commercially available programmable
microprocessors, or chips. We use two microprocessors, made by Samsung and
Epson, for the various hardware products we produce. The Samsung microprocessors
are purchased from Samsung Semiconductor in France, and the Epson
microprocessors are purchased from Alcom Electronics NV/SA, also located in
Belgium. The microprocessors are the only components of our security tokens that
are not commodity items readily available on the open market. While there is an
inherent risk associated with each supplier of microprocessors, we believe
having two sources reduces the overall risk to a commercially acceptable level.

Orders of microprocessors and some other components 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 attempt to make appropriate
arrangements with our suppliers.

We purchase the majority of our product components and arrange for shipment
to third parties for assembly and testing in accordance with our design
specifications. Our security token products are assembled

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exclusively by two independent companies, each of which is based in Hong Kong.
Purchases from one of the companies are made on a purchase order by purchase
order basis. Purchases from the other company are under a contract with
automatic one-year renewals and subject to termination on six months notice.
Each of these companies assembles our security tokens at facilities in mainland
China. One of the companies also maintains manufacturing capacity in Hong Kong.
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.

There can be no assurance that we will not experience interruptions in the
supply of either the component parts that are used in our products or
fully-assembled token devices in general. In the event that the flow of
components or finished product was interrupted there could be a considerable
delay in finding suitable replacement sources for those components, as well as
in replacement assembly subcontractors with the result that our business and
results of operations could be adversely affected.

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. For both Digipass and VACMAN
products, our main competitor is RSA Security, Inc.. There are many other
companies such as Computer Associates International, Inc., Symantec, Inc.,
ActivCard and Entegrity Solutions, Inc. which offer hardware, software and
services that range from simple locking mechanisms to sophisticated encryption
technologies. We believe that competition in this market is likely to intensify
as a result of increasing demand for security products.

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, distribution channels and price. 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.

Many 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. Accordingly, it is possible that new competitors or
alliances may emerge and rapidly acquire significant market share.

Our products are designed to allow authorized users access to a computing
environment, in some cases using patented technology as a replacement for the
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.
For additional information regarding our competition, please refer to the
section titled "Risk Factors."

SALES AND MARKETING

Our security solutions are sold through our direct sales force, as well as
through distributors, resellers and systems integrators. A sales staff of 52
coordinates our sales through both our sales channels and these strategic
partners' sales channels and makes direct sales calls either alone or with sales
personnel of vendors of computer systems. 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.

13

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 the preparation and dissemination of white papers
prepared by our support engineers which explain how we believe 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:

Below is a breakdown of revenues by product line:

For the years 1999, 2000 and 2001, the Company's top 10 customers
contributed 70%, 72% and 73%, respectively, of total worldwide revenues.

Long term contracts with the U.S. government accounted for 8% of revenues
for the year 2001. Revenues are only recognized from these contracts when
receipt of payment is assured. Future amounts due under the contracts are
cancelable by the U.S. government and are not recognized as revenue by the
Company.

A significant portion of our sales are denominated in various foreign
currencies that could impact results of operations. To minimize exposure to
risks associated with fluctuations in currency exchange rates, we attempt to
match the timing of delivery, amount of product and the currency denomination of
purchase orders from vendors with sales orders to customers.

We also experience seasonality in our business. These seasonal trends have
included higher revenue in the last quarter of the calendar year and lower
revenue in the next succeeding quarter. We believe that revenue has tended to be
higher in the last quarter due to the tendency of certain customers to implement
or complete changes in computer or network security prior to the end of the
calendar year.

See Note 10 to VASCO Notes to Consolidated Financial Statements for a
breakdown of revenues and long-lived assets between U.S. and foreign operations.

EMPLOYEES

As of March 13, 2002, we employed 86 full-time employees. Of these, 14 were
located in North America, 51 were located in Europe, 17 were located in
Australia and 4 assigned in Asia/Pacific. Of the total, 52 were involved in
sales, marketing and customer support, 20 in product production, research and
development and 14 in administration.

14

ITEM 2. PROPERTIES

Our corporate office is located in the United States in an office complex
in Oakbrook Terrace, Illinois, a suburb of Chicago. This facility is leased
through November 30, 2004, and consists of approximately 9,000 square feet.

Our European administrative, sales and marketing, research and development
and support facilities are located in a suburb of Brussels, Belgium. These
facilities consist of approximately 23,500 square feet of office space which are
occupied under a lease expiring in October 30, 2006. We believe that these
facilities are adequate for our present growth plans.

Our Australian office is located in a suburb of Brisbane, consisting
approximately 4,900 square feet under a lease expiring on December 2006.

Our Asia/Pacific sales office is located in an office complex in Singapore,
consisting approximately 377 square feet with a one-year lease, renewable
annually.

ITEM 3. LEGAL PROCEEDINGS

The Company is from time to time involved in litigation incidental to the
conduct of its business. The Company is currently not a party to any lawsuit or
proceeding which, in the opinion of management, is likely to have a material
adverse effect on the Company's business, financial condition or results of
operations.

On March 13, 2002, a suit was filed against the Company claiming patent
infringement, false designation of origin and tradedress infringement. The case
is currently being evaluated by the Company and its legal counsel. The Company
believes the suit is without merit. As the suit is in its early stages,
management is unable to estimate the effect of this suit at this time.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth
quarter of 2001, through solicitation of proxies or otherwise.

15

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

On March 20, 1998, the Company's Common Stock was approved for trading on
the NASD Electronic Bulletin Board system under the symbol "VDSI." On April 7,
2000, the Company's Common Stock was listed on the Nasdaq National Market in the
United States under the trading symbol "VDSI".

On March 13, 2002, the closing sale price for the Common Stock on the
Nasdaq was $2.99 per share. Such market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent an actual transaction. On February 28, 2002, there were approximately
123 holders of record of the Common Stock.

The following table sets forth the high and low closing bid quotations for
the Common Stock for the periods indicated.

The Company has not paid any dividends on its Common Stock since
incorporation. Dividends were paid relating to the Company's Series B Preferred
Stock, which was converted to Common Stock in September 1997. Restrictions or
limitations on the payment of dividends may be imposed under the terms of credit
agreements or other contractual obligations. In the absence of such restrictions
or limitations, the declaration and payment of dividends will be at the sole
discretion of the Board of Directors of the Company 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.

16

ITEM 6. SELECTED FINANCIAL DATA

- ---------------
(1) Represents the financial information of VASCO Corp. prior to March 11, 1998,
as the Company had not begun operations until the Exchange Offer.

(2) Includes legal, accounting and printing costs of approximately $1,218
related to preparing for the Exchange Offer that was completed in March
1998.

(3) Includes restructuring expenses of $4,284.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Certain statements contained in the following Management's Discussion and
Analysis of Financial Condition and Results of Operations are forward-looking
statements. All forward-looking statements included herein are based on
information available to the Company on the date hereof and assumptions which
the Company believes are reasonable. The Company does not assume any obligation
to update any such forward-looking statements. These forward-looking statements
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth elsewhere in this Form 10-K
and the Company's other filings with the Securities and Exchange Commission.

BACKGROUND

Our predecessor company, VASCO Corp., entered into the data security
business in 1991 through the acquisition of a controlling interest in ThumbScan,
Inc., which we renamed VASCO Data Security, Inc. in 1993. In 1996, we began an
expansion of our computer security business by acquiring Lintel Security NV/SA,
a Belgian corporation, including assets associated with the development of
security tokens and security technologies for personal computers and computer
networks. In addition, in 1996, we acquired the stock of 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. All
of these acquisitions were accounted for under the purchase method of
accounting.

On March 11, 1998, we completed a registered Exchange Offer with the
holders of the outstanding securities of VASCO Corp. In the Exchange Offer,
holders of the common stock and warrants, options and other rights to acquire
common stock of our predecessor company exchanged their securities for the same
number and kind of securities of our present company, and released any potential
claims that such holders might have had against our predecessor in connection
with the issuances of its securities and other corporate

17

actions which occurred mostly during the 1980's. In the Exchange Offer, almost
98% of our predecessor's securities were tendered and accepted for exchange. In
October 1998, we completed the merger of our predecessor with and into the
current company and thereby eliminated all remaining outstanding securities of
our predecessor and our predecessor thereby ceased to exist.

Since the Exchange Offer, we have engaged in four acquisitions. In May
1999, we acquired the assets of SecureWare SA, a French company for a
combination of approximately $1.4 million in our stock and cash.

In October 1999, we acquired Intellisoft Corp. for a combination of
approximately $8 million in our stock and cash distributed to dissenting
shareholders. This acquisition was accounted for under the pooling-of-interests
method of accounting and, therefore, all of our financial information has been
restated to include the results of IntelliSoft.

In August 2000, we acquired Invincible Data Systems (IDS) in a transaction
which was accounted for under the pooling-of-interests method of accounting. A
total of 322,565 shares were issued in the transaction. Our historical financial
information was not restated for this transaction, which was deemed immaterial.

Our latest acquisition was on March 29, 2001 when we acquired Identikey
Ltd. ("Identikey"), a privately held international security software company
headquartered in Brisbane, Australia. Under the terms of the purchase agreement,
more than 90 percent of the outstanding capital stock of Identikey was exchanged
for 366,913 shares of Company common stock, with potential additional earn-out
payments made in the form of additional shares which are based on defined
performance incentives as specified in the purchase agreement. This purchase was
accounted for under the purchase method of accounting, and accordingly, the
acquired assets have been recorded at their estimated fair values at the date of
acquisition. Intangible assets related to this transaction were $1,897,000 and
are being amortized over a period of 7 years.

OVERVIEW

We design, develop, market and support security products and services which
manage and protect against unauthorized access to computer systems of corporate
and governmental clients.

Revenue and Earnings. We sell the majority of our products in European
countries with significant sales in the United States, although we intend to
actively pursue additional markets outside of Europe, particularly South
America, Asia/Pacific, Australia and the Middle East.

Revenues from sales from our Digipass family, specifically the Digipass 300
and 500 tokens, continue to represent the majority of our total revenues. During
1999 and 2000, Digipass products accounted for 80% and 70% of revenues,
respectively. For 2001, in excess of 80% of the Company's sales were comprised
of security token devices. Although we believe it is likely that sales of the
Digipass family of tokens, which can be used on various platforms, will continue
to account for a majority of our total revenues for the next few years, we also
believe that revenues from sales of our other hardware and software data
security products, including the VACMAN product line, will increase in the
future.

Research and Development. We are devoting substantial capital and other
resources to enhancing our existing security products and developing new
products to provide enterprise-wide hardware and software security solutions.
Costs of 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. 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.

18

Variations in Operating Results. Our quarterly operating results have in
the past varied and may in the future vary significantly. Factors affecting
operating results include:

- the level of competition;

- the size, timing, cancellation or rescheduling of significant orders;
market acceptance of new products and product enhancements;

- new product announcements or introductions by our competitors;

- adoption of new technologies and standards; changes in pricing by us or
our competitors;

- our ability to develop, introduce and market new products and product
enhancements on a timely basis, if at all;

- component costs and availability;

- our success in expanding our sales and marketing programs;

- technological changes in the market for data security products;

- foreign currency exchange rates;

- and general economic trends and other factors.

In addition, we have experienced, and may experience in the future, long
sales cycles due to the size of our contracts and the timing of when our
customers take delivery of our products. We also experience seasonality in our
business. These seasonal trends have included higher revenue in the last quarter
of the calendar year and lower revenue in the next succeeding quarter. We
believe that revenue has tended to be higher in the last quarter due to the
tendency of certain customers to implement or complete changes in computer or
network security prior to the end of the calendar year. In addition, revenue has
tended to be lower in the summer months, particularly in Europe, when many
businesses defer purchase decisions. Because our operating expenses are based on
anticipated revenue levels and a high percentage of our expenses are fixed, a
small variation in the timing of recognition of revenue could cause significant
variations in operating results from quarter to quarter.

Currency Fluctuations. The majority of our supply and sales transactions
are denominated in U.S. dollars, however, a significant portion of those
transactions are denominated in various foreign currencies. In order to reduce
the risks associated with fluctuations in currency exchange rates, we attempt to
match the timing of delivery, amount of product and the currency denomination of
purchase orders received from vendors with sales orders to customers.

The financial position and results of operations 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 included as a
separate component of stockholders' equity (deficit). Gains and losses resulting
from foreign currency transactions are included in the consolidated statements
of operations. Foreign exchange transaction gains (losses) aggregating
($272,000), $289,000 and $183,000 are included in other non-operating income
(expense) for 1999, 2000, and 2001, respectively.

19

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain
consolidated financial data as a percentage of revenues for the years ended
December 31, 1999, 2000 and 2001.

The following discussion is based upon the Company's consolidated results
of operations for the years ended December 31, 2001, 2000 and 1999 (percentages
in the discussion are rounded to the closest full percentage point) and should
be read in conjunction with our consolidated financial statements included
elsewhere in this Form 10-K.

2000 COMPARED TO 2001

Revenues

Our consolidated revenues for the year ended December 31, 2001 were
$26,727,000, a decrease of $1,339,000, or 5%, as compared to the year ended
December 31, 2000. Although sales of Digipass products increased by $1,242,000
or 6%, revenues from non-token products, specifically VACMAN, decreased by
$2,581,000 or 33%.

The European operations contributed $21,242,000 or 79% of total
consolidated revenues, with the United States operations contributing the
remaining $5,485,000 or 21%.

Cost of Goods Sold

Our consolidated cost of goods sold for the year ended December 31, 2001
was $10,590,000, an increase of $522,000, or 5%, as compared to the year ended
December 31, 2000. This increase was primarily due to the sales mix. Digipass
products, which carry a slightly lower gross margin, made up 81% and 72% of
total sales for 2001 and 2000, respectively.

20

Gross Profit

Our consolidated gross profit for the year ended December 31, 2001 was
$16,136,000, a decrease of $1,860,000, or 10%, over the year ended December 31,
2000. This represents a gross margin of 60%, as compared to 2000's consolidated
gross margin of 64%. This decrease was due to stronger sales of products with
lower margins. Token products average gross margins of about 50% while non-token
products average over 90%.

Sales and Marketing Expenses

Consolidated sales and marketing expenses for the year ended December 31,
2001 were $13,579,000, an increase of $3,626,000, or 36%, over 2000. This
increase is mainly due to the increase in average full time employee headcount
of 68 in 2001 versus 43 in 2000. Also, increased sales efforts including, in
part, increased travel costs, and an increase in marketing activities, including
tradeshows, contributed to this expense. Additionally, the acquisition of
Identikey in March 2001 and the opening of the sales office in Singapore
resulted in additional expenses.

Research and Development Expenses

Consolidated research and development costs for the year ended December 31,
2001 were $4,981,000, an increase of $612,000, or 14%, as compared to the year
ended December 31, 2000. This increase was, in part, related to the acquisition
of Identikey in March 2001. As Identikey is primarily a development center, the
acquisition resulted in increased research and development headcount and
expenditures at an additional facility. Average full time employee headcount in
2001 was 38 compared to 32 in 2000.

General and Administrative Expenses

Consolidated general and administrative expenses for the year ended
December 31, 2001 were $6,349,000, an increase of $575,000, or 10%, over 2000.
This increase can be principally attributed to the acquisition of Identikey. As
a result of our fourth quarter restructuring, administrative headcount at the
end of 2001 was 13 compared to 19 at the end of 2000.

Interest Income (expense), Net

Consolidated interest income (expense), net in 2001 was $775,000 compared
to $29,000 in 2000. This increase was due to a reversal of interest expense
accrued in 2000 associated with the restructuring of the Company's long-term
debt.

Income Taxes

An income tax recovery of $13,000 was recorded for the year ended December
31, 2001, which relates to one of our European subsidiaries.

At December 31, 2001, the Company has United States net operating loss
carryforwards approximating $22,400,000 and foreign net operating loss
carryforwards approximating $3,400,000. Such losses are available to offset
future taxable income in the respective jurisdictions and expire in varying
amounts beginning in 2002 and continuing through 2020. In addition, if certain
substantial changes in the Company's ownership are deemed to have occurred,
there would be an annual limitation on the amount of the U.S. carryforwards
which could be utilized.

1999 COMPARED TO 2000

Revenues

Our consolidated revenues for the year ended December 31, 2000 were
$28,066,000, an increase of $8,669,000, or 45%, as compared to the year ended
December 31, 1999. This increase is due to a strong performance from
international operations, as the demand for Digipass products continues to grow,
resulting in

21

increased unit sales, as well as increasing orders with smaller quantities and
less volume discounting. Also, sales of VACMAN products in the U.S. more than
doubled 1999 revenues. The European operations contributed $17,000,000 or 61% of
total consolidated revenues, with the United States operations contributing the
remaining $11,065,000 or 39%.

Cost of Goods Sold

Our consolidated cost of goods sold for the year ended December 31, 2000
was $10,069,000, an increase of $2,763,000, or 38%, as compared to the year
ended December 31, 1999. Cost of goods sold has not increased at the same rate
as our revenues primarily due to product sales mix and also from efficiencies in
the manufacturing process, as well as the increasing demand for products with a
more favorable cost structure.

Gross Profit

Our consolidated gross profit for the year ended December 31, 2000 was
$17,997,000, an increase of $5,905,000, or 49%, over the year ended December 31,
1999. This represents a gross margin of 64% compared to 1999's consolidated
gross margin of 62%. The increase in gross margin is due to product sales mix as
VACMAN products provide higher gross margins.

Sales and Marketing Expenses

Consolidated sales and marketing expenses for the year ended December 31,
2000 were $9,954,000, an increase of $3,992,000, or 67%, over 1999. This
increase can be attributed to increased sales efforts including increased travel
costs, headcount, and an increase in marketing activities, including tradeshows
and advertising. Sales and marketing headcount increased from 44 at the end of
1999 to 61 at the end of 2000.

Research and Development Expenses

Consolidated research and development costs for the year ended December 31,
2000 were $4,368,000, an increase of $781,000, or 22%, as compared to the year
ended December 31, 1999. Most of this increase is due to activities relating to
the development of the VACMAN product line.

General and Administrative Expenses

Consolidated general and administrative expenses for the year ended
December 31, 2000 were $5,773,000, an increase of $2,339,000, or 68%, over 1999.
This increase can be attributed to growth in infrastructure needed to support
our growth, increased recruiting expenses and amortization charges related to
royalties. Administrative headcount increased from 12 at the end of 1999 to 18
at the end of 2000. In addition, the Company recorded approximately $150,000 of
merger costs in 2000 related to the Invincible Data Systems transaction.

Interest Income (Expense)

Consolidated interest income, net in 2000 was $29,000 compared to interest
expense, net of $815,000 in 1999. Interest income from the proceeds generated
upon the issuance of convertible preferred stock offset interest expense related
to borrowings. Additionally, interest expense from debt outstanding decreased as
long-term debt was reduced from $8,409,000 at the end of 1999 to $3,764,000 at
the end of 2000.

Income Taxes

We recorded tax expense for the year ended December 31, 2000 of $395,000,
which relates to one of our European subsidiaries.

RECENT DEVELOPMENTS

During the fourth quarter of 2001, the Company announced a restructuring of
its operations to redirect resources to its core business, strong authentication
and server software to enable enhanced security for the
22

web, remote access, corporate networks and financial transactions. A reduction
in workforce of approximately 60 employees occurred in the fourth quarter, along
with the write-off of intangible assets and property and equipment related to
non-core activities. A restructuring charge of $4,284,000 was recorded in the
fourth quarter. Severance and compensation related expenses represent
approximately 21% of the charge, approximately 72% is the write-off of goodwill
and 7% is the write-off of other assets and expenses.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2001, our aggregate consolidated indebtedness was
$3,827,000. Cash used in operating activities was $6,183,000 for the year ended
December 31, 2001. During that period we used $892,000 in investing activities
and $266,000 in financing activities. Capital expenditures were $948,000 for the
year ended December 31, 2001.

In 1996, we issued a 9% convertible note to Kyoto Securities, Ltd., a
Bahamian corporation, in the amount of $5,000,000. The note provided for
quarterly interest payments and was payable in full on May 29, 2001. The note
was convertible into shares of our Common Stock at a conversion price of $12.00
per share, or 416,667 shares. In April 2000, the note and accrued interest were
converted into 435,910 shares of common stock.

In 1997, we entered into a convertible loan agreement with Artesia Bank
N.V., formerly Banque Paribas Belgique S.A., in order to refinance the
$3,400,000 payment due December 31, 1997 in connection with our acquisition of
Digipass. The terms of the agreement provide that the $3,400,000 principal
amount is convertible, upon an offering, into shares of our Common Stock. The
original interest was at the rate of 3.25%, payable annually, and the original
maturity date was on September 30, 2002. On August 9, 2001, the terms of this
loan were restructured. Under the revised terms, the loan will now be
convertible into shares of VASCO common stock at the fixed conversion rate of
$7.50 per share rather than a floating rate based on the market price of VASCO
common stock. The maturity date of the convertible loan is September 30, 2003
and the interest rate is 6%.

In April 1999, we completed a private placement of Common Stock in the
amount of $11.5 million. The transaction represented a sale of our Common Stock
to European institutional investors at a price of $3.50 per share. A total of
3,285,714 shares of Common Stock were issued as a part of this transaction.

During the first quarter of 2000, the Company filed a registration
statement in connection with an offering of its Common Stock to the public. On
April 13, 2000, the Company terminated this offering due to the volatility of
market conditions. Costs related to this offering of $1,331,000 were written off
and included in other expense in the consolidated statement of operations.

In July 2000, the Company issued 150,000 shares of preferred stock for cash
of $15,000,000. The preferred stock is convertible into 1,052,632 shares of
Common Stock at any time over the next 48 months.

The net effect of 2001 activity resulted in a decrease in cash of
$7,490,000, resulting in a cash balance of $6,342,000 at December 31, 2001,
compared to $13,833,000 at the end of 2000. Our working capital at December 31,
2001 was $6,672,000, a decrease of $7,635,000, or 53% from $14,307,000 at
December 31, 2000. The majority of the change is attributable to operating
activities. Our current ratio was 2.0 to 1.0 at December 31, 2001. We believe
that our current cash balances and anticipated cash generated from operations
will be sufficient to meet our anticipated cash needs for the foreseeable
future.

We intend to seek acquisitions of businesses, products and technologies
that are complementary or additive to ours. There can be no assurance that any
such acquisitions will be made.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and

23

liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period.

On an on-going basis, management evaluates its estimates and judgments,
including those related to bad debts 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.

ALLOWANCE FOR DOUBTFUL ACCOUNTS: We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make payments for 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. If
the financial condition of our customers deteriorates, resulting in an
impairment of their ability to make payments, additional allowances may be
required.

VALUATION OF PREPAID LICENSE FEES, GOODWILL AND OTHER INTANGIBLE ASSETS,
AND SOFTWARE DEVELOPMENT COSTS: We assess the impairment of intangible assets
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. Factors we consider 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. The Company
assesses the recoverability of its software development costs against estimated
future revenue for the individual products over the estimated remaining economic
life of the software.

When we determine that the carrying value of intangibles and goodwill may
not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business model. Given
the highly competitive environment and technological changes, it is reasonably
possible that estimates of anticipated future revenue, the remaining economic
life of the Company's software products, or both may be reduced significantly.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS 142") which supersedes APB Opinion No. 17, "Intangible Assets".
SFAS 142 addresses how intangible assets that are acquired individually or with
a group of other assets (but not those acquired in a business combination)
should be accounted for in financial statements upon their acquisition. SFAS 142
also addresses how goodwill and other intangible assets should be accounted for
after they have been initially recognized in the financial statements. The
provisions of SFAS 142 are required to be applied starting with fiscal years
beginning after December 15, 2001. SFAS 142 is required to be applied at the
beginning of an entity's fiscal year and to be applied to all goodwill and other
intangible assets recognized in its financial statements at that date. As of
December 31, 2001, the Company has identified $242,000 of goodwill, which was
previously amortized over 7 years, which will no longer be amortized.

In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS 143"). SFAS 143 addresses financial accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and for the associated asset retirement costs. SFAS must be
applied starting with fiscal years beginning after June 15, 2002. Management is
currently evaluating the impact that the adoption of SFAS 143 will have on the
consolidated financial statements.

In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the

24

Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" it
retains many of the fundamental provisions of that Statement. SFAS No. 144 also
supersedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" for the disposal of a segment of a business. However,
it retains the requirement in Opinion 30 to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001 and interim periods within those fiscal years.
The Company is in the process of evaluating the impact that adoption of SFAS No.
144 may have on the financial statements; however, such impact, if any, is not
known or reasonably estimable at this time.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Approximately 79% of our business is conducted outside the United States,
in Europe and Asia/Pacific. A significant portion of our business operations are
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 a foreign subsidiary transacts business in a currency that
differs from its local currency. These transactions are recorded as gains or
losses in our statement of operations. Our foreign subsidiaries' business
transactions are spread across approximately 50 different countries and
currencies. This geographic diversity reduces the risk to our operating results.

We have minimal interest rate risk. Our $3.4 million long-term debt has a
fixed rate of 6%, which is not subject to market fluctuations. This note matures
in September 2003.

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 F-1 through F-20 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. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The sections entitled "Election of Directors" and "Section 16(a) Beneficial
Ownership Report Compliance" contained in the Company's Proxy Statement for the
Annual Meeting of Stockholders to be held on July 16, 2002, are incorporated
herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The section entitled "Executive Compensation" contained in the Company's
Proxy Statement for the Annual Meeting of Stockholders to be held on July 16,
2002, is incorporated herein by reference.

25

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The section entitled "Security Ownership of Certain Beneficial Owners and
Management" contained in the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on July 16, 2002, is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) The following consolidated financial statements and notes thereto,
and the related independent auditors' report, are included on pages F-1 through
F-20 of this Form 10-K:

Independent Auditors' Report

Consolidated Balance Sheets as of December 31, 2000 and 2001

Consolidated Statements of Operations for the Years Ended December 31,
1999, 2000 and 2001

Consolidated Statements of Comprehensive Loss for the Years Ended December
31, 1999, 2000 and 2001

Consolidated Statements of Stockholders' Equity (Deficit) for the Years
Ended December 31, 1999, 2000 and 2001

Consolidated Statements of Cash Flows for the Years Ended December 31,
1999, 2000 and 2001

Notes to Consolidated Financial Statements

(2) The following consolidated financial statement schedule of the Company
is included on 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.

26

(3) The following exhibits are filed with this Form 10-K or incorporated by
reference as set forth in the next page:

EXHIBIT INDEX

- ---------------

+ Incorporated by reference to the Registrant's Registration Statement on Form
S-4, as amended (Registration No. 333-35563), originally filed with the
Securities and Exchange Commission on September 12, 1997.

++ Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on May 5, 1998.

# Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on April 14,
1999.

** Confidential treatment has been granted for the omitted portions of this
document.

VASCO DATA SECURITY INTERNATIONAL, INC. WILL FURNISH ANY OF THE ABOVE
EXHIBITS TO ITS 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 $.25 PER PAGE, PLUS POSTAGE.

(b) Reports on Form 8-K

No reports on Form 8-K have been filed by the Registrant during the
quarter ended December 31, 2001.

29

This page intentionally left blank.

INDEPENDENT AUDITORS' REPORT

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,
2000 and 2001 and the related consolidated statements of operations,
comprehensive loss, stockholders' equity (deficit), and cash flows for each of
the years in the three-year period ended December 31, 2001. In connection with
our audits of the consolidated financial statements, we have also 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 auditing standards generally
accepted in the United States of America. 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 VASCO Data
Security International, Inc. and subsidiaries as of December 31, 2000 and 2001,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. 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 therein.

/s/ KPMG LLP

Chicago, Illinois
February 15, 2002, except as to Note 14,
which is as of March 13, 2002

F-1

VASCO DATA SECURITY INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

F-2

VASCO DATA SECURITY INTERNATIONAL, INC

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements

F-3

VASCO DATA SECURITY INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

See accompanying notes to consolidated financial statements.

F-4

VASCO DATA SECURITY INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001

See accompanying notes to consolidated financial statements.

F-5

VASCO DATA SECURITY INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.
F-6

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

VASCO Data Security International, Inc. and its wholly owned subsidiaries
(the Company) designs, develops, markets and supports security products and
services which manage and protect against unauthorized access to computer
systems of corporate and government customers.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of VASCO Data
Security International, Inc. and its wholly and majority owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

The financial position and results of operations 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 included as a
separate component of stockholders' equity. Gains and losses resulting from
foreign currency transactions are included in the consolidated statements of
operations. Foreign exchange transaction gains (losses) aggregating ($272,000),
$289,000 and $183,000 are included in other income (expense) for 1999, 2000, and
2001, respectively.

REVENUE RECOGNITION

License Fees. Revenues from the sale of computer security hardware and
software are recorded upon shipment or, if an acceptance period is allowed, at
the later of shipment or customer acceptance. No significant obligations exist
with regard to delivery or customer acceptance at the time of recognizing
revenue.

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

Consulting and Education Services. The Company provides consulting and
education services to its customers. Revenue from such services is generally
recognized during the period in which the services are performed.

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.

SOFTWARE COSTS

The Company capitalizes 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
and development costs, prior to the establishment of technological feasibility,
determined based upon the creation of a working model, are expensed as incurred.
The Company's policy is to amortize capitalized costs by the greater of (a) the
ratio that current gross revenues for a product

F-7

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

bear to the total of current and anticipated future gross revenues 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. The Company did not capitalize any software costs during the years
ended December 31, 1999, 2000 and 2001.

INCOME TAXES

Income taxes are accounted for 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. Deferred tax assets and
liabilities are measured 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. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The following disclosures of the estimated fair value of financial
instruments are made in accordance with the requirements of SFAS No. 107,
"Disclosures and Fair Value of Financial Instruments." The estimated fair value
amounts have been determined by the Company using available market information
and appropriate valuation methodologies. The fair values of the Company's
financial instruments were not materially different from their carrying amounts
at December 31, 2000 and 2001, except for notes payable and long-term debt, for
which the fair values were not determinable.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

RECLASSIFICATIONS

Certain amounts in the consolidated financial statements have been
reclassified to conform to the 2001 presentation.

For the year 2000, amortization of intangible assets amounting to $212,500
was reclassified from research and development costs to general and
administrative expenses.

GOODWILL AND OTHER INTANGIBLES

Goodwill is amortized on a straight-line basis over the expected period to
be benefited, which is seven years. Other intangibles are amortized on a
straight-line basis and consist of software and hardware technology totaling
$4,616,000, which is being amortized over a period of four years and workforce
and customer lists of approximately $320,000 and $542,000, respectively, which
are being amortized over a period of seven years.

The Company assesses the impairment of intangible assets 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. The Company assesses the recoverability of
its software development costs against estimated future revenue for the
individual products over the estimated remaining economic life of the software.

F-8

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

When the Company determines that the carrying value of intangibles and
goodwill may not be recoverable based upon the existence of one or more of the
above indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business model. Given
the highly competitive environment and technological changes, it is reasonably
possible that estimates of anticipated future revenue, the remaining economic
life of the Company's software products, or both may be reduced significantly.

At December 31, 2000 and 2001, ending balances of goodwill and other
intangibles, net of amortization, are as follows:

STOCK-BASED COMPENSATION

On January 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which permits entities to recognize the compensation
expense associated with the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS No. 123 allows entities to continue to apply the
provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and provide pro forma disclosures as if the fair
value method defined in SFAS No. 123 had been applied. The Company has elected
to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosures required by SFAS No. 123.

LOSS 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.

Shares issuable from securities that could potentially dilute basic
earnings per share in the future that were not included in the computation of
earnings per share because their effect was anti-dilutive were as follows:

Additionally, the net loss applicable to common stockholders for the years
ended December 31, 1999, 2000 and 2001 would have been decreased by adding back
interest expense related to the convertible notes of approximately $704,000,
$275,000 and $149,000, respectively.

F-9

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 2 -- ACQUISITIONS

Effective May 1, 1999, the Company acquired substantially all of the assets
of SecureWare SA and DMIC SA (SecureWare), as well as certain developed software
licenses from the founder of SecureWare in exchange for $738,735 in cash (of
which $151,203 was recorded in accrued liabilities at December 31, 1999) plus
174,575 shares of the Company's common stock, which had a market value based
upon the trading price of the common stock on the NASD Bulletin Board ("Market
Value") of approximately $650,000 at the time of the acquisition. SecureWare,
located in Bordeaux, France, is a software developer focusing on developing
security solutions for a number of operating systems.

The acquisition of SecureWare was accounted for under the purchase method
of accounting, and accordingly, the acquired assets have been recorded at their
estimated fair values at the date of acquisition. Purchased software related to
this transaction was $889,000 and is being amortized over a period of 5 years.
Goodwill related to this transaction was $406,000 and is being amortized over a
period of 7 years.

On October 6, 1999, the Company acquired all of the outstanding capital
stock of IntelliSoft Corporation (IntelliSoft) in exchange for 1,812,078 shares
of Common Stock which had a Market Value of approximately $7,250,000 at the time
of the acquisition. In addition, the Company paid $751,575 to IntelliSoft
dissenters to acquire their capital stock interests, which represented 9.4% of
the outstanding capital stock of IntelliSoft at the date of the acquisition. The
acquisition of these shares has been treated as the purchase and retirement of
common stock. IntelliSoft, located in Acton, MA, specializes in developing true
secure single sign-on, Web authorization, PKI, VPN, and enterprise management
solutions. This transaction was accounted for under the pooling-of-interests
method of accounting. Accordingly, the consolidated financial statements have
been restated as if IntelliSoft had been combined for all periods presented.

At the end of August 2000, the Company acquired Invincible Data Systems
(IDS) in a transaction which has been accounted for under the
pooling-of-interests method. A total of 322,565 shares were issued in this
transaction, which is deemed immaterial.

On March 29, 2001, the Company acquired Identikey Ltd., ("Identikey"), a
privately held international security software company headquartered in
Brisbane, Australia, with operations in the United States, Europe and Australia.
Under the terms of the purchase agreement, more than 90 percent of the
outstanding capital stock of Identikey was exchanged for 366,913 shares of
Company common stock, with potential additional earn-out payments made in the
form of additional shares which are based on defined performance incentives as
specified in the purchase agreement.

The acquisition of Identikey was accounted for under the purchase method of
accounting, and accordingly, the acquired assets have been recorded at their
estimated fair values at the date of acquisition. Intangible assets consisting
of technology licenses related to this transaction were $1,897,000 and are being
amortized over a period of 7 years.

The following summarized unaudited pro forma financial information for the
year 2001 assumes the Identikey acquisition occurred as of January 1, 2000.

F-10

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3 -- 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.

Inventories are comprised of the following:

NOTE 4 -- ACCRUED EXPENSES

Accrued expenses are comprised of the following:

NOTE 5 -- INCOME TAXES

At December 31, 2001, the Company has United States net operating loss
carryforwards approximating $22,400,000 and foreign net operating loss
carryforwards approximating $3,400,000. Such losses are available to offset
future taxable income in the respective jurisdictions and expire in varying
amounts beginning in 2002 and continuing through 2021. In addition, if certain
substantial changes in the Company's ownership are deemed to have occurred,
there would be an annual limitation on the amount of the U.S. carryforwards
which could be utilized.

Pretax loss was taxed in the following jurisdictions:

F-11

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The provision of income taxes consists of the following:

The differences between income taxes computed using the statutory federal
income tax rate of 34% and the provisions for income taxes reported in the
consolidated statements of operations are as follows:

The deferred income tax balances are comprised of the following:

F-12

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The net change in the total valuation allowance for the years ended
December 31, 1999, 2000 and 2001 was an increase of $676,000, $1,739,000 and
$4,380,000, respectively. In assessing the realizability of deferred tax assets,
the Company considers whether it is more likely than not that some portion or
all of the deferred tax assets will be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable income
during the period in which these temporary differences become deductible. The
Company has determined that it is more likely than not that $83,000 of deferred
tax assets will be realized. This valuation allowance will be reviewed on a
regular basis and adjustments made as appropriate.

NOTE 6 -- DEBT

Debt consists of the following:

In August 1997, the Company renegotiated the guarantee related to the final
payment for the 1996 acquisition of Digipass into a term loan in the amount of
$3.4 million with a maturity date of September 30, 2002 and an interest rate of
3.25%. In August 2001, the Company had agreed to revise the terms of the loan.
Under the new terms, the loan will now be convertible into shares of VASCO
common stock at the fixed conversion rate of $7.50 per share rather than a
floating rate based on the market price of the VASCO common stock. Also, the
maturity date of this convertible loan is September 30, 2003 with a revised
interest rate of 6%.

Aggregate maturities of debt at December 31, 2001 are as follows:

2002........................................................ $ 158,990
2003........................................................ 3,667,882
----------
Total.................................................. $3,826,872
==========

Interest expense to stockholders was $450,000, $165,000 and $0 for the
years ended December 31, 1999, 2000 and 2001, respectively.

NOTE 7 -- STOCKHOLDERS' EQUITY

PREFERRED STOCK

In July 2000, the Company issued 150,000 shares of preferred stock for cash
of $15,000,000. The preferred stock is convertible into 1,052,632 shares of
common stock at any time over the next 48 months. In conjunction with this
financing, the company issued warrants to purchase 789,474 common shares at $15
per share with an estimated imputed value using the Black-Scholes pricing-model
of approximately $4.1 million and warrants to purchase 480,000 shares at $4.25
per share with an estimated imputed value using the Black-Scholes pricing-model
of approximately $4.7 million. The warrants issued at $15 per share were
immediately exercisable. The warrants issued at $4.25 were exercisable over 48
months and the related imputed value is being accreted reducing earnings
available to common stockholders. In September 2000, 30,000 warrants at $4.25
per share were exercised.

F-13

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The value of the warrants which reduces the carrying value of the preferred
stock is being accreted and reduces earnings available to common shareholders.

COMMON STOCK

In 2001, the Company issued 25,633 shares of common stock as a result of
the exercise of options under the Company's stock compensation plan (see Note 8)
generating total proceeds of $15,664; 3,929 shares of common stock were issued
as a result of the exercise of warrants, generating total proceeds of $17,693.

In March 2001, the Company issued 366,913 shares of common stock to acquire
90% of the outstanding capital stock of Identikey Ltd.

In 2000, the Company issued 435,910 shares of common stock to convert a
$5,000,000 note and related accrued interest. In September 2000, the Company
issued 322,565 shares of common stock as part of the acquisition of Invincible
Data Systems.

Also in 2000, the Company issued 342,400 shares of common stock as a result
of the exercise of options under the Company's stock compensation plan (see Note
8) generating total proceeds of $557,213 and 303,625 shares of common stock were
issued as a result of the exercise of the warrants, generating total proceeds of
$1,724,717.

WARRANTS

Warrant activity for the years ended December 31, 1999, 2000 and 2001 are
summarized below:

NOTE 8 -- STOCK COMPENSATION PLAN

The Company's 1997 Stock Compensation Plan, as amended, ("Compensation
Plan") is designed and intended as a performance incentive. The Compensation
Plan is administered by the Compensation Committee as appointed by the Board of
Directors of the Company (Compensation Committee).

The Compensation Plan permits the grant of options to employees of the
Company to purchase shares of common stock and is intended to be a nonqualified
plan. All options granted to employees are for a period of

F-14

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ten years, are granted at a price equal to the fair market value of the common
stock on the date of the grant and are typically vested 25% on the first
anniversary of the grant, with an additional 25% vesting on each subsequent
anniversary of the grant. Alternative vesting schedules include either date or
event-based vesting.

During 2001, the Compensation Committee of the Board of Directors approved
a revised vesting schedule. The new vesting schedule for officers is based on a
time period of 36 months, with 6/36th of the options vesting at the end of the
first 6 months and 1/36th of the options vesting each month thereafter on the
last day of each month.

The Compensation Plan further permits the grant of options to directors,
consultants and other key persons (non-employees) to purchase shares of common
stock. All options granted to non-employees are granted at a price equal to the
fair market value of the common stock on the date of the grant, and may contain
vesting requirements and/or restrictions as determined by the Compensation
Committee at the time of grant. Non-cash compensation expense of $49,555 was
recognized in 2001 in accordance with FIN 44, "Accounting for Certain
Transactions Involving Stock Compensation", an interpretation of Accounting
Principles Board Opinion No. 25. This charge was attributed to stock options
issued to officers of the Company who are located outside the U.S. and whose
services are rendered under consulting agreements.

As of December 31, 2001, the Compensation Plan was authorized to issue
options representing up to 5,652,612 shares of the Company's common stock. The
authorized shares under the Compensation Plan represent 20% of the issued and
outstanding shares of the Company.

The Company applies APB Opinion No. 25 and related interpretations in
accounting for the Compensation Plan. Had compensation cost for the Compensation
Plan been determined consistent with SFAS No. 123, the Company's net loss
available to common stockholders and net loss per common share would have been
the pro forma amounts indicated below:

For purposes of calculating the compensation cost consistent with SFAS No.
123, the fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1999, 2000 and 2001: dividend yield of 0%;
expected volatility of 50%, 50%, 119%; risk free interest rates ranging from
3.91% to 6.80%; and expected lives of five years.

F-15

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following is a summary of activity under the Compensation Plan:

The following table summarizes information about stock options outstanding
at December 31, 2001:

NOTE 9 -- EMPLOYEE BENEFIT PLAN

The Company maintains a contributory profit sharing plan established
pursuant to the provisions of Section 401(k) of the Internal Revenue Code, which
provides benefits for eligible employees of the Company. The Company made no
contributions to the plan during the years ended December 31, 1999 and 2000. In
January 2001, the Company amended its benefit plans to allow company-matching.
For the year ended December 31, 2001, the Company contributed $106,000 to this
plan.

F-16

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 10 -- GEOGRAPHIC AND CUSTOMER INFORMATION

The Company allocates revenue based on the location of the country which
initiates the sale. Information regarding geographic areas for the years ended
December 31, 1999, 2000 and 2001 are as follows:

For the years 1999, 2000 and 2001, the Company's top 10 customers
contributed 70%, 72% and 73% of total worldwide revenues, respectively.

In 1999, sales to one customer contributed more than 10% of total revenues.
In 2000, there were two customers that each accounted for more than 10% of total
revenues and in 2001, there was one customer that contributed more that 10% of
consolidated revenues.

NOTE 11 -- COMMITMENTS AND CONTINGENCIES

The Company leases office space and equipment under operating lease
agreements expiring at various times through 2006.

Future minimum rental payments required under noncancelable leases are as
follows:

Rent expense under operating leases aggregated approximately $434,000,
$693,000 and $714,000 for the years ended December 31, 1999, 2000 and 2001,
respectively.

Certain executive officers are entitled to receive bonuses upon the closing
of a transaction which results in a change in control of the majority of the
outstanding stock of the Company.

F-17

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

From time to time, the Company has been involved in litigation incidental
to the conduct of its business. Currently, the Company is not a party to any
lawsuit or proceeding which, in management's opinion, is likely to have a
material adverse effect on its business, financial condition or results of
operations. (See Note 14.)

NOTE 12 -- RESTRUCTURING

During the fourth quarter of 2001, the Company announced a restructuring of
its operations to redirect resources to its core business, strong authentication
and server software to enable enhanced security for the web, remote access,
corporate networks and financial transactions. A reduction in workforce of
approximately 60 employees occurred in the fourth quarter, along with the
write-off of related intangible assets and property and equipment related to
non-core activities.

A restructuring charge of $4,284,000 was recorded in the fourth quarter. A
breakdown of this charge is as follows:

Goodwill.................................................... $ 266,000
Software licenses........................................... 2,772,000
Other intangibles........................................... 32,000
Severance and related costs................................. 901,000
Property and equipment...................................... 36,000
Other....................................................... 277,000
----------
Total.................................................. $4,284,000
==========

Of the $901,000 in severance pay, $180,000 remained outstanding at the end
of 2001. This balance is expected to be paid out by the end of the first quarter
of 2002.

Approximately 46 employees were terminated in the United States and 14 in
Europe. Research and development activities were consolidated and are now
performed primarily outside the United States and sales and marketing activities
in the United States were reduced.

F-18

VASCO DATA SECURITY INTERNATIONAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 13 -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

NOTE 14 -- SUBSEQUENT EVENT

On March 13, 2002, a suit was filed against the Company claiming patent
infringement, false designation of origin and tradedress infringement. The case
is currently being evaluated by the Company and its legal counsel. The Company
believes the suit is without merit. As the suit is in its early stages,
management is unable to estimate the effect of this suit at this time.

F-19

VASCO DATA SECURITY INTERNATIONAL, INC.

SCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS

See accompanying independent auditors' report.

F-20

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 28, 2002.

VASCO DATA SECURITY INTERNATIONAL,
INC.

/s/ MARIO R. HOUTHOOFT
--------------------------------------
Mario R. Houthooft
Chief Executive Officer and President

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 APRIL 15, 1999.

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 Mario Houthooft, 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, 2001 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.