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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
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, 2003
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
VASCO DATA SECURITY INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 36-4169320
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
1901 SOUTH MEYERS ROAD, SUITE 210
OAKBROOK TERRACE, ILLINOIS 60181
(Address of Principal Executive Offices)(Zip Code)
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of March 25, 2004, 31,720,204 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 25, 2004)
held by non-affiliates of the registrant was $44,650,000 at $2.15 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
INDEX
PAGE
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PART I
Item 1. Description of Business 3
Item 2. Properties 12
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 13
Item 6. Selected Consolidated Financial Data 15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30
Item 8. Financial Statements and Supplementary Data 30
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures 30
Item 9A. Controls and Procedures 30
PART III
Item 10. Directors and Executive Officers of the Registrant 31
Item 11. Executive Compensation 33
Item 12. Security Ownership of Certain Beneficial Owners and Management 36
Item 13. Certain Relationships and Related Transactions 38
Item 14. Principal Accountants Fees and Services 38
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8K 38
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE F-1
2
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
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, references in this Annual Report to
"VASCO," "Company," "company, " "we," "our," and "us" refer to VASCO Data
Security International, Inc. and its subsidiaries.
Additional information on the Company, its products and its results may
be found on the Company's web site at www.vasco.com.
GENERAL
The Company, through its operating subsidiaries, designs, develops,
markets and supports open standards-based hardware and software security systems
that manage and secure access to information assets. We design, develop, market
and support patented "Identity Authentication" products for e-business and
e-commerce. Our products enable secure financial transactions to be made over
private enterprise networks and public networks, such as the Internet. VASCO's
Identity Authentication software is delivered via its Digipass security
products, small "calculator" hardware devices carried by an end user, or in a
software format on mobile phones, other portable devices, and PCs. The Digipass
devices, most of which incorporate an electronic digital signature capability,
guarantee the integrity of electronic transactions and data transmissions. Some
of the Digipass units are compliant with the Europay MasterCard Visa ("EMV")
standard and are compatible with MasterCard's new smart card.
For user access control, VASCO's VACMAN Server products limit
application access to designated Digipass users. Digipass and VACMAN combine to
provide greater flexibility and a more affordable means than competing products
of authenticating to any network, including the Internet.
- -------------------
This report contains the following trademarks of the Company, some of
which are registered: VASCO, AccessKey, VACMan Server and VACMan/CryptaPak,
AuthentiCard, Digipass, and Digipass Pack.
3
VASCO's target markets are the applications and their several hundred
million users that utilize fixed passwords as security. VASCO's time-based
system generates a "one-time" password that changes with every use. As a result,
when compared to fixed passwords, it substantially reduces the risk of
unauthorized access to the application.
At the end of fiscal 2003, VASCO had shipped over 10.4 million Digipass
units since its inception. Our security solutions are sold worldwide through our
direct sales force, as well as through distributors, resellers and systems
integrators. We currently have approximately 1,500 customers in more than 60
countries. Representative customers of our products include Rabobank Nederland,
ING Bank, Fortis Bank, Wachovia, Lloyds, Daimler Chrysler, Volvo and CoStar
Group. In 2003, the Company sold 602 new accounts of which 62 were banks and 540
were corporate network access.
COMPANY BACKGROUND
Our predecessor company, VASCO Corp., entered the data security
business in 1991 through the acquisition of a controlling interest in ThumbScan,
Inc., which we renamed 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, which included assets associated with the development of
security tokens and security technologies for personal computers and computer
networks. In addition, in 1996, we acquired Digipass NV/SA, a Belgian
corporation, which was also a developer of security tokens and security
technologies and whose name we changed to VASCO Data Security NV/SA in 1997.
On March 11, 1998, we completed a registered exchange offer with the
holders of the outstanding securities of VASCO Corp. Since the exchange offer,
we have engaged in four acquisitions and one disposition. In May 1999, we
acquired the assets of SecureWare SA, a French company for a combination of our
stock and cash totaling approximately $1.4 million. In October 1999, we acquired
Intellisoft Corp. for stock and cash totaling approximately $8 million with the
cash being distributed to dissenting shareholders. In August 2000, we acquired
Invincible Data Systems (IDS) for a total of 322,565 shares of Common Stock.
Our most recent acquisition was in March 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 Common Stock. The remaining 10% of Identikey
has been acquired at various times with the final purchase completed in January
2003 in exchange for 126,426 shares of Common Stock and $23,362 in cash.
In July 2003, we sold our interest in the VACMAN Enterprise business
unit, which assets were acquired in the Intellisoft transaction, to SecureD
Services, Inc. ("SSI"). Under the terms of the agreement, the Company received a
senior secured promissory note with a face value of approximately $1.1 million,
valued at $1.0 million by an independent valuation firm, and $2 million of
Convertible Preferred Stock from SSI, valued at $0.6 million by an independent
valuation firm, in exchange for the VACMAN Enterprise assets. The promissory
note bears a 6% interest rate and is payable in 36 equal and consecutive monthly
payments. The Preferred Stock includes a 6% cumulative stock dividend, payable
quarterly, and can be converted into SSI's common stock at defined intervals
beginning July 1, 2005. In accordance with Statement of Financial Accounting
Standard (SFAS) No. 144 " Accounting for the Impairment or Disposal of
Long-Lived Assets", the assets and liabilities of this business unit have been
disaggregated from the operational assets and liabilities of the Company and
have been reported as results of discontinued operations. Prior periods have
been restated to conform to this presentation.
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 that will continue to allow them to
expand access to data and financial assets while maintaining network security.
According to International Data Corporation (IDC), demand for
information security services is expected to reach $23 billion in worldwide
annual spending by 2006. Demand for security software is expected to increase to
$14.6 billion in 2006 with double-digit annual growth for each area.
4
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 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. Most banks in European countries are expected to issue smart
cards (credit cards with a micro-chip) that are compliant with the EMV standard
starting in 2005.
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
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 that keeps track of a user's
activities after access has been granted.
- Administration and Management Tools: Software that 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 could result in their security systems being compromised.
THE VASCO SOLUTION
The Company has found that, 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.
5
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.
VASCO'S STRATEGY
We believe we have one of the most complete lines of security products
and services for Identity Authentication 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 will demonstrate to our corporate users that our
products provide mission critical security to their internal and external
security infrastructures. Following this active marketing and promotion effort,
we will work with these resellers and integrators to support their sales of
solutions that 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 established European markets
and to actively 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 Europe, Middle East, Africa and Asia marketing
campaign to raise awareness of our solutions among the
distributors and resellers of popular third party software
products and to establish relationships with them whereby they
become resellers of our products and solutions;
- Form additional strategic relationships with resellers and
vendors of complementary, innovative security products and
systems; and
- Develop a marketing and sales infrastructure, largely in the
form of new resellers, distributors, and solution providers,
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);
- Acquiring complementary technologies or businesses; and
- Developing additional applications for our products in areas
that may include securing the exchange of data in the
business-to-business field and providing security for Internet
gambling and lottery transactions, among others.
6
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 the user has (the Digipass device itself);
- What the user knows (the PIN code to activate the Digipass);
and
- Who the user is (biometrics).
The Digipass family is currently based on the first two factors. Using
the Digipass system, in order to enter a remote system or to digitally sign data
the user needs the:
- Hardware device (the token) itself so that if he or she does
not physically have the token, he or she will not be able to
log on to the system; and
- PIN code for the token so if the user does not know the
appropriate code, he or she 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 very 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 models of the Digipass, each of which has
its own distinct characteristics depending on the platform that it uses and the
functions it performs. 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 the integrity of
the contents of such transactions.
In addition, Digipass technology is designed to operate on non-VASCO
platforms such as a desktop PC or laptop. Digipass technology is also available
for personal digital assistants (PDA), mobile phones and smart cards. For users
of mobile phones, Digipass's Authentication Server generates one-time passwords
that are sent to the mobile telephone user by SMS (Short Messaging System).
Digipass technology combines the benefits of both traditional password
tokens (authentication and digital signatures) with smart card 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.
7
DIGIPASS AT WORK
[PICTURE OF DIGIPASS AT WORK]
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 compact disk or diskette that is sent to the application
owner (for example, the information technology manager in an organization or the
security department of a bank). These compact disk or diskettes are one way of
safely transporting the Digipass secrets to the host computer.
The files on compact disk or diskettes 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. Banking applications include:
- Corporate banking through direct dial-up, as well as over the
Internet, and
8
- 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.
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.
Digipass Pack
Digipass Pack is a bundling of VASCO Digipass Go 1 or Go 3 tokens and VACMAN
Radius Middleware, offering strong identity authentication to Small and Medium
Sized Enterprises ("SME"s). Although the packs contain standard Digipass Go 1/Go
3 tokens, combinations with other Digipass models are possible. Digipass Pack is
compliant with server security products of VASCO Solution Partners, like CITRIX,
Netscreen, Check Point, and CISCO and is marketed via VASCO's regional channel
partners (Distributors).
[PICTURE OF DIGIPASS PACK]
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 designed to integrate with most
popular hardware and software. Once integrated, the VACMAN components become
largely transparent to the users minimizing rollout and support issues.
VACMAN Controller
Designed by specialists in "system entry" security, VACMAN Controller
makes it easy to administer a high level of access control. The user simply adds
a field to his or her 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 the user specifies,
whether it's a one-time password using either response-only or a
challenge/response authentication scheme or an electronic signature.
VACMAN Controller allows the user the freedom to provide secure remote
access to virtually any type of application. VACMAN Controller is a library
requiring only a few 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.
9
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.
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 2005 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 13 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, 2003, 2002 and 2001, we expended $2,281,000, $2,341,000
and $3,274,000, respectively, on research and development, representing
approximately 10%, 13% and 14% of consolidated revenues for 2003, 2002 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 that are purchased
globally. Our software products are produced either in-house or by several
outside sources primarily in Australia and Europe.
The security tokens utilize commercially available programmable
microprocessors, or chips. We use two microprocessors, made by Samsung, for the
various hardware products we produce. The Samsung microprocessors are purchased
from Samsung Semiconductor in France. The microprocessors are the only
components of our security tokens that are not commodity items readily available
on the open market.
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.
10
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 by one of two
independent companies with headquarters in Hong Kong and production facilities
in China. Purchases from these companies are made on a volume purchase order
basis. These companies commit to very high production standards, and as a
result, they also have major production contracts with companies such as Sony
and Samsung. 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. In the corporate network access
market segment, our main competitor is RSA Security. In the e-banking market
segment, our main competitors are ActivCard, Xiring, Todos, Kobil, and CPS.
There are many other companies such as Computer Associates, Rainbow and Aladdin
that offer authentication 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, customer
base, 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.
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 12
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.
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
11
products. Our efforts also include the preparation and dissemination of white
papers prepared by our support engineers that 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:
BANKING/FINANCIAL SERVICES OTHER
- -------------------------- -----
Rabobank Nederland Telindus
ABN Amro Bank DaimlerChrysler
SNS Bank US Coast Guard
ING Bank University of Groningen
Fortis Bank European Commission
Mandiri Bank, Indonesia CoStar Group
SEB Sweden Volvo
Den Norske Bank Norway
BNL, Italy
HSBC, UK
Lloyds, UK
Wachovia, USA
For the years 2003, 2002 and 2001, the Company's top 10 customers
contributed 71%, 67% and 79%, respectively, of total worldwide revenues. Sales
to Rabobank Nederland and Fortis Bank each exceeded 10% of the Company's revenue
in 2003. Rabobank Nederland was the only customer to exceed 10% of the Company's
revenue in 2002 and 2001.
A significant portion of our sales is 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. For additional
information regarding how currency fluctuations can affect our business, please
refer to Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations and Item 7A - Quantitative and Qualitative Disclosures
About Market Risk.
We also experience seasonality in our business. These seasonal trends
are most notable in the summer months, particularly in Europe, when many
businesses defer purchase decisions.
FINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS
See Note 13 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 February 28, 2004, we had 75 full time employees. Of these, 8
were located in North America, 48 were located in Europe, 15 were located in
Australia and 4 located in Asia/Pacific. Of the total, 31 were involved in
sales, marketing and customer support, 13 in operations, 21 in research and
development and 10 in administration.
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.
12
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
that are occupied under a lease expiring on 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 of
approximately 4,900 square feet under a lease expiring in December 2006.
Our Asia/Pacific sales office is located in an office complex in
Singapore, consisting of approximately 310 square meters under a lease expiring
in October 2005.
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.
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 2003, through solicitation of proxies or otherwise.
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 Common Stock was listed on the Nasdaq National Market in the United
States under the trading symbol "VDSI." In February 2003, the Common Stock was
moved from the Nasdaq National Market to the Nasdaq SmallCap Market and
continued trading under the symbol "VDSI."
On March 25, 2004, the closing sale price for the Common Stock on the
Nasdaq was $2.15 per share. Such market quotations reflect inter-dealer prices,
without retail mark-up, markdown or commission and may not necessarily represent
an actual transaction. On February 27, 2004, there were approximately 2,700
holders of record of the Common Stock.
On July 15, 2003, the Company issued 2 million shares of its Common
Stock to Ubizen N.V. as part of the consideration given in exchange for all of
the Company's Series C Convertible Preferred Stock and Purchase Warrants owned
by Ubizen.
On September 11, 2003, the Company sold 800 shares, with a stated value
of $10,000 per share, of its Series D 5% Cumulative Convertible Voting Preferred
Stock and 600,000 warrants to purchase Common Stock to various accredited
investors. The Series D Preferred is convertible into 4,000,000 shares of Common
Stock. The warrants have an exercise price of $3.47 per share. The proceeds from
the sale, $8,000,000 gross and approximately $7,260,000 net, were used for
general corporate purposes. The Series D Stock can be converted into Common
Stock at any time and the warrants can be exercised at any time from the date of
issue until September 10, 2008, at which time the warrants expire.
13
The following table sets forth the high and low closing bid quotations
for the Common Stock for the periods indicated.
HIGH LOW
--------- -------
2004
First Quarter (thru March 25, 2004) ................................... $ 2.99 $ 1.83
2003
Fourth Quarter ........................................................ $ 3.15 $ 2.15
Third Quarter ......................................................... 3.20 1.17
Second Quarter ........................................................ 1.70 0.89
First Quarter ......................................................... 1.74 0.22
2002
Fourth Quarter ........................................................ $ 1.60 $ 0.67
Third Quarter ......................................................... 1.97 0.87
Second Quarter ........................................................ 2.81 1.50
First Quarter ......................................................... 3.47 2.00
The Company has not paid any dividends on its Common Stock since
incorporation. Restrictions or limitations on the payment of dividends may be
imposed under the terms of credit agreements or other contractual obligations of
the Company. 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 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.
See Item 12 for a description of securities authorized for issuance
under our equity compensation plan.
14
ITEM 6 - SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA) (1)
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Statements of Operations Data:
Total revenues $ 22,866 $ 17,370 $ 22,690 $ 21,502 $ 17,046
Operating income (loss) 1,123 (4,898)(2) (10,788)(2) (2,441) (1,205)
Income (loss) from continuing operations 761 (5,293) (9,717) (4,002) (2,512)
Income (loss) from discontinued operations 1,995 754 (2,317) (159) 299
Net income (loss) 2,756 (4,539) (12,034) (4,162) (2,212)
Net loss available to common stockholders (1,715)(3) (5,703)(4) (13,198)(4) (4,744)(5) (2,212)
Basic and diluted loss per common share $ (0.06)(3) $ (0.20)(4) $ (0.47)(4) $ (0.17)(5) $ (0.09)
Shares used in computing per share amounts 29,270 28,348 28,169 27,341 25,559
Balance Sheet Data:
Cash $ 4,817 $ 2,616 $ 6,342 $ 13,833 $ 2,576
Working capital (deficiency) 5,218 (587) 6,672 14,307 2,473
Total assets 13,383 11,133 17,451 29,313 12,318
Long-term obligations, less current portion -- -- 3,668 3,764 8,409
Stockholders' equity (deficit) 8,944 2,811 7,147 17,348 (1,037)
- -----------------------------------
(1) Years prior to 2003 have been restated to reflect the results of the
VACMAN Enterprise business unit, which was sold in the third quarter of
2003, and reflected as a discontinued operation.
(2) Includes restructuring expenses of $320 in 2002 and $3,970 in 2001.
(3) Includes the impact of a beneficial conversion feature of $3,720
related to the issuance of Series D Convertible Preferred Stock in the
third quarter of 2003, preferred stock accretion of $629 and preferred
stock dividends of $121
(4) Includes the impact of preferred stock accretion of $1,164
(5) Includes the impact of preferred stock accretion of $582
15
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion is based upon the Company's consolidated
results of operations for the years ended December 31, 2003, 2002 and 2001
(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.
We design, develop, market and support identity authentication products
that reduce the risk of loss from unauthorized transactions by validating a
person's identity using a one-time password and obtaining a legally-enforceable
digital signature, if needed, for financial transactions. Our products are used
currently in a wide variety of applications including, but not limited to,
Internet banking, Internet brokerage, e-commerce applications dealing with web
or mobile access and various corporate network access applications. As evidenced
by our current customer base, our products are purchased by Companies and,
depending on the business application, are distributed to either its employees
or its customers. Those customers may be other businesses or as an example in
the case of Internet banking, the banks' retail customers.
Our target market is any business process that uses some form of
electronic interface where the owner of that process is at risk if unauthorized
users can gain access to its process and either obtain proprietary information
or execute transactions that are not authorized. Our products can not only
increase the security associated with accessing the business process, thereby
reducing the losses from unauthorized access, but also, in many cases, can
reduce the cost of the process itself by automating activities that were
previously performed manually.
Industry Growth: We believe that, while there are no accurate
measurements of the total industry's size, the industry growth rate is
increasing and will continue to grow at a significant rate into the foreseeable
future. Growth is being driven by new government regulations, growing awareness
of the impact of identity theft, and the growth in commerce that is transacted
electronically. The issues driving the growth are global issues and the rate of
adoption in each country is a function of that country's culture, the
competitive position of businesses operating in those countries, the country's
overall economic conditions and the degree to which businesses and consumers
within the country use technology. Examples of regulations that have been
enacted in the U.S. recently that support industry growth include the Health
Insurance Portability and Accountability Act (HIPAA) and Sarbanes-Oxley Act of
2002.
Economic Conditions: The Company's revenues may vary significantly with
changes in the economic conditions in the countries in which it sells products
currently. With the Company's current concentration of revenues in Europe and
specifically in the banking/finance vertical market, significant changes in the
economic outlook for the European banking market, may have a significant effect
on the revenues of the Company. During difficult economic periods, our customers
often delay the rollout of existing applications and defer purchase decisions
related to the implementation of our product in new applications.
Currency Fluctuations. In 2003, approximately 93% of the Company's
revenue and approximately 75% of its operating expenses were generated/incurred
outside of the United States. As a result, changes in currency, especially the
Euro to U.S. Dollar, can have a significant impact on revenue and expenses. To
minimize the net impact of currency the Company attempts to denominate its
billings in a currency such that it would provide a hedge against the operating
expenses being incurred in that currency. In addition, the Company denominates
the majority of our supply contracts in U.S. dollars.
The Euro strengthened approximately 20% and the Australian Dollar
strengthened approximately 18% against the U.S. Dollar in 2003. Both currencies
strengthened approximately 5% against the U.S. Dollar in 2002. The Company
estimates that the strengthening of the two currencies in 2003 compared to 2002
resulted in an increase in revenues of approximately $1,460,000 and an increase
in operating expenses of approximately $1,630,000.
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 aggregating $146,000, $77,000
and $183,000 are included in other non-operating income (expense) for 2003, 2002
and 2001, respectively.
16
REVENUE
Revenues by Geographic Regions: We sell the majority of our products in
European countries with significant sales in the United States and other
countries, primarily Australia and Asia/Pacific. The breakdown of revenue in
each of our major geographic areas was as follows:
YEAR EUROPE UNITED STATES OTHER COUNTRIES TOTAL
---- ------ ------------- --------------- -----
Total Revenue:
2003 $ 19,201,000 $ 1,498,000 $ 2,167,000 $ 22,866,000
2002 14,658,000 1,423,000 1,289,000 17,370,000
2001 21,089,000 1,448,000 153,000 22,690,000
Percent of Total:
2003 84% 7% 9% 100%
2002 84% 8% 8% 100%
2001 93% 6% 1% 100%
Total revenues in 2003 increased $5,496,000 or 32% over 2002. Revenue
generated in Europe were $4,543,000, or 31% higher than 2002. The increase was
primarily attributable to increased volumes from existing customers of
approximately $2,055,000, an increase from net new customers (customers with
revenues in 2003 that had no revenue in 2002 less customers with revenue in 2002
that had no revenue in 2003) of approximately $1,118,000 and the benefit from
changes in the currency rate of approximately $1,370,000. The increase in
revenues from other countries primarily reflects revenues from new customers in
2003 and benefits from currency of approximately $90,000.
Total revenues in 2002 decreased $5,320,000 or 23% from 2001. The
decline was due to weakness in demand in the European market, especially in the
banking segment as noted in the table below.
We expect to increase our penetration of the U.S. market by adding
sales-related staff and intend to actively pursue additional markets,
particularly South America and the Middle East in 2004.
Revenues by Target Market: Revenues are generated currently from two
primary markets, banking/finance ("Banking") and corporate network access
("CNA") through the use of both direct and indirect sales channels. The
breakdown of revenue between the two primary markets is as follows:
YEAR BANKING CNA TOTAL
---- ------- --- -----
Total Revenue:
2003 $ 17,725,000 $ 5,141,000 $ 22,866,000
2002 14,169,000 3,201,000 17,370,000
2001 21,331,000 1,359,000 22,690,000
Percent of Total:
2003 78% 22% 100%
2002 82% 18% 100%
2001 94% 6% 100%
Revenues from the Banking market increased $3,556,000 or 25% in 2003
over 2002 and revenues from the CNA market increased $1,940,000 or 61% in the
same period. The increase in revenues in both markets is attributable, in part,
to the development of the indirect sales channel, which includes distributors,
resellers, and solution partners. The indirect
17
sales channel supplements the Company's direct sales force in the Banking market
and is the primary source of revenues in the CNA market. The Company focused on
developing the indirect sales channel in 2001 and it has resulted in significant
increases in revenues in each of the years presented.
The decline in the Banking segment in 2002 as compared to 2001 was
attributable in part to a weak economy in the European Banking market and the
fact that a number of the Company's major strategic Banking customers had made
significant purchases in 2001. Since our product is used for specific
applications, it is not uncommon for revenues from specific customers to vary
significantly year-to-year as they go through the various phases of their
marketing plans and deployments of Digipass units to their customers.
The amounts shown above for CNA currently include revenues generated in
the e-commerce market. We expect that the e-commerce market will be an important
source of future revenue for the Company as our products will not only provide a
higher level of security for purchases made over the Internet, they can also
help protect our customers' revenue stream by making it more difficult for
subscribers to our customers' Internet services to share passwords.
GROSS PROFIT AND OPERATING EXPENSES
The following table sets forth, for the periods indicated, certain
consolidated financial data as a percentage of revenues for the years ended
December 31, 2003, 2002 and 2001.
PERCENTAGE OF REVENUE
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
----- ----- -----
Revenues................................................................. 100.0% 100.0% 100.0%
Cost of goods sold....................................................... 39.4 41.2 45.6
----- ----- -----
Gross profit............................................................. 60.6 58.8 54.4
Operating costs:
Sales and marketing................................................ 30.6 45.8 42.7
Research and development........................................... 10.0 13.5 14.4
General and administrative......................................... 15.0 26.1 27.1
Non-cash compensation (recovery)................................... 0.1 (0.3) 0.2
Restructuring expenses............................................. - 1.9 17.5
----- ----- -----
Total operating costs...................................... 55.7 87.0 101.9
----- ----- -----
Operating income (loss).................................................. 4.9 (28.2) (47.5)
Interest income (expense)................................................ (0.3) (1.6) 3.4
Other income (expense), net.............................................. 0.5 0.1 1.2
----- ----- -----
Income (loss) from continuing operations................................. 5.1 (29.7) (42.9)
Provision for income taxes............................................... 1.8 0.8 (0.1)
----- ----- -----
Net income (loss) from continuing operations............................. 3.3 (30.5) (42.8)
===== ===== =====
Gross Profit
2003 Compared to 2002
Consolidated gross profit for the year ended December 31, 2003 was
$13,856,000, an increase of $3,646,000, or 36%, from the year ended December 31,
2002. Gross profit as a percentage of revenue was 61% in 2003, as compared to
59% in 2002. The increase in the gross profit as a percentage of revenue
reflects the beneficial impact of currency and the increase in CNA revenues as a
percentage of total revenues, partially offset by a decline in the average sales
price of the Digipass units sold due to a change in mix of revenues within the
Banking market.
As previously noted, the Company's purchases of inventory are
denominated in U.S. dollars. Also, as previously noted, the Company denominates
a portion of its sales in Euros in order to offset the affects of currency on
operating expenses. As the Euro and Australian dollars strengthened during the
year, revenues from sales made in Euros and Australian Dollars increased, as
measured in U.S. dollars, without the corresponding increase in cost of goods
sold. The
18
benefit from changes in currency rates as noted above was approximately
$1,460,000 and represents an improvement in the gross profit rate of
approximately 2.7 percentage points.
Consolidated gross profits, as a percentage of revenue, benefited in
2003 as revenues from the CNA market increased from 18% to 22% of total revenue.
Gross profits as a percentage of revenue on sales made to the Banking and CNA
markets were approximately 55% and 84%, respectively, in 2003. The difference in
the margin percentages between the two markets reflects the fact that orders
from Banking market are substantially larger than orders from the CNA market and
that the Company provides volume purchase discounts.
Gross profit as a percentage of revenue was adversely impacted by the
change in mix of sales within the Banking segment. While the Company did not
change its standard pricing in 2003, the mix of sales within the markets
impacted the gross profit percentage. In 2003, the Company received more orders
from its larger strategic Banking customers, which have a lower average selling
price, reflecting the larger order size. As a result, the margin within the
Banking segment in 2003 was lower than in 2002.
2002 Compared to 2001
Consolidated gross profit for the year ended December 31, 2002 was
$10,210,000, a decrease of $2,140,000, or 17%, from the year ended December 31,
2001. Gross profit as a percentage of revenue was 59% in 2002, as compared to
54% in 2001. This increase in the gross profit as a percentage of revenue
primarily reflects the increase in CNA revenues as a percentage of total revenue
and the change in mix of revenue within the Banking market. In 2002, sales to
the CNA market increased from 6% to 18% of total revenue. Also, revenues from
our larger strategic Banking customers, which have lower gross profit
percentages as a result of their larger order quantities, declined significantly
in 2002 from 2001.
Sales and Marketing Expenses
2003 Compared to 2002
Consolidated sales and marketing expenses for the year ended December
31, 2003 were $6,987,000, a decrease of $969,000, or 12%, from 2002. This
decrease was primarily due to the decrease in compensation-related expenses, a
reduction in advertising and printed marketing materials, and a reduction in
travel. The average full-time sales and marketing employee headcount declined
10% to 47 in 2003 from 52 in 2002. The reduction in sales and marketing was
partially offset by the increased strength of the Euro.
2002 Compared to 2001
Consolidated sales and marketing expenses for the year ended December
31, 2002 were $7,956,000, a decrease of $1,740,000, or 18%, from 2001. This
decrease is primarily due to the decrease in average full-time sales and
marketing employee headcount to 52 in 2002 from 68 in 2001 and their related
expenses.
Research and Development Expenses
2003 Compared to 2002
Consolidated research and development costs for the year ended December
31, 2003 were $2,281,000, a decrease of $60,000, or 3%, as compared to the year
ended December 31, 2002. The reduction reflects lower fees paid to third parties
and lower compensation partially offset by the strengthening of the Euro and
Australian dollar. Average full-time research and development employee headcount
in 2003 was 17 compared to 16 in 2002.
2002 Compared to 2001
Consolidated research and development costs for the year ended December
31, 2002 were $2,341,000, a decrease of $933,000, or 29%, as compared to the
year ended December 31, 2001. Average full-time research and development
employee headcount in 2002 was 16 compared to 34 in 2001.
19
General and Administrative Expenses
2003 Compared to 2002
Consolidated general and administrative expenses for the year ended
December 31, 2003 were $3,423,000, a decrease of $1,119,000, or 25%, from 2002.
This decrease can be principally attributed to lower headcount, reduced spending
on professional services, the collection of cash on accounts upon which a
reserve had been established in prior years, a reduction in depreciation and
amortization expenses, a reduction in travel expenses and a reduction in
office-related expenses such as rent and telephone. Average full-time general
and administrative employee headcount in 2003 was 10 compared to 12 in 2002. The
reduction in general and administrative expenses were partially offset by legal
expenses associated with the ActivCard litigation, which was settled in the
fourth quarter of 2003, and the impact of the strengthening of the Euro.
2002 Compared to 2001
Consolidated general and administrative expenses for the year ended
December 31, 2002 were $4,542,000, a decrease of $1,606,000, or 26%, from 2001.
This decrease was primarily due to a reduction in headcount, reduced spending on
professional services, and a reduction of amortization expenses resulting from
the write-off of assets as part of the restructuring in the fourth quarter of
2001. Average full-time general and administrative employee headcount in 2003
was 12 compared to 16 in 2002.
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.
Restructuring Expenses
There were no restructuring expenses for the year ended December 31,
2003 as compared with $320,000 in 2002. The expense in 2002 reflects changes in
estimates of the reserves established in the fourth quarter of 2001 and
primarily relate to the shutdown of the French operation and excess office space
in the United States.
Restructuring expenses for the year ended December 31, 2001 were
$3,970,000 reflecting the costs of a reduction in staff of 60 employees and the
write-off of intangible assets and property and equipment that were deemed not
to be part of the core operations.
Interest Income (Expense), Net
Consolidated net interest income (expense) was an expense of $80,000 in
2003 compared to expense of $270,000 in 2002. This decrease in expense was
primarily due to an increase in average net cash balances, up from an average of
$20,000 in 2002 to $2,050,000 in 2003. The Company's term debt of $3,400,000 and
accrued interest was repaid in full in the third quarter of 2003. The term debt
had an annual interest rate of 6%. The Company invested its cash balances in
short-term money market instruments at nominal rates of interest.
Consolidated net interest income (expense) was an expense of $270,000
in 2002 compared to income of $775,000 in 2001. This increase in expense was
primarily due to a reduction in average invested cash balances, down from an
average of $6,900,000 in 2001 to $20,000 in 2002 and the reversal in 2001 of an
expense accrual recorded in 2000 for the restructuring of the Company's
long-term debt. As part of the debt restructuring the interest rate on the term
debt increased from 3.25% to 6%, effective August 1, 2001, on a $3.4 million
term loan, due September 30, 2003.
Other Income (Expense)
Other income (expense) primarily includes exchange gains (losses) on
transactions that are denominated in currencies other than the subsidiaries'
functional currency. The increase in other income of $100,000 in 2003 over 2002
primarily reflects an increase in exchange gains of $69,000 during that period.
20
Other income (expense) decreased $268,000 in 2002 from 2001. Foreign
exchange transaction gains declined $106,000 during that period.
Income Taxes
Income tax expense for 2003 was $397,000 and compares to expense of
$140,000 in 2002. The expense relates primarily to the Belgian operating
subsidiary, whose tax loss carryforwards were fully utilized in 2003. The
Company reported an income tax benefit in 2001 of $13,000.
At December 31, 2003, the Company has United States net operating loss
carryforwards approximating $27,650,000 and foreign net operating loss
carryforwards approximating $4,070,000. Such losses are available to offset
future taxable income in the respective jurisdictions and expire in varying
amounts beginning in 2004 and continuing through 2023. 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 that
could be utilized.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, the Company had cash balances totaling $4,817,000
and no outstanding term debt. Cash generated from operating activities was
$2,409,000 during the year ended December 31, 2003. During 2003, we generated
$128,000 from investing activities and used $267,000 in financing activities
consisting of a capital raise, debt payments and the repurchase of the Company's
Series C Convertible Preferred Stock. Net capital expenditures, assets purchased
less assets sold, generated $16,000 for the year ended December 31, 2003.
In 1997, we entered into a convertible loan agreement with Artesia Bank
N.V., formerly Banque Paribas Belgique S.A. and now doing business as Dexia Bank
("Dexia"), 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 provided
that the $3,400,000 principal amount was 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 was convertible into shares of our Common Stock at the fixed
conversion rate of $7.50 per share, rather than a floating rate based on the
market price of our Common Stock, and the interest rate increased from 3.25% to
6% annually. The loan and accrued interest was repaid in full in September 2003.
In July 2000, the Company issued 150,000 shares of Series C Convertible
Preferred Stock (the "Series C Preferred Stock") and warrants to purchase
1,269,474 shares of Common Stock for cash of $15,000,000 to Ubizen N.V.
("Ubizen"). The preferred stock was convertible into 1,052,632 shares of Common
Stock at any time through July 2004. If not converted by July 2004, the
preferred stock would have been, at the option of the Company, either
repurchased or converted into Common Stock at a rate equal to the average market
price of the Common Stock for 30 consecutive business days on which the common
stock was traded prior to the conversion date less five (5) percent.
In July 2003, the Company reached an agreement with Ubizen whereby it
purchased and redeemed all of the Series C Convertible Preferred Stock and
Common Stock Purchase Warrants owned by Ubizen in exchange for $4,000,000 in
cash and 2,000,000 shares of Common Stock. Under the terms of the Purchase
Agreement, the Company paid $3,000,000 to Ubizen and issued 2,000,000 shares of
Common Stock on July 25, 2003. An additional $1,000,000 was paid to Ubizen in
November 2003. Using the closing price of the Common Stock on July 25, 2003, the
value of the stock issued was $4,000,000. The Common Stock issued by the Company
is subject to a lock-up period wherein the lock-up expired or will expire in
increments of 500,000 shares each on October 15, 2003, January 15, 2004, April
15, 2004 and July 15, 2004. Once the lock-up expires, the shares will be subject
to volume trading restrictions through January 1, 2005.
On September 11, 2003, the Company sold 800 shares, with a stated
valued of $10,000 per share, of its Series D 5% Cumulative Convertible Voting
Preferred Stock (the "Series D Preferred Stock") and 600,000 warrants to
purchase Common Stock. The Series D Preferred Stock carries a 5% dividend, is
convertible into 4 million shares of Common Stock at a fixed price of $2.00 per
share and will vote with the Common Stock as a class on matters presented to the
stockholders. The net proceeds from the sale totaled $7,260,000 of which
$5,786,000 was allocated to the Series D Preferred Stock and $1,474,000 was
allocated to the warrants based upon their relative fair values. In addition, a
beneficial conversion value was calculated for the Series D Preferred Stock as
the difference between the price of the Common Stock at the transaction
21
date and the conversion price of the Series D Preferred Stock. The amount of the
beneficial conversion, $3,720,000, is analogous to a dividend and was recorded
to accumulated deficit.
The Company maintains an overdraft agreement with Fortis Banque/Bank of
Belgium. Under terms of the agreement, the Company can borrow an amount equal to
80% of its Belgium subsidiary's defined accounts receivable up to maximum of two
million Euros. Borrowings under the overdraft agreement accrue interest at an
annual rate of 5.7% and the Company is obligated to pay a quarterly commitment
fee of 0.125%. As of December 31, 2003, approximately 1,065,000 Euros were
available under the overdraft agreement and there were no borrowings outstanding
under the agreement. The assets, excluding inventory, of the Belgian subsidiary
secure the agreement and while it has no specific termination date, it can be
terminated with thirty (30) days notice. The agreement is governed by the
General Lending Conditions for Corporate Customers, registered in Brussels,
Belgium on December 20, 2001.
The net effect of 2003 activity resulted in an increase in cash of
$2,201,000 and a cash balance of $4,817,000 at December 31, 2003, compared to
$2,616,000 at the end of 2002. Our working capital at December 31, 2003 was
$5,218,000, an increase of $5,804,000 from a deficit of $586,000 at December 31,
2002. The change is attributable to the generation of a positive cash flow from
operations in 2003 and the proceeds of the financing partially offset by the
purchase of the Company's Series C Convertible Preferred Stock and the repayment
of the loan from Dexia. Our current ratio was 2.18 to 1.0 at December 31, 2003.
We believe that our current cash balances, credit available under our existing
overdraft agreement and the anticipated cash generated from operations,
including the realization of deferred revenue recorded as a current liability
and deposits received on orders of Digipass to be delivered in 2004, will be
sufficient to meet our anticipated cash needs for the foreseeable future.
The net effect of 2002 activity resulted in a decrease in cash of
$3,727,000 and a cash balance of $2,616,000 at December 31, 2002, compared to
$6,342,000 at the end of 2001. Our working capital at December 31, 2002 was a
deficit $586,000, a decrease of $7,247,000 from working capital total of
$6,661,000 at December 31, 2001. The decrease in cash was primarily attributable
to the generation of a loss from operations in 2002, the repayment of the debt
and the impact of exchange rates on cash. The decline in the current ratio was
primarily attributable to the decline in cash and the reclassification of our
term loan of $3,400,000 from Dexia, which was due September 30, 2003, from
long-term debt to current maturities of long-term debt.
There is risk, however, that our revenue and cash receipts will not be
sufficient to meet the operating needs of the business. If this is the case, we
will need to significantly reduce our workforce, sell certain of our assets,
enter into strategic relationships or business combinations, discontinue some or
all of our operations, or take other similar restructuring actions. While we
expect that these actions would result in a reduction of recurring costs, they
also may result in a reduction of recurring revenues and cash receipts. It is
also likely that we would incur substantial non-recurring costs to implement one
or more of these restructuring actions.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off-balance sheet arrangements.
CONTRACTUAL OBLIGATIONS
The Company has the following contractual obligations, which are
primarily office and car leases:
Payments Due by Period
-------------------------------------------------------------------------------
Less than 1-3 3-5 More than
Total 1 year years years 5 years
----------- ---------- ----------- ----------- ----------
Long-Term Debt Obligations.................. $ - $ - $ - $ - $ -
Capital Lease Obligations...................... - - - - -
Operating Lease Obligations................. 2,268,469 895,677 1,287,887 50,943 33,962
Purchase Obligations........................... 2,103,422 2,103,422 - - -
Other Long-Term Liabilities Reflected
on the Balance Sheet......................... - - - - -
----------- ---------- ----------- ----------- ----------
Total Contractual Obligations.............. $ 4,371,891 $2,999,099 $ 1,287,887 $ 50,943 $ 33,962
=========== ========== =========== =========== ==========
22
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 liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated 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, net realizable value of inventory,
investments in SecureD Services, Inc. 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 goods and services. We analyze accounts receivable, customer
credit-worthiness, current economic trends and changes in our customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. If
the financial condition of our customers deteriorates, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
NET REALIZABLE VALUE OF INVENTORY: We maintain reserves for inventory
where it appears that the carrying cost of the inventory may not be recovered
through subsequent sale of the inventory. We analyze the quantity of inventory
on hand, the quantity sold in the past year, the anticipated sales volume in the
form of sales to new customers as well as sales to previous customers, the
expected sales price and the cost of making the sale when evaluating the
valuation of our inventory. If the sales volume or sales price of a specific
model declines significantly, additional reserves may be required.
VALUATION OF INVESTMENT IN SECURED SERVICES, INC.: The initial value of
consideration received from SecureD Services, Inc. ("SSI"), in exchange for the
assets of the VACMAN Enterprise business unit, was established by an independent
valuation firm. On an ongoing basis, we review information made available by SSI
through its filings with the Securities and Exchange Commission and its press
releases and consider it within the context of the assumptions made by the
independent valuation firm. We also monitor SSI's compliance with the terms of
the specific investment instruments to which they relate. Considering the
start-up nature of SSI, the highly-competitive environment in which they operate
and the uncertainty associated with SSI's access to additional capital, it may
be that SSI's business prospects will deteriorate and, as a result, require the
Company to reduce the value of its investment in SSI.
The investment in SSI as of December 31, 2003 was $1,467,000. While SSI
had remained current on payments related to the notes receivable through
December 31, 2003, the full amount of the investment is at risk if SSI is
unsuccessful in executing their business plan.
VALUATION OF GOODWILL AND OTHER INTANGIBLE ASSETS, AND SOFTWARE
DEVELOPMENT COSTS: We assess the impairment of intangible assets and goodwill
annually and 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 purchased software 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 frequency of technological changes
23
in our industry, 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.
The total amount of Goodwill and other intangible assets as of December
31, 2003 was $1,628,000, and the full amount is at risk of impairment. See
footnote 1 to the financial statements for more detailed information.
RESEARCH AND DEVELOPMENT: We are devoting substantial capital and other
resources to enhance our existing security products and develop new products to
provide identity authentication security solutions on different platforms and
for different applications. 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148 Accounting for
Stock-Based Compensation -- Transition and Disclosure an amendment of FASB
Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
SFAS No. 123, to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. SFAS No. 148 also amends APB Opinion No. 28, Interim
Financial Reporting, to require disclosure about those effects in interim
financial information. The Company has adopted the disclosure provisions, but
does not intend to change to the fair value method of accounting for stock-based
employee compensation.
In January 2003, the FASB issued FIN 46, Consolidation of Variable
Interest Entities. FIN 46 requires companies to consolidate variable interest
entities ("VIE") if the company has a majority of risks, rewards or both of the
VIE. FIN 46 will be effective for most VIEs beginning in the fourth quarter of
2003. The Company does not have any investments in VIEs and FIN 46, therefore,
has no affect on our financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. SFAS No. 149 clarifies when a
contract with an initial net investment meets the characteristics of a
derivative and when a derivative contains a financing component that warrants
special reporting in the statements of cash flows. SFAS No. 149 is generally
effective for contracts entered into or modified after June 30, 2003, and had no
impact on the Company's financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150 Accounting for Certain
Financial instruments with Characteristics of both Liabilities and Equity. SFAS
No. 150 sets standards for classification and measurement by an issuer of
financial instruments with characteristics of both liabilities and equity. It
requires that instruments that include an obligation of the issuer be reported
as a liability. The Company has not issued any financial instruments with these
characteristics and SFAS No. 150 has had no affect on its financial statements.
CERTAIN FACTORS
There are a number of other factors that could affect future results.
You should carefully consider the following factors as well as other information
contained in this annual report. If any of the following items were to occur,
our business, financial condition or operating results could be materially and
adversely affected.
WE HAD A HISTORY OF OPERATING LOSSES AND HAVE A LARGE ACCUMULATED
DEFICIT.
Although we have reported net income of $2,756,000 for the year ended
December 31, 2003, we have incurred net losses of $4,539,000 and $12,034,000 for
the years ended December 31, 2002 and 2001, respectively, and as of December 31,
2003, our accumulated deficit is $43,693,000.
24
WE FACE SIGNIFICANT COMPETITION AND IF WE LOSE OR FAIL TO GAIN MARKET
SHARE OUR FINANCIAL RESULTS WILL SUFFER.
The market for computer and network security products is highly
competitive. Our competitors include organizations that provide computer and
network security products based upon approaches similar to and different from
those that we employ such as RSA Security, ActivCard, Rainbow Technologies, and
Aladdin Knowledge Systems. Many of our competitors have significantly greater
financial, marketing, technical and other competitive resources than we do. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements, or to devote greater resources to the
promotion and sale of their products.
TECHNOLOGICAL CHANGES OCCUR RAPIDLY IN OUR INDUSTRY AND OUR DEVELOPMENT
OF NEW PRODUCTS IS CRITICAL TO MAINTAIN OUR REVENUES.
The introduction by our competitors of products embodying new
technologies and the emergence of new industry standards could render our
existing products obsolete and unmarketable. Our future revenue growth and
operating profit will depend in part upon our ability to enhance our current
products and develop innovative products to distinguish ourselves from the
competition and to meet customers' changing needs in the data security industry.
We cannot assure you that security-related product developments and technology
innovations by others will not adversely affect our competitive position or that
we will be able to successfully anticipate or adapt to changing technology,
industry standards or customer requirements on a timely basis.
THE SALES CYCLE FOR OUR PRODUCTS AND TECHNOLOGY IS LONG, AND WE MAY
INCUR SUBSTANTIAL EXPENSES FOR SALES THAT DO NOT OCCUR WHEN ANTICIPATED.
The sales cycle for our products, which is the period of time between
the identification of a potential customer and completion of the sale, is
typically lengthy and subject to a number of significant risks over which we
have little control. If revenue falls significantly below anticipated levels,
our business would be seriously harmed.
A typical sales cycle in the Banking market is often three to six
months and with larger Banking transactions up to eighteen months. Purchasing
decisions for our products and systems may be subject to delay due to many
factors that are not within our control, such as:
- The time required for a prospective customer to recognize the
need for our products;
- The significant expense of many data security products and
network systems;
- Customers' internal budgeting processes; and
- Internal procedures customers may require for the approval of
large purchases.
WE HAVE A SIGNIFICANT DEPENDENCE ON MAJOR CUSTOMERS AND LOSING ANY OF
THESE CUSTOMERS COULD RESULT IN A SIGNIFICANT LOSS IN REVENUES
If we don't find other customers who generate significant future
revenues, the unforeseen loss of one or more of our major customers, or the
inability to maintain reasonable profit margins on sales to any of these
customers, would have a material adverse effect on our results of operations and
financial condition.
OUR SUCCESS DEPENDS ON ESTABLISHING AND MAINTAINING STRATEGIC
RELATIONSHIPS WITH OTHER COMPANIES TO DEVELOP, MARKET AND DISTRIBUTE OUR
TECHNOLOGY AND PRODUCTS AND, IN SOME CASES, TO INCORPORATE OUR TECHNOLOGY INTO
THEIR PRODUCTS.
Part of our business strategy is to enter into strategic alliances and
other cooperative arrangements with other companies in our industry. We
currently are involved in cooperative efforts with respect to incorporation of
our products into products of others, research and development efforts,
marketing efforts and reseller arrangements. None of these relationships are
exclusive, and some of our strategic partners also have cooperative
relationships with certain of our competitors. If we are unable to enter
cooperative arrangements in the future or if we lose any of our current
strategic or cooperative relationships, our business could be harmed. We do not
control the time and resources devoted to such activities by parties with whom
we have relationships. In addition, we may not have the resources available to
satisfy our commitments, which may adversely affect these relationships. These
relationships may not continue, may not be commercially successful, or may
require our expenditure of significant financial, personnel and administrative
resources
25
from time to time. Further, certain of our products and services compete with
the products and services of our strategic partners.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND OUR FAILURE TO OBTAIN
CAPITAL WOULD INTERFERE WITH OUR GROWTH STRATEGY.
Our ability to obtain financing will depend on a number of factors,
including market conditions, our operating performance and investor interest.
These factors may make the timing, amount, terms and conditions of any financing
unattractive. They may also result in our incurring additional indebtedness or
accepting stockholder dilution. If adequate funds are not available or are not
available on acceptable terms, we may have to forego strategic acquisitions or
investments, defer our product development activities, or delay the introduction
of new products.
WE MUST CONTINUE TO ATTRACT AND RETAIN HIGHLY SKILLED TECHNICAL
PERSONNEL FOR OUR RESEARCH AND DEVELOPMENT DEPARTMENT.
The market for highly skilled technicians in Europe, Asia, Australia
and the United States is highly competitive. If we fail to attract, train,
assimilate and retain qualified technical personnel for our research and
development department, we will experience delays in introductions of new or
modified products, loss of clients and market share and a reduction in revenues.
WE FACE A NUMBER OF RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS,
ANY OR ALL OF WHICH COULD RESULT IN A DISRUPTION IN OUR BUSINESS AND A DECREASE
IN OUR REVENUES.
Our business internationally is subject to a number of risks any or all
of which could result in a disruption in our business and a decrease in our
revenues. These include:
- Inconsistent regulations and unexpected changes in regulatory
requirements;
- Difficulties and costs of staffing and managing international
operations;
- Potentially adverse tax consequences;
- Wage and price controls;
- Uncertain protection for intellectual property rights;
- Imposition of trade barriers;
- Differing technology standards;
- Uncertain demand for electronic commerce;
- Linguistic and cultural differences;
- Political instability; and
- Social unrest.
WE ARE SUBJECT TO FOREIGN EXCHANGE RISKS, AND IMPROPER MANAGEMENT OF
THAT RISK COULD RESULT IN LARGE CASH LOSSES.
Because a significant number of our principal customers are located
outside the United States, we expect that international sales will continue to
generate a significant portion of our total revenue. We are subject to foreign
exchange risks because the majority of our costs are denominated in U.S.
dollars, whereas a significant portion of the sales and expenses of our European
operating subsidiaries are denominated in various foreign currencies. A decrease
in the value of any of these foreign currencies relative to the U.S. dollar
could affect the profitability in U.S. dollars of our products sold in these
markets. We do not currently hold forward exchange contracts or other hedging
instruments to exchange foreign currencies for U.S. dollars to offset currency
rate fluctuations.
WE HAVE A GREAT DEPENDENCE ON A LIMITED NUMBER OF SUPPLIERS AND THE
LOSS OF THEIR MANUFACTURING CAPABILITY COULD MATERIALLY IMPACT OUR OPERATIONS.
In the event that the supply of components or finished products is
interrupted or relations with either of our principal vendors is terminated,
there could be a considerable delay in finding suitable replacement sources to
manufacture our products at the same cost or at all. The majority of our
products are manufactured by three independent vendors, one headquartered in
Europe and the other two in Hong Kong. Our security tokens are assembled at
facilities in mainland
26
China. The importation of these products from China exposes us to the
possibility of product supply disruption and increased costs in the event of
changes in the policies of the Chinese government, political unrest or unstable
economic conditions in China or developments in the United States that are
adverse to trade, including enactment of protectionist legislation.
WE DEPEND SIGNIFICANTLY UPON OUR PROPRIETARY TECHNOLOGY AND
INTELLECTUAL PROPERTY AND THE FAILURE TO PROTECT OUR PROPRIETARY RIGHTS COULD
REQUIRE US TO REDESIGN OUR PRODUCTS OR REQUIRE US TO ENTER INTO ROYALTY OR
LICENSING AGREEMENTS, ANY OF WHICH COULD REDUCE REVENUE AND INCREASE OUR
OPERATING COSTS.
We currently rely on a combination of patent, copyright and trademark
laws, trade secrets, confidentiality agreements and contractual provisions to
protect our proprietary rights. We seek to protect our software, documentation
and other written materials under trade secret and copyright laws, which afford
only limited protection, and generally enter into confidentiality and
nondisclosure agreements with our employees and with key vendors and suppliers.
There has been substantial litigation in the technology industry
regarding intellectual property rights, and we may have to litigate to protect
our proprietary technology. We expect that companies in the computer and
information security market will increasingly be subject to infringement claims
as the number of products and competitors increases. Any such claims or
litigation may be time-consuming and costly, cause product shipment delays,
require us to redesign our products or require us to enter into royalty or
licensing agreements, any of which could reduce revenue and increase our
operating costs.
OUR PATENTS MAY NOT PROVIDE US WITH COMPETITIVE ADVANTAGES.
We hold several patents in the United States and a corresponding patent
in some European countries, which cover multiple aspects of our technology. The
U.S. patents expire between 2005 and 2010 and the patent in those European
countries expires in 2008. There can be no assurance that we will continue to
develop proprietary products or technologies that are patentable, that any
issued patent will provide us with any competitive advantages or will not be
challenged by third parties, or that patents of others will not hinder our
competitive advantage.
WE ARE SUBJECT TO PRODUCT LIABILITY RISKS.
A malfunction of or design defect in our products which results in a
breach of a customer's data security could result in tort or warranty claims
against us. We do not presently maintain product liability insurance for these
types of claims.
THERE IS SIGNIFICANT GOVERNMENT REGULATION OF TECHNOLOGY EXPORTS AND TO
THE EXTENT WE CANNOT MEET THE REQUIREMENTS OF THE REGULATIONS WE MAY BE
PROHIBITED FROM EXPORTING SOME OF OUR PRODUCTS, WHICH COULD NEGATIVELY IMPACT
OUR REVENUES.
Our international sales and operations are subject to risks such as the
imposition of government controls, new or changed export license requirements,
restrictions on the export of critical technology, trade restrictions and
changes in tariffs. If we become unable to obtain foreign regulatory approvals
on a timely basis our business in those countries would no longer exist and our
revenues would decrease dramatically. Certain of our products are subject to
export controls under U.S. law. The list of products and countries for which
export approval is required, and the regulatory policies with respect thereto
may be revised from time to time and our inability to obtain required approvals
under these regulations could materially adversely affect our ability to make
international sales.
WE EMPLOY CRYPTOGRAPHIC TECHNOLOGY IN OUR AUTHENTICATION PRODUCTS THAT
USES COMPLEX MATHEMATICAL FORMULATIONS TO ESTABLISH NETWORK SECURITY SYSTEMS.
Many of our products are based on cryptographic technology. With
cryptographic technology, a user is given a key that is required to encrypt and
decode messages. The security afforded by this technology depends on the
integrity of a user's key and in part on the application of algorithms, which
are advanced mathematical factoring equations. These codes may eventually be
broken or become subject to government regulation regarding their use, which
would render our technology and products less effective. The occurrence of any
one of the following could result in a decline in demand for our technology and
products:
27
- Any significant advance in techniques for attacking
cryptographic systems, including the development of an easy
factoring method or faster, more powerful computers;
- Publicity of the successful decoding of cryptographic messages
or the misappropriation of keys; and
- Increased government regulation limiting the use, scope or
strength of cryptography.
ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR
FINANCIAL CONDITION.
We may make investments in complementary companies, products or
technologies. Should we do so, our failure to successfully manage future
acquisitions could seriously harm our operating results. In the event of any
future purchases, we will face additional financial and operational risks,
including:
- Difficulty in assimilating the operations, technology and
personnel of acquired companies;
- Disruption in our business because of the allocation of
resources to consummate these transactions and the diversion
of management's attention from our existing business;
- Difficulty in retaining key technical and managerial personnel
from acquired companies;
- Dilution of our stockholders, if we issue equity to fund these
transactions;
- Assumption of operating losses, increased expenses and
liabilities; and
- Our relationships with existing employees, customers and
business partners may be weakened or terminated as a result of
these transactions.
WE EXPERIENCE VARIATIONS IN QUARTERLY OPERATING RESULTS AND ARE SUBJECT
TO SEASONALITY, BOTH OF WHICH MAY RESULT IN A VOLATILE STOCK PRICE.
In the future, as in the past, our quarterly operating results may vary
significantly resulting in a volatile stock price. Factors affecting our
operating results include:
- The level of competition;
- The size, timing, cancellation or rescheduling of significant
orders;
- New product announcements or introductions by current
competitors;
- Technological changes in the market for data security products
including the adoption of new technologies and standards;
- Changes in pricing by current 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;
- Market acceptance of new products and product enhancements;
- Changes in foreign currency exchange rates; and
- General economic trends.
We also experience seasonality in all markets. These seasonal trends
are most notable in the summer months, particularly in Europe, when many
businesses defer purchase decisions.
A SMALL GROUP OF PERSONS CONTROL A SUBSTANTIAL AMOUNT OF OUR COMMON
STOCK AND COULD DELAY OR PREVENT A CHANGE OF CONTROL.
Our board of directors, our officers and their immediate families and
related entities beneficially own approximately 35%, with Mr. T. Kendall Hunt
controlling approximately 33%, of the outstanding shares of our common stock not
including the shares that are issuable (a) upon conversion of our Series D
preferred stock, (b) upon exercise of warrants purchased in conjunction with the
Series D preferred stock or (c) as dividends upon the Series D preferred stock.
If the foregoing categories of shares are included as outstanding shares, the
beneficial ownership percentages are 30% and 28%, respectively. As the chairman
of the board of directors and our largest stockholder, Mr. Hunt may exercise
substantial control over our future direction and operation and such
concentration of control may have the effect of discouraging, delaying or
preventing a change in control and may also have an adverse effect on the market
price of our common stock.
28
OUR STOCK PRICE MAY BE VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR
SHARES AT OR ABOVE ACCEPTABLE PRICES.
The market price of our common stock may fluctuate significantly in
response to factors, some of which are beyond our control, including the
following:
- Actual or anticipated fluctuations in our operating results;
- Changes in market valuations of other technology companies;
- Announcements by us or our competitors of significant
technical innovations, contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
- Additions or departures of key personnel;
- Future sales of common stock;
- Any deviations in net revenues or in losses from levels
expected by the investment community; and
- Trading volume fluctuations.
CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER
OF OUR COMPANY MORE DIFFICULT.
Our corporate charter and Delaware law contain provisions, such as a
class of authorized but unissued preferred stock which may be issued by our
board without stockholder approval, that might enable our management to resist a
takeover of our company. Delaware law also limits business combinations with
interested stockholders. These provisions might discourage, delay or prevent a
change in our control or a change in our management. These provisions could also
discourage proxy contests, and make it more difficult for you and other
stockholders to elect directors and take other corporate actions. The existence
of these provisions could limit the price that investors might be willing to pay
in the future for shares of our common stock.
FUTURE ISSUANCES OF BLANK CHECK PREFERRED STOCK MAY REDUCE VOTING POWER
OF COMMON STOCK AND MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE
IN CONTROL.
Our corporate charter authorizes the issuance of up to 500,000 shares
of preferred stock with such designations, rights, powers and preferences as may
be determined from time to time by our board of directors, including such
dividend, liquidation, conversion, voting or other rights, powers and
preferences as may be determined from time to time by the board of directors
without further stockholder approval. The issuance of preferred stock could
adversely affect the voting power or other rights of the holders of common
stock. In addition, the authorized shares of preferred stock and common stock
could be utilized, under certain circumstances, as a method of discouraging,
delaying or preventing a change in control.
U.S. INVESTORS MAY HAVE DIFFICULTIES IN MAKING CLAIMS FOR ANY BREACH OF
THEIR RIGHTS AS HOLDERS OF SHARES BECAUSE SOME OF OUR ASSETS AND EXECUTIVES ARE
NOT LOCATED IN THE UNITED STATES.
Several of our executives are residents of Belgium, and a substantial
portion of our assets and those of some of our executives are located in
Belgium. As a result, it may not be possible for investors to effect service of
process on those persons located in Belgium, or to enforce judgments against
some of our executives based upon the securities or other laws of jurisdictions
other than Belgium. Moreover, we believe that under Belgian law there exist
certain restrictions on the enforceability in Belgium in original actions, or in
actions of enforcement of judgments rendered against us in courts outside
jurisdictions that are a party to the Brussels Convention on Jurisdiction and
the Enforcement of Judgments in Civil and Commercial Matters (as amended).
Actions for enforcement of such judgments may be successful only if the Belgian
court confirms the substantive correctness of the judgment of such court, and is
satisfied:
- That the judgment is not contrary to the principles of public
policy in Belgium or rules of Belgian public law;
- That the judgment did not violate the rights of the defendant;
- That the judgment is final under applicable law;
- That the court did not accept its jurisdiction solely on the
basis of the nationality of the plaintiff; and
- As to the authenticity of the text of the judgment submitted
to it.
Judgments rendered in the courts of parties to the Brussels Convention
will be enforceable by the courts of Belgium without reexamination of the merits
of the case provided such judgment is final and otherwise satisfies all of the
29
conditions provided for in this Convention. If proceedings have been brought in
one country, however, new proceedings in another country may be barred.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Exchange Risk - In 2003, approximately 93% of our
business was conducted outside the United States in Europe and Asia/Pacific. A
significant portion of our business operations is transacted in foreign
currencies. As a result, we have exposure to foreign exchange fluctuations. We
are affected by both foreign currency translation and transaction adjustments.
Translation adjustments result from the conversion of the foreign subsidiaries'
balance sheets and income statements to U.S. dollars at year-end exchange rates
and weighted average exchange rates, respectively. Translation adjustments
resulting from this process are recorded directly into stockholders' equity.
Transaction adjustments result from currency exchange movements when a foreign
subsidiary transacts business in a currency that differs from its local
currency. These adjustments are recorded as gains or losses in our statements of
operations. Our foreign subsidiaries' business transactions are spread across
approximately 60 different countries and currencies. This geographic diversity
reduces the risk to our operating results.
Interest Rate Risk - We have minimal interest rate risk. We have no
outstanding debt and our cash is invested in short-term instruments at current
market rates. If rates were to increase or decrease by one percentage point, the
Company's interest income would increase or decrease approximately $50,000
annually.
Impairment Risk - At December 31, 2003, we had goodwill and other
intangible assets of $1,628,000 related mostly to technology purchased in 2001
as part of our acquisition of Identikey. We will assess the net realizable value
of the intangible assets on a regular basis, but at least annually, to determine
if we have incurred any declines in the value of our capital investment. While
we did not experience impairment during the year ended December 31, 2003, we may
incur impairment charges in future periods.
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-24 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.
ITEM 9A - CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains a system of disclosure controls and procedures
that is designed to ensure that information required to be disclosed by the
Company in this Form 10-K, and in other reports required to be filed under the
Securities Exchange Act of 1934, is recorded, processed, summarized and reported
within the time periods specified in the rules and forms for such filings.
Management of the Company, under the direction of the Company's Chief Executive
Officer and Chief Financial Officer, reviewed and performed an evaluation of the
effectiveness of the Company's disclosure controls and procedures. Based on that
review and evaluation, the Chief Executive Officer and Chief Financial Officer,
along with other key management of the Company, have determined that the
disclosure controls and procedures were and are effective as designed to ensure
that material information relating to the Company and its consolidated
subsidiaries would be made known to them on a timely basis.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls
during the quarter ended December 31, 2003.
30
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
T. KENDALL "KEN" HUNT -- Mr. Hunt is Chairman of the Board and Chief
Executive Officer. He served as our Chief Executive Officer through June 1999.
He returned as CEO in November 2002. He has been a director since July 1997 and
currently serves a one-year term. He served since 1990 as Chairman and President
of our predecessor, VASCO Corp. Mr. Hunt is a director of SecureD Services,
Inc., a publicly-held company and two privately-held companies,
Cyberloanofficer.com, and Amuseneering, Inc. Mr. Hunt received a B.B.A. from the
University of Miami, Miami, Florida and an M.B.A. from Pepperdine University,
Malibu, California. Mr. Hunt is 60 years old.
MICHAEL P. CULLINANE -- Mr. Cullinane has been a director since April
10, 1998 and currently serves a one-year term. He is the Chairman of our Audit
Committee and a member of our Governance and Nominating Committee and our
Compensation Committee. Mr. Cullinane served as the Executive Vice President and
Chief Financial Officer and a director of Divine, Inc. from July 1999 to May
2003. He served as Executive Vice President, Chief Financial Officer and a
director of PLATINUM Technology International, Inc. from 1988 to June 1999. On
February 25, 2003, Divine, Inc. filed for protection under the federal
bankruptcy laws. Mr. Cullinane received a B.B.A. from the University of Notre
Dame, South Bend, Indiana. Mr. Cullinane is 54 years old.
FORREST D. LAIDLEY -- Mr. Laidley has been a director since July 1997
and currently serves a one-year term. Mr. Laidley was our Secretary from our
inception through September 2000. He has been involved with us and our
predecessor, VASCO Corp., for certain periods since 1984 in similar capacities
and currently serves as Chairman of our Compensation Committee and a member of
our Governance and Nominating Committee. He is President and sole stockholder of
Forrest Properties, Inc., an Illinois real estate development corporation. Mr.
Laidley received a B.A. in History from Yale University, New Haven, Connecticut
and a J.D. from DePaul University, Chicago, Illinois. Mr. Laidley is 60 years
old.
MICHAEL A. MULSHINE -- Mr. Mulshine has been a director since July 1997
and currently serves a one-year term. He served since 1992 as a director of our
predecessor, VASCO Corp. He is a member of our Governance and Nominating
Committee, Audit Committee and Compensation Committee. He is, and since 1977 has
been, a principal of Osprey Partners, a management consulting firm. Mr. Mulshine
is a director of Prediction Systems, Inc., a privately held company. Mr.
Mulshine received a B.S. in Electrical Engineering from Newark College of
Engineering, Newark, New Jersey. Mr. Mulshine is 64 years old.
JOHN R. WALTER -- Mr. Walter has been a director since April 2003 and
currently serves a one-year term. He is Chairman of our Governance and
Nominating Committee and is a member of our Audit Committee. Mr. Walter is
Chairman and CEO of Ashlin Management Co., a private investment and management
services firm. Mr. Walter also serves as a director for Abbott Laboratories,
Inc., Deere & Company, Manpower, Inc., and SNP Corporation of Singapore. Mr.
Walter received a B.S. degree in management from Miami University, Oxford, Ohio.
Mr. Walter is 57 years old.
EXECUTIVE OFFICERS
JAN VALCKE -- Mr. Valcke is President & Chief Operating Officer. Mr.
Valcke has been an officer of the Company since 1996. From 1992 to 1996, he was
Vice-President of Sales and Marketing of Digipass NV/SA, a member of the
Digiline group. He co-founded Digiline in 1988 and was a member of the Board of
Directors of Digiline. Mr.Valcke received a degree in Science from St. Amands
College in Kortrijk, Belgium. Mr. Valcke is 50 years old.
CLIFFORD K. BOWN -- Mr. Bown is Executive Vice President & Chief
Financial Officer. Mr. Bown started his career with KPMG LLP where he directed
the audits for several publicly held companies, including a global leader that
provides integrated and embedded communications solutions. From 1991 to 1993, he
was CFO for publicly held XL/DATACOMP, a $300 million provider of midrange
computer systems and support services in the U. S. and U. K. Mr. Bown also held
CFO positions in two other companies focused on insurance and healthcare from
1995 through 2001. Mr.
31
Bown received a B.S. in Accountancy from the University of Illinois, Urbana,
Illinois, his MBA from the University of Chicago, and he has a CPA certificate.
Mr. Bown is 52 years old.
AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors has determined that Mr. Cullinane, Chairman of
the Audit Committee, Mr. Mulshine, member of the Audit Committee and Mr. Walter,
member of the Audit Committee, each qualify as a financial expert and has
designated each person as a financial expert. Each member of the Audit Committee
has been determined to be independent as defined by The Nasdaq Stock Market,
Inc. and the Securities and Exchange Commission.
SECTION 16(a) BENEFICIAL OWNERSHIP COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires directors
and executive officers, and persons who beneficially own more than 10% of a
registered class of our equity securities, to file reports of ownership and
changes in ownership with the Securities and Exchange Commission and The Nasdaq
Stock Market, Inc. Directors, executive officers and beneficial owners of more
than 10% of the outstanding shares of Common Stock are required by Commission
regulations to furnish us with copies of all Section 16(a) forms that they file.
Based solely on review of the copies of such forms or written representations
that no reports under Section 16(a) were required, and except as provided in the
paragraphs below and as previously disclosed in the Company's proxy statement
filed on May 27, 2003, we believe that for the year period ended December 31,
2003, all of the Company's directors, executive officers and greater than 10%
beneficial owners complied with Section 16(a) filing requirements applicable to
them.
Forrest D. Laidley did not file a timely Form 4 report with respect to
the sale of 297,403 shares of Common Stock during the period from May 16, 2003
through June 20, 2003. A Form 5 reporting these transactions was filed on
January 14, 2004.
Michael A. Mulshine did not file a timely Form 4 report with respect to
the sale of 9,500 shares of Common Stock sold on March 8, 2002. A Form 4
reporting these transactions was filed on March 24, 2004.
CODE OF ETHICS
The Company has adopted a Code of Ethics that applies to all of its
employees, including its principal executive officer and principal financial
officer. A copy of the Code of Ethics is attached hereto as Exhibit 10.54.
32
ITEM 11 - EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation awarded to, earned by,
or paid for services rendered to VASCO and our subsidiaries in all capacities
during the three years ended December 31, 2003, 2002 and 2001 for our Chief
Executive Officer, President and Chief Operating Officer and Executive Vice
President, who are the only executive officers of VASCO and our subsidiaries
whose salary and bonus for such year exceeded $100,000 (collectively, the "Named
Executive Officers").
LONG-TERM COMPENSATION
-------------------------
ANNUAL COMPENSATION AWARDS
--------------------------------------- ------------------------- PAYOUTS
OTHER RESTRICTED SECURITIES -------
ANNUAL STOCK UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS/SARS PAYOUTS COMPENSATION
POSITION YEAR ($) ($) ($) ($) (#) ($) ($)
- --------------------- ---- ------- ------ ------------ ---------- ------------ ------- ------------
T. KENDALL HUNT (1) 2003 173,750 -- -- -- 125,000 -- --
Chairman and Chief 2002 152,627 42,500 -- -- 120,000 -- --
Executive Officer 2001 165,000 25,000 -- -- 90,000 -- --
JAN VALCKE (2) 2003 277,991 -- -- -- 100,000 -- --
President and Chief 2002 166,667 40,000 34,889 -- 50,000 -- --
Operating Officer 2001 155,000 36,600 8,597 -- 50,000 -- --
CLIFFORD K. BOWN (3) 2003 150,000 -- -- -- 75,000 -- --
Executive Vice 2002 50,600 -- -- -- 75,000 -- --
President, Chief
Financial Officer and
Secretary
(1) Mr. Hunt returned as CEO of the Company on November 20, 2002.
(2) Mr. Valcke was elected President and COO on November 20, 2002. Other Annual
Compensation primarily includes employment-related expenses billed by Mr.
Valcke as an independent contractor.
(3) Mr. Bown joined the Company as Executive Vice President and Chief Financial
Officer on August 19, 2002. He was appointed Secretary of the Company as of
October 21, 2002.
33
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth all options granted to the Named Executive
Officers during 2003.
INDIVIDUAL GRANTS
PERCENT OF
TOTAL
NUMBER OF OPTIONS/
SECURITIES SARS POTENTIAL REALIZABLE VALUE AT
UNDERLYING GRANTED TO ASSUMED ANNUAL RATES OF STOCK PRICE
OPTIONS/ EMPLOYEES EXERCISE OF APPRECIATION FOR OPTION TERM (2)
SARs GRANTED IN FISCAL BASE PRICE EXPIRATION -----------------------------------
NAME (1) YEAR ($/sh) DATE 5% ($) 10% ($)
---- ------------ ----------------- ----------- ---------- ------ -------
T. Kendall Hunt 125,000 21.7 % 0.72 1/08/13 56,601 143,437
Jan Valcke 100,000 17.4% 0.72 1/08/13 45,280 114,749
Clifford K. Bown 75,000 13.0% 0.76 1/08/13 36,004 91,242
(1) Vesting schedule is based on a time period of 36 months, with 6/36th of the
options vesting at the end of the first six months and 1/36th of the options
vesting each month thereafter on the last day of each month.
(2) The potential realizable value amounts shown illustrate the values that
might be realized upon exercise immediately prior to the expiration of their
term using five percent and ten percent appreciation rates as required to be
used in this table by the Securities and Exchange Commission, compounded
annually, and are not intended to forecast future appreciation, if any, of our
stock price. Additionally, these values do not take into consideration the
provisions of the options providing for nontransferability or termination of the
options following termination of employment. Therefore, the actual values
realized may be greater or less than the potential realizable values set forth
in the table.
AGGREGATED OPTION /SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION/SAR VALUES
The following table sets forth the aggregate value as of December 31,
2003 of unexercised stock options held by the Named Executive Officers. The
Named Executive Officers did not exercise any stock options during 2003 and the
relevant columns have, therefore, been omitted.
NUMBER OF SECURITIES UNDERLYING
UNEXERCISED OPTIONS/SARS AT FISCAL VALUE OF UNEXERCISED IN-THE-MONEY
YEAR-END OPTIONS/SARS AT FISCAL YEAR-END ($) (1)
---------------------------------- ---------------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
T. Kendall Hunt 348,858 171,142 135,365 173,635
Jan Valcke 222,971 110,779 89,583 130,417
Clifford K. Bown 56,250 93,750 74,132 129,618
(1) Market value of underlying securities is based on the closing price of the
Common Stock as reported on the Nasdaq National market on December 31, 2003
($2.34) minus the exercise price.
34
COMPENSATION OF DIRECTORS
The Compensation Committee of our Board of Directors reviews and sets
the salaries and incentive compensation for our executive officers. The
Compensation Committee reviews information relevant to Director compensation and
presents its recommendation for such compensation to the full Board for its
approval. The Compensation Committee also administers our stock option plan. In
its capacity as administrator of the stock option plan, the Compensation
Committee has authority to grant stock options to all employees and determine
the terms thereof. The Compensation Committee also makes recommendations to the
Board for its approval relative to options to be granted to non-employee Board
members. The members of the Compensation Committee for 2003 were: Forrest D.
Laidley, Michael P. Cullinane and Michael A. Mulshine.
Each of our directors received a quarterly cash payment of $3,750 in
connection with his service on the Board of Directors in 2003. Our directors are
also reimbursed for expenses incurred in connection with their attendance at
periodic Board meetings. In addition, non-employee directors are eligible to
receive stock option grants from time to time. In 2003, options to purchase
20,000 shares of our Common Stock were issued to each of Messrs. Cullinane,
Laidley, Mulshine, and Walter. Options to Messrs. Cullinane, Laidley and
Mulshine were at a per share exercise price of $0.72 and the options to Mr.
Walter were at a per share exercise price of $1.50.
EMPLOYMENT AGREEMENTS
Mr. Hunt's salary and bonus are determined pursuant to his employment
agreement dated November 20, 2002. Mr. Hunt's annual salary, any discretionary
bonus and stock options will be determined by the Compensation Committee for
each fiscal year of the Company during the employment period. In 2003, Mr. Hunt
received a base salary of $173,750 and 125,000 stock options. In the event Mr.
Hunt is terminated Without Cause, he quits for Good Reason, or he is terminated
or quits for Good Reason after a Change in Control (as the foregoing terms are
defined in his employment agreement), Mr. Hunt will continue to receive his base
pay and any applicable Incentive Compensation over a 24-month period. In the
event of such termination, Mr. Hunt has agreed to abide by several non-compete
restrictions. Mr. Hunt's current 2004 annual base salary is $225,000 with a
target bonus, if specific objectives are met, of $75,000.
Mr. Valcke's salary and bonus are determined pursuant to an Independent
Contractor Employment Agreement (the "Agreement") dated November 20, 2002. Mr.
Valcke's annual salary, his bonus and stock options will be determined by the
Compensation Committee for each fiscal year of the Company during the employment
period. In 2003, Mr. Valcke received $277,971 in base compensation and 100,000
stock options. Either Mr. Valcke or the Company have the option to terminate Mr.
Valcke's employment with or without cause, for any reason whatsoever, without
any breach of the Agreement by giving six (6) month's written notice. In the
event of such termination, Mr. Valcke has agreed to abide by various non-compete
and non-solicitation restrictions for up to 12 months following termination of
the Agreement. Mr. Valcke's 2004 base compensation is 260,000 Euros with a
target bonus, if specific objectives are met of 40,000 Euros.
Mr. Bown's salary and bonus are determined pursuant to his employment
agreement dated January 1, 2003. Mr. Bown's annual salary, any discretionary
bonus and stock options will be determined by the Compensation Committee for
each fiscal year of the Company during the employment period. In 2003, Mr. Bown
received a base salary of $150,000, no cash bonus, and 75,000 stock options. In
the event Mr. Bown is terminated Without Cause, he quits for Good Reason, or he
is terminated or quits for Good Reason after a Change in Control (as the
foregoing terms are defined in his employment agreement), Mr. Bown will continue
to receive his base pay and any applicable Incentive Compensation over a
12-month period. In the event of such termination, Mr. Bown has agreed to abide
by various non-compete restrictions. Mr. Bown's 2004 annual base salary is
$175,000 with a target bonus, if specific objectives are met of $50,000.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
For 2003, our Compensation Committee was comprised of Messrs. Laidley,
Cullinane and Mulshine. Forrest D. Laidley serves as a Director and was
previously our Secretary. Also, Mr. Laidley was previously a partner in the law
firm of Laidley & Porter, which firm performed various legal services for us.
Mr. Laidley and his former partners have made equity investments in us from time
to time through various private placements and are currently stockholders.
35
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth shares of our Common Stock that are
authorized to be issued under the Company's 1997 Stock Compensation Plan, as
amended and restated in 1999:
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION
BE ISSUED UPON EXERCISES EXERCISE PRICE OF PLANS (EXCLUDING
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED IN
Plan Category WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMN (a))
- ---------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ---------------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 2,962,875 $ 2.54 3,122,182
security holders
Equity compensation
plans not approved by
security holders none not applicable not applicable
The following table sets forth certain information with respect to the
beneficial ownership of our Common Stock as of March 25, 2004 for each person or
entity who is known to us to beneficially own five percent or more of the Common
Stock. For purposes of the table, a person or group of persons is deemed to have
beneficial ownership of any shares as of a given date that such person has the
right to acquire within 60 days after such date.
NAME AND ADDRESS OF AMOUNT AND NATURE OF
BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
------------------- -------------------- ----------------
T. Kendall Hunt
1901 S. Meyers Road
Ste. 210 10,308,361(1) 32.767%
Oakbrook Terrace, IL 60181
Ubizen N.V.
Philipssite 5
B-3001 1,982,145 6.300%
Leuven Belgium
(1) Includes 200,000 shares held in the T. Kendall Hunt Charitable Remainder
Trust and 1,111,300 shares held by Barbara J. Hunt, Mr. Hunt's spouse, as to
which shares Mr. Hunt disclaims beneficial ownership.
36
The table below sets forth certain information with respect to the
beneficial ownership of our Common Stock as of March 31, 2004 for (i) each of
our directors, (ii) each of our named executive officers, and (iii) all
directors and executive officers as a group. The persons named in the table have
sole voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them unless otherwise indicated. For purposes of
the table, a person or group of persons is deemed to have beneficial ownership
of any shares as of a given date which such person has the right to acquire
within 60 days after such date.
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP (1) PERCENT OF CLASS
- ------------------------------------ ------------------------ ----------------
T. Kendall Hunt
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181 10,308,361 (2) 32.767%
Jan Valcke
Koningin Astridlaan 164
B-1780 Wemmel, Belgium 256,749 0.816%
Forrest D. Laidley
1901 S. Meyers Road
Ste. 210 97,000 0.308%
Oakbrook Terrace, IL 60181
Michael P. Cullinane
1901 S. Meyers Road
Ste. 210 77,000 0.245%
Oakbrook Terrace, IL 60181
Michael A. Mulshine
1901 S. Meyers Road
Ste. 210 106,400 0.338%
Oakbrook Terrace, IL 60181
John R. Walter
1901 S. Meyers Road
Ste. 210 25,000 0.079%
Oakbrook Terrace, IL 60181
Cliff Bown
1901 S. Meyers Road
Ste. 210 82,083 0.261%
Oakbrook Terrace, IL 60181
All Executive Officers and Directors
as a Group
(6 persons) 10,952,593 34.814%
(1) The number of shares beneficially owned by each director and executive
officer is determined under rules promulgated by the Securities and Exchange
Commission, and the information is not necessarily indicative of beneficial
ownership for any other purpose. Under such rules, beneficial ownership includes
any shares as to which the individual has sole or shared voting power or
investment power and also any shares that the individual has the right to
acquire within 60 days after March 31, 2004 through the exercise of any stock
option or other right. The inclusion herein of such shares, however, does not
constitute an admission that the named stockholder is a direct or indirect
beneficial owner of such shares. Unless otherwise indicated, each person or
entity named in the table has sole voting power and investment power (or shares
such power with his or her spouse) with respect to all shares of capital stock
listed as owned by such person or entity.
(2) Includes 200,000 shares held in the T. Kendall Hunt Charitable Remainder
Trust and 1,111,300 shares held by Barbara J. Hunt, Mr. Hunt's spouse, as to
which shares Mr. Hunt disclaims beneficial ownership.
37
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In 2002, the Company loaned Belgian employees who received stock
options in 1999 and 2000, 141,895 Euros to pay taxes assessed on those options
by the Belgian Government. Even though stock options granted to all employees
were granted at prices equal to the fair market value of the Common Stock on the
date of the grant, Belgian employees who were recipients of stock options were
assessed taxes based on the value determined under Belgian tax legislation dated
March 26, 1999. The total amounts advanced in 2002 were based on each
recipient's specific tax assessment. Due to the uncertainty of collecting the
amounts loaned to the employees, the notes were fully reserved for as of
December 31, 2003 and 2002.
In July 2003, the Company sold its VACMAN Enterprise business unit
(VACMAN) to SecureD Services, Inc. (SSI), a then newly organized company in
which T. Kendall Hunt has a 19% equity ownership interest and is one of three
directors on its board. The transaction was approved by all of the independent
directors of the Company. The Company received a $1.1 million senior secured
promissory note and $2.0 million of convertible preferred stock from SSI in
exchange for the VACMAN assets. The note is payable in 36 monthly installments
and bears interest at 6% per annum. The preferred stock pays a 6% cumulative
stock dividend quarterly, and may be converted into SSI common stock on a
share-for-share basis in phases commencing July 1, 2005. An independent
valuation firm valued the transaction at approximately $1.6 million. SSI has
since merged with a public company and its common stock is traded on the OTC
Bulletin Board.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following sets forth the amount of fees paid to our registered
public accounting firm, KPMG LLP, for services rendered in 2003 and 2002:
AUDIT FEES: The aggregate fees billed by KPMG LLP for professional
services rendered for the audit of the Company's annual financial statements,
the reviews of the financial statements included in the Company's quarterly
reports on Form 10-Q, and services normally provided by the independent auditor
in connection with statutory and regulatory filings were $221,050 for the fiscal
year ended December 31, 2003, and $166,046 for the fiscal year ended December
31, 2002.
AUDIT RELATED FEES: The aggregate fees billed by KPMG LLP for assurance
and related services related to the performance or review of the Company's
financial statements and not described above under "Audit Fees" were
approximately $39,450 for the 2003 fiscal year. There were no audit-related fees
billed for the 2002 fiscal year. In 2003, the audit-related services included
audits of the carve-out financial statements for the VACMAN Enterprise business
as required under the agreement to sell the business unit.
TAX FEES: The aggregate fees billed by KPMG LLP for tax compliance and
tax advice were approximately $83,220 for the 2003 fiscal year and approximately
$158,980 for the 2002 fiscal year. The fees for 2003 primarily related to the
filing of the Company's tax returns. The fees for 2002 included the costs of
filing the Company's tax returns and the costs associated with the protest of
the Belgian tax assessment.
ALL OTHER FEES: The aggregate fees billed by KPMG LLP for products and
services other than those described above were $ 3,500 for the 2002 fiscal year
and related to a review of selected executives' expense reports. There were no
such fees in 2003.
It is currently the policy of the Audit Committee of the Board of
Directors to pre-approve all services rendered by KPMG LLP. With the exception
of the Tax Fees, which primarily relate to the filing of the fiscal 2002 tax
returns, the Audit Committee had pre-approved all of the above fees in 2003.
PART IV
ITEM 15 - 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'
38
report, are included on pages F-1 through F-23 of this Form 10-K:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Operations for the Years Ended December 31,
2003, 2002 and 2001
Consolidated Statements of Comprehensive Income (Loss) for the Years
Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Stockholders' Equity (Deficit) for the Years
Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31,
2003, 2002 and 2001
Notes to Consolidated Financial Statements
(2) The following consolidated financial statement schedule of the
Company is included in this Form 10-K:
- Schedule II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because such
schedules are not required or the information required has been presented in the
aforementioned consolidated financial statements.
(3) The following exhibits are filed with this Form 10-K or
incorporated by reference as set forth at the end of the list of exhibits:
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
+3.1 Certificate of Incorporation of Registrant, as amended.
++3.2 Bylaws of Registrant, as amended and restated.
4.1 Intentionally Omitted.
+4.2 Specimen of Registrant's Common Stock Certificate.
4.3 Intentionally Omitted.
+4.4 Form of Letter of Transmittal and Release.
+4.5 Form of Registrant's Warrant Agreement.
+4.6 Form of Registrant's Option Agreement.
+4.7 Form of Registrant's Convertible Note Agreement.
+10.1 Netscape Communications Corporation OEM Software Order Form dated March
18, 1997 between VASCO Data Security, Inc. and Netscape Communications
Corporation.**
+10.2 License Agreement between VASCO Data Security, Inc. and SHIVA
Corporation effective June 5, 1997.**
+10.3 Heads of Agreement between VASCO Data Security International, Inc.,
VASCO Data Security Europe S.A., Digiline International Luxembourg,
Digiline S.A., Digipass S.A., Dominique Colard and Tops S.A. dated May
13, 1996.
39
+10.4 Agreement relating to additional terms and conditions to the Heads of
Agreement dated July 9, 1996, among the parties listed in Exhibit 10.3.
+10.5 Agreement between VASCO Data Security International, Inc., VASCO Data
Security Europe SA/NV, Mario Houthooft and Guy Denudt dated March 1,
1996.
+10.6 Asset Purchase Agreement dated as of March 1996 by and between Lintel
Security SA/NV and Lintel SA/NV, Mario Houthooft and Guy Denudt.
+10.7 Management Agreement dated January 31, 1997 between LINK BVBA and VASCO
Data Security NV/SA (concerning services of Mario Houthooft).
+10.8 Sublease Agreement by and between VASCO Data Security International,
Inc. and APL Land Transport Services, Inc. dated as of August 29, 1997.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
+10.10 Lease Agreement by and between TOPS S.A. and Digipass S.A. effective
July 1, 1996.
+10.11 Lease Agreement by and between Perkins Commercial Management Company,
Inc. and VASCO Data Security, Inc. dated November 21, 1995.
+10.12 Asset Purchase Agreement by and between VASCO Data Security
International, Inc. and Wizdom Systems, Inc. dated August 20, 1996.
+10.13 1997 VASCO Data Security International, Inc. Stock Option Plan, as
amended.
+10.14 Distributor Agreement between VASCO Data Security, Inc. and Hucom, Inc.
dated June 3, 1997.**
+10.15 Non-Exclusive Distributor Agreement by and between VASCO Data Security,
Inc. and Concord-Eracom Nederland BV dated May 1, 1994.**
+10.16 Banque Paribas Belgique S. A. Convertible Loan Agreement for $3.4
million.
+10.17 Pledge Agreement dated July 15, 1997 by and between T. Kendall Hunt and
Banque Paribas Belgique S.A.
+10.18 Engagement Letter between Banque Paribas S.A. and VASCO Data Security
International, Inc. dated June 20, 1997, as amended.
+10.19 Financing Agreement between Generale Bank and VASCO Data Security
International, Inc. dated as of June 27, 1997.
+10.20 Letter Agreement between Generale Bank and VASCO Data Security
International, Inc. dated June 26, 1997.
+10.21 Form of Warrant dated June 16, 1997 (with Schedule).
+10.22 Form of Warrant dated October 31, 1995 (with Schedule).
+10.23 Form of Warrant dated March 7, 1997 (with Schedule).
+10.24 Form of Warrant dated August 13, 1996 (with Schedule).
+10.25 Form of Warrant dated June 27, 1996 (with Schedule).
+10.26 Form of Warrant dated June 27, 1996 (with Schedule).
40
+10.27 Convertible Note in the principal amount of $500,000.00, payable to
Generale de Banque dated July 1, 1997 (with Schedule).
+10.28 Agreement by and between VASCO Data Security NV/SA and S.I.
Electronics Limited effective January 21, 1997.**
+10.29 Agreement effective May 1, 1993 by and between Digipass s.a. and
Digiline s.a.r.l.
+10.30 VASCO Data Security, Inc. purchase order issued to National Electronic
& Watch Co. LTD. **
+10.31 VASCO Data Security, Inc. purchase order issued to Micronix Integrated
Systems.**
+10.32 Agreement between Registrant and VASCO Data Security International,
Inc. dated as of August 25, 1997.
+10.33 Convertible Note dated June 1, 1996 made payable to Mario Houthooft in
the principal amount of $373,750.00.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
+10.34 Convertible Note dated June 1, 1996 made payable to Guy Denudt in the
principal amount of $373,750.00.
+10.35 Osprey Partners Warrant (and Statement of Rights to Warrant and Form of
Exercise) issued June 1, 1992.
+10.36 Registration Rights Agreement dated as of October 19, 1995 between
certain purchasing shareholders and VASCO Data Security International,
Inc.
+10.37 First Amendment to Registration Rights Agreement dated July 1, 1996.
+10.38 Second Amendment to Registration Rights Agreement dated March 7, 1997.
+10.39 Purchase Agreement by and between VASCO Data Security International,
Inc. and Kyoto Securities Ltd.
+10.40 Convertible Note dated May 28, 1996 payable to Kyoto Securities, Ltd.
in principal amount of $5 million.
+10.41 Amendment to Purchase Agreement and Convertible Note by and between
VASCO Data Security International, Inc. and Kyoto Securities, Ltd.
+10.42 Executive Incentive Compensation Plan.
+10.43 Letter for Credit granted by Generale de Banque to Digipass SA dated
January 27, 1997.
++10.44 License Agreement dated as of March 25, 1998 by and between VASCO Data
Security International, Inc., for itself and its subsidiaries, and
Lernout & Hauspie Speech Products N.V.
++10.45 Loan Agreement dated as of March 31, 1998 by and between Lernout &
Hauspie Speech Products N.V. and VASCO Data Security International,
Inc.
++10.46 Convertible Note dated April 1, 1998 payable to Lernout & Hauspie
Speech Products N.V. in the principal amount of $3 million.
#10.47 Amendment I dated as of December 31, 1998 to the License Agreement
dated as of March 25, 1998 by and between VASCO Data Security
International, Inc., for itself and its subsidiaries, and Lernout &
Hauspie Speech Products N.V.
41
10.48 Acquisition of Identikey, Ltd. (Incorporated by reference - Form 8-K
filed March 29, 2001.)
10.49 Agreement with Artesia Bank to revise the terms of the $3.4 million
convertible loan. (Incorporated by reference - Form 8-K filed August
9, 2001.)
## 10.50 Employment agreement with T. Kendall Hunt
## 10.51 Independent Contractor Employment agreement with Jan Valcke
## 10.52 Employment agreement with Clifford Bown
## 10.53 Indemnification Agreement with T. Kendall Hunt
10.54 Code of Ethics
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
21 Subsidiaries of Registrant. (Incorporated by reference - Form 10-K
filed April 2, 2001.)
23 Consent of KPMG LLP.
31.1 Statement Under oath of Principal Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, dated March 29, 2004.
31.2 Statement Under oath of Principal Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, dated March 29, 2004.
32.1 Statement Under oath of Principal Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, dated March 29, 2004.
32.2 Statement Under oath of Principal Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, dated March 29, 2004.
- --------------------------
+ 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.
## Incorporated by reference to the Registrant's Annual Report on Form
10-K, originally filed with the Securities and Exchange Commission on
March 31, 2003.
** 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
(1) On October 24, 2003, the Company filed a Form 8K covering items 12,
7, and 9 that included:
42
- A copy of the press release dated October 23, 2004 providing a
financial update of the Company for the third quarter and
nine-months ended September 30, 2003, and
- The text of the script for the earnings conference call held
on October 23. 2003.
(2) On February 13, 2004, the Company filed a Form 8K covering items
12, 7, and 9 that included:
- A copy of the press release dated February 12, 2004 providing
a financial update of the Company for the fourth quarter and
full-year ended December 31, 2003, and
- The text of the script for the earnings conference call held
on February 12, 2004.
43
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VASCO DATA SECURITY INTERNATIONAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
FINANCIAL STATEMENTS
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002 F-3
Consolidated Statements of Operations for the Years ended
December 31, 2003, 2002 and 2001 F-4
Consolidated Statements of Comprehensive Income (Loss) for the Years ended
December 31, 2003, 2002 and 2001 F-5
Consolidated Statements of Stockholders' Equity (Deficit) for the Years ended
December 31, 2003, 2002 and 2001 F-6
Consolidated Statements of Cash Flows for the Years ended
December 31, 2003, 2002 and 2001 F-7
Notes to Consolidated Financial Statements F-8
FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule is included herein:
Schedule II - Valuation and Qualifying Accounts F-24
All other financial statement schedules are omitted because they are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
F-1
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, 2003 and 2002 and the related consolidated statements of
operations, comprehensive income (loss), stockholders' equity (deficit), and
cash flows for each of the years in the three-year period ended December 31,
2003. 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated 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, 2003 and 2002,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2003, 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.
As discussed in Note 1 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill
and other Intangible Assets", in 2002.
/s/ KPMG LLP
Chicago, Illinois
February 11, 2004
F-2
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2003 2002
------------ ------------
ASSETS
Current assets:
Cash $ 4,817,114 $ 2,615,935
Accounts receivable, net of allowance for doubtful accounts
of $470,471 and $461,129 in 2003 and 2002, respectively 2,522,670 2,870,533
Inventories, net 1,074,647 1,579,125
Prepaid expenses 476,353 394,867
Assets of discontinued operations - 155,661
Deferred income taxes 69,881 -
Other current assets 696,993 119,687
------------ ------------
Total current assets 9,657,658 7,735,808
Property and equipment
Furniture and fixtures 1,940,399 1,485,140
Office equipment 2,221,220 1,926,553
------------ ------------
4,161,619 3,411,693
Accumulated depreciation (3,279,527) (2,255,693)
------------ ------------
Net property and equipment 882,092 1,156,000
Intangible assets, net of accumulated amortization of $4,084,587
and $3,545,104 in 2003 and 2002, respectively 1,378,362 1,910,504
Goodwill 249,967 249,967
Note receivable and investment in SSI 1,132,499 -
Other assets 82,602 81,161
------------ ------------
TOTAL ASSETS $ 13,383,180 $ 11,133,440
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 3,589,645
Accounts payable 1,697,950 1,849,572
Liabilities related to discontinued operations - 107,643
Deferred revenue 386,446 644,330
Accrued wages and payroll taxes 1,514,729 1,234,734
Other accrued expenses 840,480 896,438
------------ ------------
Total current liabilities 4,439,605 8,322,362
Stockholders' equity :
Series C Convertible Preferred Stock, $.01 par value - 500,000 shares
authorized; 150,000 shares issued and outstanding in 2002 - 9,108,066
Series D Convertible Preferred Stock, $10,000 par value - 500,000 shares
authorized; 800 shares issued and outstanding in 2003 5,785,829 -
Common stock, $.001 par value - 75,000,000 shares authorized;
30,425,284 shares issued and outstanding in 2003
28,389,484 shares issued and outstanding in 2002 30,425 28,389
Additional paid-in capital 47,167,362 36,763,330
Accumulated deficit (43,693,494) (42,608,077)
Accumulated other comprehensive income (loss) -
cumulative translation adjustment (346,547) (480,630)
------------ ------------
Total stockholders' equity 8,943,575 2,811,078
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 13,383,180 $ 11,133,440
============ ============
F-3
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Net revenues $ 22,865,942 $ 17,370,003 $ 22,689,975
Cost of goods sold 9,010,157 7,159,794 10,340,173
------------ ------------ ------------
Gross profit 13,855,785 10,210,209 12,349,802
------------ ------------ ------------
Operating costs:
Sales and marketing (exclusive of $40,900, $(11,719) and 6,987,324 7,955,998 9,696,007
$15,065 for 2003, 2002 and 2001, respectively, reported
below as non-cash compensation (recovery))
Research and development 2,281,056 2,340,910 3,274,070
General and administrative (exclusive of $(38,397) and 3,423,413 4,542,103 6,147,937
$34,490 for 2002 and 2001, respectively,
reported below as non-cash compensation (recovery))
Non-cash compensation (recovery) 40,900 (50,116) 49,555
Restructuring expenses - 319,743 3,970,427
------------ ------------ ------------
Total operating costs 12,732,693 15,108,638 23,137,996
------------ ------------ ------------
Operating income (loss) from continuing operations 1,123,092 (4,898,429) (10,788,194)
Interest income (expense), net (80,163) (269,867) 774,894
Other income, net 114,730 15,375 283,861
------------ ------------ ------------
Income (loss) before income taxes 1,157,659 (5,152,921) (9,729,439)
Provision (benefit) for income taxes 396,936 140,446 (12,782)
------------ ------------ ------------
Net income (loss) from continuing operations 760,723 (5,293,367) (9,716,657)
Discontinued operations:
Income (loss) from discontinued operations, net of tax 638,339 754,372 (2,317,313)
Gain on sale of discontinued operations, net of tax 1,356,632 - -
------------ ------------ ------------
Net income (loss) 2,755,694 (4,538,995) (12,033,970)
Preferred stock beneficial conversion option (3,720,000) - -
Preferred stock accretion and dividends (750,548) (1,163,984) (1,163,984)
------------ ------------ ------------
Net loss available to common shareholders $ (1,714,854) $ (5,702,979) $(13,197,954)
============ ============ ============
Basic and diluted net income (loss) per common share:
Income (loss) from continuing operations $ (0.13) $ (0.22) $ (0.39)
Income (loss) from discontinued operations 0.07 0.02 (0.08)
------------ ------------ ------------
Net loss $ (0.06) $ (0.20) $ (0.47)
============ ============ ============
Weighted average common shares outstanding:
Basic 29,269,992 28,347,573 28,168,685
============ ============ ============
Dilutive 29,269,992 28,347,573 28,168,685
============ ============ ============
See accompanying notes to consolidated financial statements.
F-4
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the Years Ended December 31,
-------------------------------------------
2003 2002 2001
------------ ------------ ------------
Net income (loss) $ 2,755,694 $ (4,538,995) $(12,033,970)
Other comprehensive income (loss) -
cumulative translation adjustment 134,083 (31,357) (153,127)
------------ ------------ ------------
Comprehensive income (loss) $ 2,889,777 $ (4,570,352) $(12,187,097)
============ ============ ============
See accompanying notes to consolidated financial statements.
F-5
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Preferred Stock Common Stock
------------------------ -------------------------
Description Shares Amount Shares Amount
----------- -------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 2000 ......... 150,000 $ 6,780,098 27,866,583 $ 27,867
======== ============ ========== ============
Net loss ............................. - - - -
Foreign currency translation
adjustment ........................ - - - -
Exercise of stock options ............ - - 25,633 26
Exercise of stock warrants ........... - - 3,929 3
Stock issued for acquisition ......... - - 366,913 367
Preferred stock accretion ............ - 1,163,984 - -
Non-cash compensation ................ - - - -
-------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 2001 ......... 150,000 $ 7,944,082 28,263,058 $ 28,263
======== ============ ========== ============
Net loss ............................. - - - -
Foreign currency translation
adjustment ........................ - - - -
Stock issued for acquisition ......... - - 126,426 126
Preferred stock accretion ............ - 1,163,984 - -
Non-cash compensation ................ - - - -
-------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 2002 ......... 150,000 $ 9,108,066 28,389,484 $ 28,389
======== ============ ========== ============
Net income ........................... - - - -
Foreign currency translation
adjustment ........................ - - - -
Exercise of stock options ............ - - 35,800 36
Preferred stock accretion ............ - 629,437 - -
Purchase and redemption of series
C preferred stock and warrants .... (150,000) (9,737,503) 2,000,000 2,000
Issuance of series D preferred
stock ............................. 800 5,785,829 - -
Dividend payable ..................... - - - -
Non-cash compensation ................ - - - -
-------- ------------ ---------- ------------
BALANCE AT DECEMBER 31, 2003 ......... 800 $ 5,785,829 30,425,284 $ 30,425
======== ============ ========== ============
Additional Accumulated Other Total
Paid-In Accumulated Comprehensive Stockholders'
Description Capital Deficit Income (Loss) Equity (Deficit)
----------- ------- ------- ------------ ----------------
BALANCE AT DECEMBER 31, 2000 ......... $ 36,871,200 $(26,035,112) $ (296,146) $ 17,347,907
============ ============ ============ ============
Net loss ............................. - (12,033,970) - (12,033,970)
Foreign currency translation
adjustment ........................ - - (153,127) (153,127)
Exercise of stock options ............ 15,638 - - 15,664
Exercise of stock warrants ........... 17,690 - - 17,693
Stock issued for acquisition ......... 1,902,999 - - 1,903,366
Preferred stock accretion ............ (1,163,984) - - --
Non-cash compensation ................ 49,555 - - 49,555
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2001 ......... $ 37,693,098 $(38,069,082) $ (449,273) $ 7,147,088
============ ============ ============ ============
Net loss ............................. - (4,538,995) - (4,538,995)
Foreign currency translation
adjustment ........................ - - (31,357) (31,357)
Stock issued for acquisition ......... 284,332 - - 284,458
Preferred stock accretion ............ (1,163,984) - - -
Non-cash compensation ................ (50,116) - - (50,116)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2002 ......... $ 36,763,330 $(42,608,077) $ (480,630) $ 2,811,078
============ ============ ============ ============
Net income ........................... - 2,755,694 - 2,755,694
Foreign currency translation
adjustment ........................ - - 134,083 134,083
Exercise of stock options ............ 63,381 - - 63,417
Preferred stock accretion ............ (629,437) - - -
Purchase and redemption of series
C preferred stock and warrants .... 5,735,503 - - (4,000,000)
Issuance of series D preferred
stock ............................. 5,193,685 (3,720,000) - 7,259,514
Dividend payable ..................... - (121,111) - (121,111)
Non-cash compensation ................ 40,900 - - 40,900
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 2003 ......... $ 47,167,362 $(43,693,494) $ (346,547) $ 8,943,575
============ ============ ============ ============
See accompanying notes to consolidated financial statements
F-6
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years ended December 31,
---------------------------------------------
2003 2002 2001
------------- ----------- ------------
Cash flows from operating activities:
Net income (loss) from continuing operations $ 760,723 $(5,293,367) $ (9,716,657)
Adjustments to reconcile net income (loss) from continuing operations
to net cash provided by (used in) operating activities:
Depreciation and amortization 1,061,018 1,188,140 5,388,468
Deferred tax expense (benefit) (69,881) 83,000 -
Gain on sale of fixed assets - - (15)
Non-cash compensation expense 40,900 (50,116) 49,555
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable, net 697,373 1,284,291 466,694
Inventories, net 669,951 666,205 (943,269)
Prepaid expenses (22,248) 27,597 70,811
Other current assets (185,391) 560,952 (76,146)
Accounts payable (369,990) (1,699,886) 363,851
Deferred revenue (295,900) 27,663 411,662
Accrued wages and payroll taxes 20,986 325,920 198,915
Accrued expenses (226,370) (722,207) (1,207,076)
Net cash provided by (used in) discontinued operations 327,664 691,424 (1,392,546)
------------- ------------ ------------
Net cash provided by (used in) operations 2,408,835 (2,910,384) (6,385,753)
------------- ------------ ------------
Cash flows from investing activities:
Acquisition of Identikey, Ltd. (7,341) (23,362) 141,156
Other assets 2,593 (50,952) -
Additions to property and equipment (124,204) (15,961) (874,290)
Disposals of property, plant and equipment, net 140,257 - -
Payments received on note receivable 116,382 - -
------------- ----------- ------------
Net cash provided by (used in) investing activities 127,687 (90,275) (733,134)
------------- ----------- ------------
Cash flows from financing activities:
Repayment of debt (3,589,645) (236,954) (299,236)
Purchase and retirement of Series C preferred stock (4,000,000) - -
Proceeds from issuance of Series D preferred stock, net of issuance costs 7,259,515 - -
Proceeds from exercise of stock options and warrants 63,417 - 33,357
------------- ----------- ------------
Net cash used in financing activities (266,713) (236,954) (265,879)
Effect of exchange rate changes on cash (68,630) (488,892) (105,439)
Net increase (decrease) in cash 2,201,179 (3,726,505) (7,490,205)
Cash, beginning of year 2,615,935 6,342,440 13,832,645
------------- ----------- ------------
Cash, end of year $ 4,817,114 $ 2,615,935 $ 6,342,440
============= =========== ============
See accompanying notes to consolidated financial statements.
F-7
VASCO DATA SECURITY INTERNATIONAL, INC.
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. VASCO has operations in
Belgium, Australia, Singapore and the United States.
Principles of Consolidation
The consolidated financial statements include the accounts of VASCO
Data Security International, Inc. and its wholly 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 aggregating $146,000, $77,000 and
$183,000 are included in other income (expense) for 2003, 2002 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.
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. Reserves are recorded for inventory when the
carrying cost of the inventory may not be recovered through subsequent sale of
the inventory.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the related
assets ranging from three to seven years. Additions and improvements are
capitalized, while expenditures for maintenance and repairs are charged to
operations as incurred. Gains or losses resulting from sales or retirements are
recorded as incurred, at which time related costs and accumulated depreciation
are removed from the accounts.
Research and Development Costs
Costs for research and development, principally the design and
development of hardware and software prior to the determination of technological
feasibility, are expensed as incurred on a project-by-project basis. The
Company's research and development costs were $2,281,000, $2,341,000 and
$3,274,000 for 2003, 2002 and 2001, respectively.
F-8
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 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, 2003, 2002 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
At December 31, 2003 and 2002 the Company's financial instruments were
accounts receivable, notes receivable, accounts payable and accrued liabilities.
The estimated fair value of The Company's financial instruments has been
determined by 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, 2003 and 2002.
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.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company assesses the recoverability of long-lived assets and
certain intangibles by comparing the carrying amount of the asset to a projected
discounted cash flow expected to result and eventual disposition of the asset.
If an asset is considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying value of the asset exceeds the fair
value of the asset.
Valuation of Investment in Secured Services, Inc.
The Company received from Secured Services, Inc. ("SSI") preferred
stock and a note receivable as consideration for assets of the VACMAN Enterprise
business unit. An independent valuation firm established the initial value of
the consideration received from SSI. On an ongoing basis, the Company reviews
information made available by SSI through its public filings and evaluates that
information within the context of the assumptions made by the independent
valuation firm to determine if a reduction in the value of the investment in SSI
is required. At December 31,2003, there was no reduction in the carrying value
of the Company's investment in SSI.
F-9
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Goodwill and Other Intangibles
The Company accounts for goodwill and other intangible assets in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets". This
statement replaced the requirements to amortize intangible assets with
indefinite lives and goodwill with a requirement for an impairment test. SFAS
142 also established requirements for identifiable intangible assets, which
included customer lists and proprietary technology. As a result, on January 1,
2002, VASCO reclassified $320,507 of gross intangible assets, $55,650 net, to
goodwill. Operating income for the twelve months ended December 31, 2001
included $183,291 of amortization of goodwill and other intangible assets that
are not included in 2002 results, because of the implementation of SFAS No. 142.
Had the Company implemented SFAS 142 on January 1, 2001, net loss available to
common shareholders would have been $13,014,663 and loss per common share would
have been $0.46.
The Company assesses the impairment of intangible assets and goodwill
each year-end and whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. The Company completed its last review
during December 2003. 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.
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, the Company measures 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.
Stock-Based Compensation
At December 31, 2003, the Company had a stock-based employee
compensation plan, which is described more fully in Note 8. The Company accounts
for the plan under the recognition and measurement principles of APB Opinion No.
25, "Accounting for Stock Issued to Employees", and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying Common Stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation", to stock based employee compensation:
For the Years ended December 31,
------------------------------------------------
2003 2002 2001
------------- ------------- ------------
Net loss available to common
shareholders as reported.......................................... $ (1,714,854) (5,702,979) $(13,197,954)
Add: Total stock-based employee compensation
determined under fair value based methods for
all awards, net of tax............................................ (1,015,743) (1,005,450) (614,084)
------------ ------------- ------------
Pro forma net loss.............................................. $ (2,730,597) $ (6,708,429) $(13,812,038)
============ ============= ============
Net loss per common share-basic and diluted:
As reported....................................................... $ (0.06) $ (0.20) $ (0.47)
Pro forma......................................................... $ (0.09) $ (0.24) $ (0.49)
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
F-10
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
used for grants in 2003, 2002 and 2001: dividend yield of 0%; expected
volatility of 120%, 118%, 119%; risk free interest rates ranging from 3.40% to
6.80%; and expected lives ranging from 1 to 5 years.
Loss Per Common Share
Basic earnings per share are based on the weighted average number of
shares outstanding and exclude 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 effect diluted
earnings per share in the future that were not included in the computation of
diluted earnings per share because their effect was anti-dilutive were as
follows:
2003 2002 2001
--------- --------- ---------
Stock options ........................................................ 2,926,375 4,609,000 3,280,837
Warrants ............................................................. 600,000 1,239,747 1,377,251
Convertible term loan ................................................ - 453,333 453,333
Convertible preferred stock .......................................... 4,000,000 1,052,632 1,052,632
--------- --------- ---------
Total ............................................................ 7,526,375 7,354,712 6,164,053
========= ========= =========
The amounts included above for the convertible preferred stock for 2002
and 2001 reflect the number of shares that would be issued if converted prior to
the mandatory conversion date. See Note 7 for information related to the
mandatory conversion.
Additionally, the net loss applicable to common stockholders for the
years ended December 31, 2003, 2002 and 2001 would have been decreased by adding
back interest expense related to the convertible term loan of approximately
$153,000, $204,000 and $149,000, respectively, and the net loss would have been
further decreased by adding back the beneficial conversion option, accretion and
accrued dividends related to the convertible preferred stock of $4,470,548 in
2003, and $1,163,984 in both 2002 and 2001.
Reclassifications
Certain prior year amounts in the consolidated financial statements
have been reclassified to conform to the 2003 presentation.
Overhead allocations ceased in the third quarter of fiscal 2002 because
their basis for allocation was no longer appropriate nor was it representative
of the operational activities of the department affected. For the fiscal years
2002 and 2001, net allocations from the Company's general and administrative and
the research and development cost centers have been reclassified from sales and
marketing to their original cost centers.
F-11
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 2 - GOODWILL AND OTHER INTANGIBLES
Intangible asset data as of December 31, 2003 is as follows:
Gross Carrying Accumulated
Amount Amortization
-------------- ------------
Amortized intangible assets -
Capitalized technology............................................ $ 5,462,949 $ 4,084,587
Unamortized intangible assets - Goodwill.............................. $ 1,222,898 $ 972,931
Aggregate amortization expense........................................ $ 539,483
Estimated amortization expense for the years ended:
December 31, 2004.................................................. $ 326,326
December 31, 2005.................................................. 326,314
December 31, 2006.................................................. 326,314
December 31, 2007.................................................. 326,314
December 31, 2008.................................................. 73,095
At December 31, 2003 and 2002, ending balances of goodwill and other
intangibles, net of amortization are as follows:
2003 2002
---------- -----------
Goodwill.............................................................. $ 249,967 $ 249,967
Capitalized Technology................................................ 1,378,362 1,874,862
Customer Lists and Other.............................................. - 35,642
---------- -----------
Total.............................................................. $1,628,329 $ 2,160,471
========== ===========
NOTE 3 - ACQUISITIONS
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 were 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, 2001.
2001
------------
Net revenues ............................................... $ 22,689,975
Net loss ................................................... (13,084,785)
Preferred stock accretion .................................. (1,163,984)
Basic and diluted net loss per common share ................ $ (0.50)
============
Weighted average common shares outstanding ................. 28,257,387
============
F-12
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The remaining 10% of Identikey has been acquired at various times with
the final purchase completed in January 2003. During 2002, in exchange for the
shares not obtained in the initial transaction, the Company issued 126,426
shares of Common Stock and paid $23,362 in cash. Intangible assets related to
the purchase of the Identikey shares in 2002 were valued at $274,563 and are
being amortized over the same period as the intangible assets identified in the
initial transaction.
NOTE 4 - INVENTORIES
Inventories, net of valuation allowance of $252,354 and $111,566 at
December 31, 2003 and 2002, respectively, are comprised of the following:
December 31,
-------------------------
2003 2002
---------- -----------
Component parts .............................................. $ 277,065 $ 772,523
Work-in-process and finished goods ........................... 797,582 806,602
---------- -----------
Total .................................................... $1,074,647 $1,579,125
========== ===========
NOTE 5 - OTHER ACCRUED EXPENSES
Accrued expenses are comprised of the following:
December 31,
--------------------
2003 2002
-------- --------
Accrued interest ........................................... $ - $ 56,745
Restructuring reserve ...................................... 134,368 368,574
Other accrued expenses ..................................... 706,112 471,119
-------- --------
Total .................................................. $840,480 $896,438
======== ========
NOTE 6 - INCOME TAXES
At December 31, 2003, the Company has United States net operating loss
carryforwards approximating $27,650,000 and foreign net operating loss
carryforwards approximating $4,070,000 . Such losses are available to offset
future taxable income in the respective jurisdictions and expire in varying
amounts beginning in 2004 and continuing through 2023. In addition, if certain
substantial changes in the Company's ownership were deemed to have occurred,
there would be an annual limitation on the amount of the U.S. carryforwards that
could be utilized.
Income (loss) before income taxes was generated in the following
jurisdictions:
For the Years Ended December 31,
---------------------------------------------
2003 2002 2001
------------ ----------- ------------
Domestic:
Continuing operations........................... $ (1,988,802) $(4,261,016) $ (6,878,033)
Discontinued operations......................... 1,994,971 754,372 (2,317,313)
------------ ----------- ------------
Total domestic................................ 6,169 (3,506,644) (9,195,346)
Foreign............................................ 3,146,461 (891,905) (2,851,406)
------------ ----------- ------------
Total........................................... $ 3,152,630 $(4,398,549) $(12,046,752)
============ =========== ============
F-13
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The provision (benefit) for income taxes consists of the following:
For the Years Ended December 31,
-----------------------------------------
2003 2002 2001
------------ --------- --------
Current:
Federal ................................. $ - $ - $ -
State ................................... - - -
Foreign ................................. 466,817 57,446 (12,872)
Deferred:
Federal ................................. $ - $ 83,000 $ -
State ................................... - - -
Foreign ................................. (69,881) - -
------------ --------- --------
Total ................................ $ 396,936 $ 140,446 $(12,872)
============ ========= ========
The differences between income tax provision (benefit) computed using
the statutory federal income tax rate of 35% and the provision (benefit) for
income taxes reported in the consolidated statements of operations are as
follows:
For the Years Ended December 31,
----------------------------------------------
2003 2002 2001
------------ ------------ ------------
Expected tax expense (benefit) at statutory rate.......................... $ 1,103,421 $ (1,495,506) $ (4,095,896)
Increase (decrease) in income taxes resulting from:
Foreign taxes at rates other than the federal statutory rate............ - 75,734 60,210
Settlement of foreign taxes............................................. 143,731 - -
Change in foreign tax rates............................................. (128,612) - -
State income taxes net of federal benefit............................... 309 (175,439) (368,546)
Permanent adjustments................................................... 52,022 - -
Change in valuation allowance primarily related to the generation
(utilization) of net operating loss carryforwards................... (738,766) 1,731,996 4,380,000
Other, net.............................................................. (35,169) 3,661 11,450
------------ ------------ ------------
Total............................................................... $ 396,936 $ 140,446 $ (12,782)
============ ============ ============
Included in the net change in the valuation allowance are differences
between estimates used for book purposes and the actual tax return as filed for
fiscal years 2002 and 2001.
F-14
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The deferred income tax balances are comprised of the following:
As of December 31,
-----------------------------
2003 2002
------------ ------------
Deferred tax assets:
U.S. net operating loss carryforwards................................ $ 10,783,000 $ 10,260,000
Foreign net operating loss carryforwards............................. 1,383,000 1,994,000
Accounts receivable.................................................. 7,000 47,000
Inventory............................................................ 36,000 -
Capitalized technology............................................... 34,000 -
Accrued expenses..................................................... 39,000 135,000
Deferred revenue..................................................... 25,000 27,000
------------ ------------
Total gross deferred tax assets.................................... $ 12,307,000 $ 12,463,000
Less valuation allowance........................................... (12,230,000) (12,445,000)
------------ ------------
77,000 18,000
Deferred tax liabilities:
Fixed assets......................................................... (7,000) (18,000)
------------ ------------
Net deferred income taxes.......................................... $ 70,000 $ -
============ ============
The net change in the total valuation allowance for the years ended
December 31, 2003, 2002 and 2001 was an increase (decrease) of $(215,000),
$2,205,000 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. This valuation allowance will be reviewed on a regular basis
and adjustments made as appropriate. The Company has provided a reserve at
December 31, 2003 for all of the gross tax assets except for inventory and
capitalized technology associated with its Belgian operations The Company
anticipates realizing these deferred tax assets in the future as the Company
expects to generate taxable income in Belgium in 2004.
In October of 2003, the Company paid 185,000 Euros to settle
outstanding tax assessments from the Belgian tax authorities for fiscal years
2000 and 1999. As a result, certain inter-company research and development costs
previously expensed were required to be capitalized and amortized over a
three-year period. At December 31, 2003, the remaining unamortized costs of
84,000 Euros has been recorded as a deferred tax asset of the Company.
NOTE 7 - DEBT
Debt consists of the following:
December 31,
-----------------------------
2003 2002
-------- ------------
Convertible note, interest payable at 6% ..................... $ - $ 3,400,000
Installment notes payable .................................... - 221,651
-------- ------------
- 3,621,651
Less current maturities ...................................... - (3,621,651)
-------- ------------
Long-term debt ............................................... $ - $ -
======== ============
In August 1997, the Company renegotiated the guarantee with Artesia
Bank N.V., formerly Banque Paribas Belgique S.A. and now doing business as Dexia
Bank ("Dexia") 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 agreed to
revise the terms of the loan. Under the new terms, the loan was convertible into
shares of VASCO Common
F-15
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 was reset to September 30, 2003 with a revised
interest rate of 6%. On September 11, 2003, the Company sold $8,000,000 of its
Series D Preferred Stock and Warrants to purchase Common Stock. A portion of the
proceeds was used to repay the debt to Dexia including accrued interest.
The installment notes payable primarily reflect amounts due under an
unsecured installment loan with KBC Bank of Belgium. The loan was initiated on
September 28, 1999 in the amount of 495,788 Euros payable monthly over the next
60 months with interest accruing at 5.3% annually. In September 2003, the terms
were revised to accelerate the payment on the loan such that it was fully repaid
by September 30, 2003 and the interest rate was reduced to 5.16 percent.
The Company maintains an overdraft agreement with Fortis Banque/Bank of
Belgium. Under terms of the agreement, the Company can borrow an amount equal to
80% of its Belgium subsidiary's defined accounts receivable up to maximum of two
million Euros. Borrowings under the overdraft agreement accrue interest at an
annual rate of 5.7% and the Company is obligated to pay a quarterly commitment
fee of 0.125%. As of December 31, 2003, approximately 1,065,000 Euros were
available under the overdraft agreement and there were no borrowings outstanding
under the agreement. The agreement is secured by the assets of the Belgian
subsidiary, excluding inventory, and while it has no specific termination date,
it can be terminated with thirty (30) days notice. The agreement is governed by
the General Lending Conditions for Corporate Customers, registered in Brussels,
Belgium on December 20, 2001.
Interest expense related to debt was $156,541, $220,895 and $164,291
for the years ended December 31, 2003, 2002 and 2001, respectively. The weighted
average interest rate related to debt was 6.0% for 2003.
NOTE 8 - STOCKHOLDERS' EQUITY
Preferred Stock
On September 11, 2003, the Company sold 800 shares of Series D 5%
Cumulative Convertible Voting Preferred Stock (the "Series D Preferred Stock")
and 600,000 detachable warrants to purchase Common Stock. The Series D Preferred
Stock carries a 5% dividend, is convertible into 4 million shares of Common
Stock at a fixed price of $2.00 per share and will vote with the Common Stock as
a class on matters presented to the stockholders. The implied value of the
Series D Preferred Stock was $5,714,000, calculated based upon the annual
dividend rate divided by a required rate of return. The warrants are
exercisable, over a five-year period, at $3.47 per share and were valued at
$1,455,000 using the Black-Scholes pricing model. Of the net proceeds from the
sale, $5,786,000 was allocated to the Series D Preferred Stock and $1,474,000
was allocated to the warrants based upon their relative fair values. In
addition, a beneficial conversion value was calculated for the Series D
Preferred Stock as the difference between the price of the Company's Common
Stock at the transaction date and the conversion price of the Series D Preferred
Stock. The amount of the beneficial conversion, $3,720,000, is analogous to a
preferred dividend and was recorded to accumulated deficit.
In July 2000, the Company issued 150,000 shares of Series C Preferred
Stock for cash of $15,000,000. The preferred stock was convertible into
1,052,632 shares of Common Stock at any time through July 2004. In conjunction
with this financing, the Company issued Common Stock Purchase Warrants to
purchase 789,474 common shares at $15 per share with an estimated fair 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 fair
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 fair value was
being accreted over their lives reducing earnings available to holders of Common
Stock. The value of the warrants, which reduces the carrying value of the
preferred stock, was being accreted and reduced earnings available to common
shareholders. The preferred stock and warrants were purchased and redeemed by
the Company on July 15, 2003. See Common Stock.
Common Stock
On July 15, 2003, the Company reached an agreement with Ubizen N.V.
("Ubizen") whereby VASCO purchased and redeemed all 150,000 shares of the Series
C Convertible Preferred Stock (the "Series C Preferred Stock") and 1,239,474
Common Stock Purchase Warrants owned by Ubizen. Under the terms of the Purchase
Agreement, the Company paid $4 million to Ubizen and issued 2 million shares of
the Company's Common Stock on July 25, 2003 at a fair value of $4,000,000. The
Common Stock issued by the Company is subject to a lock-up period wherein the
lock-up will expire in increments of 500,000 shares each on
F-16
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
October 15, 2003, January 15, 2004, April 15, 2004 and July 15, 2004. Once the
lock-up expires, the shares will be subject to volume trading restrictions
through January 1, 2005.
In 2003, the Company issued 35,800 shares of Common Stock as a result
of the exercise of options under the Company's stock compensation plan (see Note
9) generating total proceeds of $63,417.
In 2002, the Company issued 126,426 shares of Common Stock to acquire
the majority of the remaining outstanding capital stock of Identikey Ltd. The
Company recorded additional intangible assets, in the form of capitalized
technology of $274,563 related to the issuance of this 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
9) generating total proceeds of $15,664. In addition, 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.
Warrants
Warrant activity for the years ended December 31, 2003, 2002 and 2001
is summarized below:
Weighted
Number of Average Exercise
Shares Price Exercise Price
---------- ---------------- --------------
Outstanding at December 31, 2000......................... 1,764,883 $ 9.59 $ 4.25 - 15.00
Granted...................................... - - -
Exercised.................................... (3,929) 4.50 4.50
Cancelled.................................... (383,703) 6.61 -
---------- ---------------- --------------
Outstanding at December 31, 2001......................... 1,377,251 10.44 4.25 - 15.00
Granted...................................... - - -
Exercised.................................... - - -
Cancelled.................................... (137,777) 4.50 4.50
---------- ---------------- --------------
Outstanding at December 31, 2002......................... 1,239,474 11.10 4.25 - 15.00
Granted...................................... 600,000 3.47 3.47
Exercised.................................... - - -
Cancelled.................................... (1,239,474) 11.10 4.25 - 15.00
---------- ---------------- --------------
Outstanding at December 31, 2003........................ 600,000 $ 3.47 $ 3.47
========== ================ ==============
NOTE 9 - STOCK COMPENSATION PLAN
The Company's 1997 Stock Compensation Plan, as amended and restated in
1999, ("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 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 may include either date or event-based
vesting.
F-17
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During 2001, the Compensation Committee 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
(recovery) of $40,900, $(50,116) and $49,555 was recognized in 2003, 2002 and
2001, respectively, in accordance with FASB Interpretation No. 44, "Accounting
for Certain Transactions Involving Stock Compensation", an interpretation of
Accounting Principles Board Opinion No. 25. This expense (recovery) 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, 2003, the Compensation Plan was authorized to issue
options representing up to 6,085,057 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 following is a summary of activity under the Compensation Plan:
Options Outstanding Options Exercisable
------------------------- -----------------------
Weighted - Weighted - Weighted-Average
Number of Average Number of Average Fair Value of
Shares Price Shares Price Options Granted
---------- ---------- --------- ---------- ----------------
Outstanding at December 31, 2000 2,342,217 $ 5.30 984,775 $ 3.71
Granted........................................... 1,248,000 1.34 $0.65
Exercised......................................... (25,633) 0.61
Forfeited......................................... (283,747) 8.07
----------
Outstanding at December 31, 2001 3,280,837 3.76 1,235,545 4.49
Granted........................................... 1,642,750 2.22 1.75
Exercised......................................... -
Forfeited......................................... (314,587) 5.11
----------
Outstanding at December 31, 2002 4,609,000 3.12 1,917,056 3.63
Granted........................................... 591,000 0.75 $0.50
Exercised......................................... (35,800) 1.77
Forfeited......................................... (2,237,825) 3.31
----------
Outstanding at December 31, 2003 2,926,375 $ 2.55 1,651,534 $ 3.11
==========
F-18
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table summarizes information about stock options outstanding at
December 31, 2003:
Options Outstanding Options Exercisable
--------------------------------------------- ------------------------
Weighted - Weighted - Weighted -
Average Average Average
Number of Remaining Exercise Number of Exercise
Range of Exercise Prices Shares Contractual Life Price Shares Price
- ---------------------------------------- --------- ---------------- ---------- --------- ---------
$ 0.0000 - 2.3000....................... 2,102,375 8.2 years $ 1.51 887,824 $ 1.51
$ 2.3001 - 4.6000....................... 570,750 4.6 years $ 3.48 553,650 $ 3.49
$ 4.6001 - 6.9000....................... 61,500 4.5 years $ 5.53 60,250 $ 5.54
$ 6.9001 - 9.2000....................... 72,250 6.0 years $ 8.88 60,185 $ 8.88
$ 9.2001 - 11.5000...................... 94,500 6.7 years $ 10.25 70,875 $ 10.25
$ 11.5001 - 13.8000..................... 10,000 6.8 years $ 12.44 7,500 $ 12.44
$ 13.8001 - 16.1000..................... 15,000 6.1 years $ 15.88 11,250 $ 15.88
--------- ---------- --------- --------
2,926,375 $ 2.55 1,651,534 $ 3.11
========= ========== ========= ========
In 2002, the Company loaned Belgian employees who received stock
options in 1999 and 2000, 141,895 Euros to pay taxes assessed on those options
by the Belgian Government. Even though stock options granted to all employees
were granted at prices equal to the fair market value of the Common Stock on the
date of the grant, Belgian employees who were recipients of stock options were
assessed taxes based on the value determined under Belgian tax legislation dated
March 26, 1999. The total amounts advanced in 2002 were based on each
recipient's specific tax assessment. Due to the uncertainty of collecting the
amounts loaned to the employees, the notes have been fully reserved for as of
December 31, 2003 and 2002.
NOTE 10 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
For the Years ended December 31,
-----------------------------------------
2003 2002 2001
------------ -------- -----------
Supplemental disclosure of cash flow information:
Interest paid.................................................. $ 156,541 $341,998 $ 188,294
Income taxes paid.............................................. 748,945 - 121,359
Supplemental disclosure of non-cash investing activities:
Common stock issued in connection with acquisition............. $ - $284,458 $ 1,903,366
Note receivable and preferred stock received
from sale of business unit.............................. 1,553,000 - -
Supplemental disclosure of non-cash financing activities:
Common stock issued to redeem Series C preferred stock
and warrants (in shares)................................ 2,000,000 - -
Increase in additional paid-in capital related to beneficial
conversion of Series D preferred stock.................. $ 3,720,000 - -
Deemed dividend on preferred stock............................. (3,720,000) - -
Dividends accrued on preferred stock........................... (121,111) - -
F-19
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 11 - DISCONTINUED OPERATIONS
On July 8, 2003, effective as of July 1, 2003, VASCO sold its VACMAN
Enterprise ("VME") business, originally known as Intellisoft and/or Snareworks,
to SecureD Services, Inc. (SSI). Under the terms of the agreement, VASCO
received a senior secured promissory note with a face value of approximately
$1.1 million, valued at $1.0 million by an independent valuation firm, and $2
million of Convertible Preferred Stock from SSI, valued at $0.6 million by an
independent valuation firm, in exchange for the VACMAN Enterprise assets. The
promissory note bears a 6% interest rate and is payable in 36 equal and
consecutive monthly payments. The Preferred Stock includes a 6% cumulative stock
dividend, payable quarterly, and can be converted into SSI's common stock at
defined intervals beginning July 1, 2005. In accordance with Statement of
Financial Accounting Standard (SFAS) No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets", the assets and liabilities of this business unit
have been disaggregated from the operational assets and liabilities of the
Company. The results of the operations of VME for the twelve months ended
December 31, 2003 have been reported as results of discontinued operations.
Prior periods have been restated to conform to this presentation. The Company
recorded a gain on the sale of $1.4 million comprised of the proceeds of $1.6
million less net basis in the assets sold and related fees of the sale.
Assets of and liabilities related to discontinued operations included
in the consolidated balance sheet are as follows:
December 31,
-----------------------
2003 2002
------- -----------
Accounts receivable.................... $ - $ 10,724
Prepaid expenses....................... - 12,612
Property and equipment, net............ - 132,325
------- -----------
Total Assets $ - $ 155,661
======= ===========
Accounts payable....................... $ - $ 852
Deferred revenue....................... - 75,721
Other accrued expenses................. - 31,070
------- -----------
Total Liabilities $ - $ 107,643
======= ===========
Prior to the sale, during 2003, discontinued operations had revenue of
$1,033,269, cost of sales of $81,904 and operating expenses of $313,026.
NOTE 12 - 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. In January 2001, the
Company amended its benefit plan to allow Company-matching. For the years ended
December 31, 2003, 2002 and 2001, the Company contributed $23,000, $19,000 and
$0, respectively, to this plan.
F-20
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 13 - GEOGRAPHIC AND CUSTOMER INFORMATION
The Company allocates revenue based on the location of the country that
initiates the sale. Information regarding geographic areas for the years ended
December 31, 2003, 2002 and 2001 is as follows and has been restated to reflect
discontinued operations:
UNITED STATES EUROPE OTHER TOTAL
------------- ------------ ------------ ------------
2003
Revenue from continuing operations ............................ $ 1,498,000 $ 19,201,000 $ 2,167,000 $ 22,866,000
Gross profit from continuing operations ....................... 1,299,000 11,173,000 1,384,000 13,856,000
Income from discontinued operations ........................... 638,000 -- -- 638,000
Gain on sales of discontinued operations ...................... 1,357,000 -- -- 1,357,000
Long-lived assets related to continuing operations ............ 2,610,000 973,000 143,000 3,726,000
Long-lived assets related to discontinued operations .......... -- -- -- --
2002
Revenue from continuing operations ............................ $ 1,423,000 $ 14,658,000 $ 1,289,000 $ 17,370,000
Gross profit from continuing operations ....................... 1,161,000 8,658,000 391,000 10,210,000
Income (loss) from discontinued operations .................... 754,000 -- -- 754,000
Long-lived assets related to continuing operations ............ 1,849,000 1,449,000 100,000 3,398,000
Long-lived assets related to discontinued operations .......... 132,000 -- -- 132,000
2001
Revenue from continuing operations ............................ $ 1,448,000 $ 21,089,000 $ 153,000 $ 22,690,000
Gross profit from continuing operations ....................... 808,000 11,437,000 105,000 12,350,000
Income (loss) from discontinued operations .................... (2,317,000) -- -- (2,317,000)
Long-lived assets related to continuing operations ............ 1,870,000 1,877,000 111,000 3,858,000
Long-lived assets related to discontinued operations .......... 296,000 -- -- 296,000
For the years 2003, 2002 and 2001, the Company's top 10 customers
contributed 71%, 67% and 79%, respectively, of total worldwide revenues.
In 2003, there were two customers that contributed more than 10% of
consolidated revenues and in 2002 and 2001 there was one customer that
contributed more than 10% of consolidated revenues.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
The Company leases office space and automobiles under operating lease
agreements expiring at various times through 2007.
Future minimum rental payments required under non-cancelable leases are
as follows:
Year Amount
---- ------
2004..................... $ 895,677
2005..................... 710,381
2006..................... 546,392
2007..................... 31,114
2008..................... 16,981
Thereafter............... 67,924
----------
Total................ $2,268,469
==========
Rent expense under operating leases aggregated approximately $685,000,
$799,000 and $714,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
F-21
VASCO DATA SECURITY INTERNATIONAL, INC.
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 that, in management's opinion, is likely to have a
material adverse effect on its business, financial condition or results of
operations.
NOTE 15 - 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. The
restructuring included a reduction in workforce of approximately 60 employees,
in addition to the write-off of intangible assets and property and equipment.
A restructuring charge of $4,284,000 was recorded in the fourth quarter
of 2001. Detail of this charge is as follows:
Write-off of goodwill ............................................. $ 266,000
Write-off of software licenses ..................................... 2,772,000
Write-off of other intangible assets ............................... 32,000
Accrual of severance and related costs ............................. 901,000
Write-off of property and equipment ................................ 36,000
Other .............................................................. 277,000
----------
Subtotal .................................................... 4,284,000
Accrual of severance and related costs
related to discontinued operations ............................. 314,000
----------
Total related to continuing operations ...................... $3,970,000
==========
Of the $901,000 in severance and related costs, $180,000 remained
outstanding as of December 31, 2001 and was paid by the end of the first quarter
of 2002.
As part of the restructuring, 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.
During the fourth quarter of 2002, the Company recorded additional
restructuring charges of $320,000 related to operations in France and excess
space in its U.S. headquarters. Of the $320,000 recorded, $134,400 remained
unpaid at December 31, 2003 and is included in accrued expenses.
F-22
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 16 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The quarterly results of operations for the fiscal year 2002 have been
restated to reflect the operations of VME as a discontinued operation. See Note
11 - Discontinued Operations
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
----------- ----------- ----------- -----------
2003
Net sales ............................................... $ 5,118,000 $ 5,953,000 $ 5,599,000 $ 6,196,000
Gross profit from continuing operations ................. 2,959,000 3,531,000 3,453,000 3,913,000
Operating expenses ...................................... 2,942,000 2,847,000 3,395,000 3,548,000
Operating income from continued operations .............. 17,000 684,000 58,000 365,000
Discontinued operations ................................. 314,000 170,000 1,481,000 30,000
Net income .............................................. 481,000 721,000 1,288,000 266,000
Basic and diluted net income (loss) per share ........... $ 0.01 $ 0.01 $ (0.08) $ 0.00
=========== =========== =========== ===========
2002
Net sales ............................................... $ 5,478,000 $ 3,761,000 $ 4,740,000 $ 3,391,000
Gross profit from continuing operations ................. 3,249,000 2,115,000 2,679,000 2,167,000
Operating expenses ...................................... 3,760,000 3,590,000 3,584,000 4,175,000
Operating income from continued operations .............. (510,000) (1,476,000) (905,000) (2,007,000)
Discontinued operations ................................. 341,000 192,000 212,000 9,000
Net income .............................................. (161,000) (1,670,000) (809,000) (1,899,000)
Basic and diluted net income (loss) per share ........... $ (0.02) $ (0.07) $ (0.04) $ (0.07)
=========== =========== =========== ===========
F-23
SCHEDULE II
VASCO DATA SECURITY INTERNATIONAL, INC.
VALUATION AND QUALIFYING ACCOUNTS
Bad Debt
Allowance for Doubtful Accounts Beginning Expense Accounts Ending
For Trade Accounts Receivable Balance (Recovery) Written Off Balance
------------------------------- --------- ---------- ----------- --------
Year ended December 31, 2003........................... $ 461,129 $ 91,692 $ (82,080) $470,741
Year ended December 31, 2002........................... 206,913 320,735 (66,519) 461,129
Year ended December 31, 2001........................... 286,377 259,714 (339,178) 206,913
Obsolescence
Beginning Expense Inventory Ending
Reserve for Obsolete Inventories Balance (Recovery) Written Off Balance
-------------------------------- --------- ------------ ----------- --------
Year ended December 31, 2003........................... $ 111,566 $ 140,788 $ - $252,354
Year ended December 31, 2002........................... 91,518 20,048 - 111,566
Year ended December 31, 2001........................... - 136,332 (44,814) 91,518
See accompanying independent auditors' report
F-24
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 29, 2004.
VASCO Data Security International, Inc.
/s/ T. Kendall Hunt
---------------------------------------
T. Kendall Hunt
Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT
IN THE CAPACITIES INDICATED ON MARCH 29, 2004.
POWER OF ATTORNEY
Each of the undersigned, in his capacity as an officer or director, or
both, as the case may be, of VASCO Data Security International, Inc. does hereby
appoint T. Kendall Hunt, and each of them severally, his true and lawful
attorneys or attorney to execute in his name, place and stead, in his capacity
as director or officer, or both, as the case may be, this Annual Report on Form
10-K for the fiscal year ended December 31, 2003 and any and all amendments
thereto and to file the same with all exhibits thereto and other documents in
connection therewith with the Securities and Exchange Commission. Each of said
attorneys shall have power to act hereunder with or without the other attorney
and shall have full power and authority to do and perform in the name and on
behalf of each of said directors or officers, or both, as the case may be, every
act whatsoever requisite or necessary to be done in the premises, as fully and
to all intents and purposes as to which each of said officers or directors, or
both, as the case may be, might or could do in person, hereby ratifying and
confirming all that said attorneys or attorney may lawfully do or cause to be
done by virtue hereof.
SIGNATURE TITLE
--------- -----
/s/ T. Kendall Hunt Chief Executive Officer and Chairman
- ------------------------------------------ (Principal Executive Officer)
T. Kendall Hunt
/s/ Jan Valcke President and Chief Operating Officer
- ------------------------------------------ (Principal Operating Officer)
Jan Valcke
/s/ Clifford K. Bown Chief Financial Officer and Secretary
- ------------------------------------------ (Principal Financial Officer and
Clifford K. Bown Principal Accounting Officer)
/s/ Michael P. Cullinane Director
- ------------------------------------------
Michael P. Cullinane
/s/ Forrest D. Laidley Director
- ------------------------------------------
Forrest D. Laidley
/s/ Michael A. Mulshine Director
- ------------------------------------------
Michael A. Mulshine
/s/ John R. Walter Director
- ------------------------------------------
John R. Walter