VASCO DATA SECURITY INTERNATIONAL INC - 10-K Annual Report

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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, 1998
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.

As of April 14, 1999, 24,472,430 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 the Over-the-Counter Bulletin Board on April 14, 1999)
held by non-affiliates of the registrant was $54,079,641 (13,110,216
shares at $4.125 per share).

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the
Annual Meeting of Stockholders to be held
June 15, 1999 are to be incorporated by reference into Part III of
this Form 10-K.

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 the "Management's
Discussion and Analysis of Financial Condition and Results of
Operations," contains "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995 concerning,
among other things, the prospects, developments and business
strategies for the Company (as defined) and its operations, including
the development and marketing of certain new products and the
anticipated future growth in certain markets in which the Company
currently markets and sells its products or anticipates selling and
marketing its products in the future. These forward-looking
statements (i) are identified by their use of such terms and phrases
as "expected," "expects," "believe," "believes," "will,"
"anticipated," "emerging," "intends," "plans," "could," "may,"
"estimates," "should," "objective" and "goals" and (ii) are subject
to risks and uncertainties and represent the Company's present
expectations or beliefs concerning future events. The Company
cautions that the forward-looking statements are qualified by
important factors that could cause actual results to differ
materially from those in the forward-looking statements, including
(a) risks of general market conditions, including demand for the
Company's products and services, competition and price levels and the
Company's historical dependence on relatively few products, certain
suppliers and certain key customers, and (b) risks inherent to the
computer and network security industry, including rapidly changing
technology, evolving industry standards, increasing numbers of patent
infringement claims, changes in customer requirements, price
competitive bidding, changing government regulations and potential
competition from more established firms and others. Therefore,
results actually achieved may differ materially from expected results
included in, or implied by, these statements.

Item 1 - Description of Business

General Description of Business

VASCO Data Security International, Inc., a Delaware corporation
(the "Company" or "VASCO"), was incorporated on July 15, 1997 and is
the successor to the operations of VASCO Corp. (see "1998
Reorganization _ Exchange Offer"). Its executive office is located
at 1901 South Meyers Road, Suite 210, Oakbrook Terrace, Illinois
60181; (630) 932-8844. On March 20, 1998, the Company's Common
Stock, $.001 par value per share (the "Common Stock") was approved
for trading on the Over-the-Counter Bulletin Board system with the
symbol: VDSI.

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

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

1998 Reorganization - Exchange Offer

The Company was organized in 1997 as a subsidiary of VASCO
Corp., a Delaware corporation ("VASCO Corp."). Pursuant to an
exchange offer (the "Exchange Offer") by the Company for securities
of VASCO Corp. that was completed March 11, 1998, the Company
acquired 97.7% of the common stock of VASCO Corp. Consequently,
VASCO Corp. became a subsidiary of the Company, with the remaining
2.3% of VASCO Corp. shareholders representing a minority interest.
On October 28, 1998, this minority interest was merged into the
Company and VASCO Corp. ceased to exist.

For purposes of the discussion of the general business of the
Company below, references to the "Company" shall refer to VASCO Corp.
for periods prior to March 11, 1998, the date on which VASCO Corp.
became a subsidiary of VASCO.

Prior Organizational History

The Company is essentially a holding company that conducts its
business through operating subsidiaries in the United States and
Europe.

The Company presently has two operating subsidiaries. VASCO Data
Security, Inc. ("VDS"), a Delaware corporation headquartered in
Oakbrook Terrace, Illinois, is owned directly by the Company. The
Company's other operating subsidiary, VASCO Data Security NV/SA
("VDS NV/SA"), is a Belgian corporation headquartered in a suburb of
Brussels, Belgium. VDS NV/SA is owned by the Company's European
holding company subsidiary, VASCO Data Security Europe SA ("VDSE").
VDS and VDS NV/SA are engaged in the design, development, marketing
and support of open standards-based hardware and software based
security systems which manage and secure access to information assets
and also provide products that permit their customers to encrypt
data.

[company organization chart]

* One share held by T. Kendall Hunt.

VDS. In November 1989, a Utah corporate predecessor of the
Company acquired an option to purchase a controlling interest in
ThumbScan, Inc. ("ThumbScan"). The Company acquired a controlling
interest in ThumbScan in January 1991, and in December 1991 VASCO
Data Security International, Inc. increased its holdings in
ThumbScan. VASCO subsequently acquired the remaining shares of
ThumbScan. In July 1993, ThumbScan was renamed VASCO Data Security,
Inc.

VDS NV/SA. VASCO Data Security NV/SA ("VDS NV/SA") is a
combination of two European companies (Lintel Security NV and
Digipass SA) acquired by the Company, through VDSE, in 1996, and
accounts for a substantial portion of VASCO's consolidated revenues.

Acquisition of Lintel Security. In 1996, the Company began a
significant expansion of its computer security business by acquiring
a 15% interest in Lintel Security NV ("Lintel Security"). Lintel
Security, a newly formed Belgian corporation, concurrently purchased
from Lintel NV, a Brussels, Belgium based company, certain assets
associated with the development of security tokens and security
technologies for personal computers ("PCs"), computer networks and
telecommunications systems using Data Encryption Standard ("DES") and
Rivest, Shamir, Adelman ("RSA") cryptographic algorithms. The Company
acquired the remaining 85% of Lintel Security in June 1996. At the
time of acquisition of Lintel NV's assets by Lintel Security,
Lintel NV was a competitor of the Company in Europe. The purchase
price paid for Lintel Security was approximately $4.4 million, and
was paid in cash, shares of VASCO common stock, and VASCO warrants
and convertible notes.

Acquisition of Digipass. In July 1996, the Company acquired the
stock of Digipass SA ("Digipass") for an aggregate purchase price of
$8.2 million. Digipass, based in a suburb of Brussels, was also a
developer of security tokens and security technologies for PCs,
computer networks and telecommunications systems using the DES
cryptographic algorithm. At the time of acquisition, Digipass was a
competitor of the Company in Europe.

Prior to the Company's acquisition of Digipass, certain assets
and liabilities of the interactive voice response ("IVR") business of
Digiline SA, an integrator of IVR products based in Belgium, were
transferred to Digipass. Digipass' IVR products were used primarily
in telebanking applications and incorporate authentication and access
control technology. During 1997, VDS NV/SA sold the IVR business for
approximately $200,000.

In January 1997, Digipass changed its name to "VASCO Data
Security NV/SA." Concurrent with this event Lintel Security's
operations were consolidated with those of VDS NV/SA at a single
location near Brussels.

The Company 's original business was providing consulting,
training and software services to companies and government agencies.
These services were marketed as VASCO Performance Systems ("VPS"). In
1996, management determined that the Company should focus its
energies and resources on the data security industry, where it
believed significant growth and profit potential existed.
Accordingly, on August 20, 1996, the Company sold the assets of VPS
and withdrew from the consulting and technical training business.

Financial Information about Industry Segments

During each of the last three fiscal years, the Company has
operated in only one industry segment.

Financial Information Relating to Foreign and Domestic Operations and
Export Sales

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

Narrative Description of the Business

General

The Company designs, develops, markets and supports open
standards-based hardware and software security systems which manage
and secure access to information assets. The Company's hardware
products include time-synchronous response only, challenge/response
and time-synchronous challenge/response user authentication devices,
some of which incorporate an electronic digital signature feature to
guarantee the integrity of data transmissions. These devices are
commonly referred to as security tokens.

The Company's security tokens are based upon its core encryption
technology, which utilizes two widely known and accepted algorithms,
DES and RSA. The Company's Cryptech division produces high speed
hardware and software encryption products used both internally for
its security tokens and for original equipment manufacturers ("OEM")
vendors requiring real time encryption services. In addition, the
Company has introduced a smartcard security token that uses the
challenge/response mode and the X.509 certificate authentication
standard.

The Company's security tokens are designed to be used with the
VASCO Access Control Manager ("VACMan") server software or to be
integrated directly into applications. Together, the Company's
software and hardware products provide what it believes is an
economical state-of-the-art authentication, authorization and
accounting security system.

As of December 31, 1998, the Company had over 2.6 million
security token devices, its primary product line, in use. The
Company's security products are sold primarily to value-added
resellers and distributors, and to a lesser extent end-users.

The Company has embarked upon an aggressive campaign to expand
its distributor and reseller network. Distributors and resellers that
have entered into agreements with the Company's operating
subsidiaries include, among others, Concord-Eracom Nederland BV,
Protect Data Norge AS, Sirnet AB, All Tech Data Systems, Inc., Clark
Data Systems, Inc. and HUCOM, Inc.

Representative end-users of the Company's products include
ABN-AMRO Bank, First Union National Bank N.A., Generale Bank, Artesia
Bank N.V. (formerly Banque Paribas Belgigue S.A.), Rabobank, S-E
Banken, Volvo Data North America, Inc., France Telecom, Manitoba
Telephone and Andrew Corp.

Industry Background

The Data Security Industry. The increasing use and reliance upon
proprietary or confidential data by businesses, government and
educational institutions that is accessible remotely by users,
together with the growth in electronic commerce, has made data
security a paramount concern. The Company believes that data security
concerns will spur significant growth in the demand for both
enterprise and consumer security solutions.

Enterprise Security. With the advent of personal computers and
distributed systems in the form of wide area networks ("WANs"),
intranets which connect users in disparate facilities, local area
networks ("LANs"), which connect users located in a single facility
and the public network known as the Internet/ World Wide Web (the
"Internet"), and 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. As a result of the increased number of users having
direct and remote access to enterprise networks and data, including a
growing number of mobile computer users and telecommuters that
perform some or all of their work from home or other remote
locations, data has become increasingly vulnerable to unauthorized
access.
Unauthorized access can range from users who are authorized to
access portions of an enterprise's computing resources accessing
unauthorized portions, to hackers who have no legitimate access
breaking into a network and stealing or corrupting data. The
consequences of such unauthorized access, which can often go
undetected, can range from theft of proprietary information or other
assets to the alteration or destruction of stored data. As a result
of unauthorized access stemming from the increased use of
enterprise-wide computing and remote access, network security has
become a primary concern to most companies that use and rely on data.
This increased attention to data security has stimulated demand for
data security products. The Company believes that enterprises are
seeking solutions which will continue to allow them to expand access
to data while maintaining adequate security.

Consumer Security. In addition to the need for enterprise-wide
security, the proliferation of PCs in both home and office, combined
with widespread access to the Internet, have created significant
opportunities for electronic commerce such as electronic bill
payment, home banking and home shopping. All of these activities are
primarily based on the use of the Internet. According to published
reports, the growth in the number of Internet users worldwide is
expected to increase from approximately 28 million in 1996 to
approximately 175 million by the end of 2001.

The public generally perceives that there is a risk involved in
using credit cards to make purchases via the Internet and this
perception has hampered the development of consumer-based electronic
commerce. Accordingly, the Company believes that successful expansion
of electronic commerce requires the implementation of improved
security measures which accurately identify users and reliably
encrypt data transmissions over the Internet.

Products

Current Data Security Solutions

Data security and secured access to on-line commerce generally
consist of five 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 was 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.

AccessControl: Includes firewalls, which limit a user's access
to data to only that data which he or she is authorized to access,
and authorization and accounting systems, which also limit access to
data and keep track of a user's activities after access has been
granted.

Anti-Virus: Programs that scan for and, in many cases, remove
destructive computer programs known as computer viruses that can
become imbedded into programs residing on a computer.

Administration and Management Tools: Set, implement and
monitor 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
these five components. However, most companies only implement a
patchwork combination of these components, which can result in their
security systems being compromised.

Historically, the Company's primary products have been security
tokens. Security tokens are an integral part of identification and
authentication systems, which in turn serve as the foundation for
each of the five components of data security outlined above. The
Company has sought to leverage its identification and authentication
expertise by expanding its product offerings to include the other
components of data security, in each case incorporating the Company's
security tokens. The Company has sought to expand its product
offerings to reach its ultimate goal of supplying a full range of
security products for integrated, enterprise-wide security solutions,
which will meet the needs of the emerging data security market.

Identification and Authentication. Identification and
authentication systems provide the foundation for security systems by
validating the identity of each user attempting to access information
or data contained in a system, regardless of location. The most
common use of an identification and authentication device is to
authenticate local and remote users who have established a network
connection to a company's computer network. Authentication is often
done in conjunction with a firewall to authenticate internal users of
stand-alone PCs on networks or to authenticate customers and
suppliers who have been granted access to a restricted portion of the
Company's data or other information.

There are three basic methods used to authenticate a user. The
first method identifies who the user is, utilizing a hard-to-forge
physical attribute such as the user's fingerprints, voice patterns or
eye retina patterns. In each case, the physical attribute, or
biometric, must be capable of being scanned and converted to a
digital document. While biometric devices offer a high level of
authentication, they are susceptible to replay attacks. Replay
attacks collect samples of a user's biometric "print" (i.e., voice,
finger, retina) and then replay the "print" to access a target
system. Furthermore, current technology requires additional hardware
to acquire, or read, the biometric "print." The added hardware
presents two challenges for biometric solutions: one is the cost and
the second is installation and maintenance.

The second authentication method is identifying what the user
knows, usually a password known only to the specific user. Passwords,
while easy to use, are also the least secure because they tend to be
short and static, and are often transmitted without encryption
("clear text"). As a result, passwords are vulnerable to decoding or
observation and subsequent use by unauthorized persons. Once a user's
password has been compromised, the integrity of the entire computer
network can be compromised.

The third authentication method identifies what the user has,
generally a physical device or token intended for use by that
specific user. Tokens are small devices ranging from simple credit
card-like devices to more complex devices capable of generating
time-synchronized challenge/ response access codes. Early examples of
simple tokens include building access passes.

Certain token-based systems require both possession of the token
itself and a PIN to indicate that the token is being used by an
authorized user. Such an approach, referred to as two-factor
authentication, provides much greater security than single factor
systems such as passwords or simple possession of a token. Early
implementations of two-factor authentication include automatic teller
machine ("ATM") cards. ATM cards require the user to possess the card
and to know the PIN before engaging in the transaction. The Company
believes that the use of the two-factor authentication system is the
optimal solution for reliable computer and network security and has
targeted its products toward this end.

Security Tokens. A security token is a small, portable
computing device designed to generate a one-time password. They are
normally difficult to counterfeit and are assigned to an individual
user. The user transmits a token-generated password, along with an
assigned user ID, to a host or authentication server, requesting
access, generally to a network. Token-generated passwords are derived
from a secret key or seed value. An authentication server on the
network receives and decrypts the token password with a corresponding
decryption key, validates the user, and (if validated) grants access.
Currently available security tokens are event-based,
time-synchronous, response only or challenge/response based.

Event-based tokens have the same list of predetermined passwords
as the authentication server. Passwords are generated by the token in
a predetermined manner, which is expected by the server, and the
passwords remain valid for indefinite periods of time. As a result of
the passwords being generated from a predetermined list and their
ease of calculation by unauthorized users, event-based tokens are the
easiest to compromise.

Time-synchronous tokens require the authentication server and
the token to be password time-synchronous. When used, the token will
calculate and display a password using a stored secret seed value and
the current time of day. The server then determines whether the
password received is correct for the time frame that it was used in.
The principal drawbacks for time-synchronous tokens are extensive
maintenance with respect to clock synchronization and the possibility
of multiple uses within the specified time frame. Usually, steps are
taken to limit the re-use of a password, however, when a
time-synchronous token is defined to multiple authentication servers,
a common practice, then there is a risk of a password being re-used
to access other servers. Nevertheless, these devices provide a
higher level of security than event-based tokens.

Response only tokens use either an "event" or time to calculate
the response only password. Response only tokens require the user to
activate the token and read the password.

Challenge/response tokens provide the highest level of security.
The authentication server responds to a request for access by issuing
a randomly generated challenge in the form of a numeric or
alphanumeric sequence. The token, using its embedded seed value, or
key, encrypts the challenge. The result is an encrypted response
which the user then transmits back to the authentication server via
the user's PC keyboard. The server in turn retrieves the key that has
been assigned to that user and decrypts the user's response. Assuming
a match exists, the server authenticates the user and grants access.

As with time-synchronous tokens, challenge/response tokens do
not transmit an encryption key. However, unlike time-synchronous
tokens, passwords of challenge/response tokens are one-time passwords
that can never be re-used. In addition, there is no opportunity to
initiate a second, illegal session with a challenge/response token.
Each attempt at access is accompanied by a new challenge and a
correspondingly unique password response.

Although challenge/response tokens generate true one-time
passwords, it is possible to compromise the internal seed value of
pure challenge/response tokens that only use the seed value and the
challenge to calculate the response.

Time synchronous challenge/response tokens can be used to add
another variable in the calculation of the one-time password. In
addition to the secret seed value and the challenge from the host
server, the time of day can be used. Because there is a challenge,
the time synchronization does not have to be nearly as exact as with
time-synchronous tokens. When time is used as an input variable for
challenge response tokens, it is impossible, with today's most
advanced computers, to use dictionary attacks to compromise the
token.

Smartcards. Smartcards are credit card sized devices that
contain an embedded microprocessor, memory and secure operating
system. Smartcards have been used in many applications, for example,
as stored value cards, either for making general purchases or for
specific applications such as prepaid calling cards, and as health
care cards, which are used to store patient and provider information
and records. Major smartcard chip and card manufacturers include
Gemplus SA, Schlumberger Ltd., Philips Electronics N.V., Siemens A.G.
and Groupe Francois Charles Oberthur (FCO). These vendors, together
with cryptographic vendors, have worked to make smartcard standards
compatible with cryptographic standards to offer a security solution
with authentication and digital signature capabilities.

The Company's Solution

To date, most approaches to network security have been limited
in scope and have failed to address critical aspects of data
security. The Company believes that an effective enterprise-wide
solution must address and assimilate issues relating to the
following: ease of use and administration, reliability,
interoperability with heterogeneous enterprise environments and
existing customer applications, and scaleability. The Company also
believes that, in order to capitalize on this growing market need for
enterprise-wide security solutions, network security products must
embody both hardware and software components and provide an
industry-accepted, open standards-based solution.

Accordingly, the Company has adopted the following approach to
data security:

(i) In designing its products, it has sought to
incorporate all industry-accepted, open,
non-proprietary, remote access protocols, such as
RADIUS and TACACS+. This permits interoperability
between the Company's security token products and
leading remote access servers.

(ii) It has incorporated the two most widely known
and accepted algorithms - the DES and RSA algorithms -
into its products and has sought to refine its offering
of single-function, multi-function, challenge/response,
response only and digital signature security token
products. The Company believes that its combination of
software and hardware products provide security with
added speed, cryptographic functionality, reliability
and flexibility not attainable with software-only
programs. Its products provide two-factor
authentication requiring the authorized user to possess
both the token and the appropriate PIN.

(iii) In addition to providing identification and
authentication features in its security products, the
Company has included accounting and auditing features
that allow customers to track and analyze all user
access and attempted access to network systems. This
permits easier customer implementation and monitoring
of corporate security policies.

(iv) The Company has designed its security systems
to support various platforms - such as Windows NT and
Unix - thereby allowing customers to ensure the same
security for remote users as is provided to
office-based users.

(v) The Company has sought to design products that are easy
to use and competitively priced. It also is increasing
its customer support capabilities to ensure the smooth
installation and maintenance of its systems.

As a result of this approach, the Company believes that it has
positioned itself to market a new generation of open standards-based
hardware and software security systems, including those designed to
provide security to Internet users, and it intends to continue to
grow to provide a full range of identification and authentication and
other security products.

Security Token Products. Generally, the Company's
challenge/response tokens work as follows: when a user logs onto a
computer or enters a program or network with a user ID, the computer
generates a numeric or alphanumeric challenge and displays both the
challenge and a flashing bar pattern on the terminal screen. The user
holds a token up to the flashing pattern on the screen, and the token
reads and interprets the pattern and then displays a unique, or
one-time, password on its liquid crystal display. The user then
enters this password on the computer keyboard and, if a match exists,
access to the computer, program or network is granted. If the
terminal screen is not able to display a flashing bar pattern, the
user can enter the numeric or alphanumeric challenge into the keypad
on the token. PIN protected break-in attempts to unlock the key are
tracked by the token internally. After a pre-programmed number of
invalid attempts, the token will be locked out of the system until an
authorized administrator provides an unlock code to reset the token.

Some of the Company's products also are able to perform "digital
signatures" for applications which require proof that a transaction
was authorized. A combination of numbers from the transaction are
entered into a token which produces an encrypted number that only
that specific token, and the information from the transaction, could
have created. This number is then entered as part of the transaction,
acting as a digital signature authorizing the transaction.

The Company's security tokens include a family of devices known
as Digipass. During the first quarter of 1998, the Company began
full production and shipping of its Digipass 300, which is an
optical, hand-held multiple-mode security token capable of operating
in time-synchronous response only, challenge/response and time
synchronous challenge/response modes and of performing digital
signature functions. In addition to the Digipass 300, the Company
also offers the Digipass 500, a time-synchronous response only token
that generates a one-time password, to authenticate users of PCs and
networks and to verify data transmissions by electronic signature.

Smartcards are also emerging as viable security devices. The
Company currently offers a smartcard product, VACMan/CryptaPak, that
combines two authentication standards on one smartcard.
VACMan/CryptaPak is a standards based smartcard solution that secures
Internet applications based on the X.509 authentication standard and
also secures remote dial-in access based on the RADIUS authentication
standard. It includes a smartcard, smartcard reader and software that
enables Netscape Communications Corporation's Communicator to
authenticate users via the X.509 certificate standard and software
that enables remote dial-in users to be authenticated via the RADIUS
authentication standard.

Encryption Products. Hardware encryption product offerings from
the Company include DES and RSA microprocessor chips that perform
algorithmic functions for use in, among other things, ATMs, fax
machines, modems and security servers. The Company's DES and RSA
chips are also the central component of its PC DES/RSA Cards, which
are printed circuit boards that enable software applications to
provide encryption security.

Access Control Products. The Company has, through a strategic
relationship, developed the VACMan access control system, which
centralizes security services in a single location, supports all of
the Company's token devices, and is based on industry standard
protocols to maximize interoperability. VACMan also incorporates
authorization and accounting features.

The Company's Strategy

The Company's objective is to establish itself as a "best of
breed" solutions vendor and to become a leader in the data security
market. The Company's growth is largely dependent on the successful
implementation of its business strategy. There can be no assurance
that the Company will be able to successfully implement its business
strategy or that, if implemented, such strategy will be successful.
Key elements of the Company's strategy for achieving this objective
are listed below:

Increase Name Recognition. The Company intends to increase the
name recognition of its products. It believes that by establishing
itself as a brand name, it will obtain a key competitive advantage.
The Company believes that the market for data security products is
confused by multiple technologies and conflicting claims and that
end-users will ultimately be more comfortable buying a well-known
product. The Company intends to increase its name recognition by
emphasizing sales to well-known visible end-users, expanding its
distribution network, increasing its presence at technology trade
shows and other increased marketing activities such as print media
campaigns.

Expand Product Line. The Company plans to continue to broaden
its line of security products to meet its customers' needs. The
Company intends to accomplish this by continuing to develop
identification and authentication expertise, as well as by seeking
strategic relationships and acquiring complementary assets or
businesses.

Expand Global Presence. The implementation of data security
products for electronic banking in the European market has become
widespread and as a result, the market for the Company's products has
grown more quickly in Europe than in North America. Sales by the
Company's European subsidiary, VDS NV/SA, and its U.S. subsidiary,
VDSI, represented 81% and 19%, respectively, of the Company's total
revenue for the year ended December 31, 1998. Nevertheless, sales to
U.S. customers represented just 6% of the Company's sales for the
year ended December 31, 1998. The Company believes that there are

significant opportunities for its products in the developing North
American market and further believes it is well positioned to take
advantage of this growing market. The Company intends to maintain and
expand its leadership role in the identification, authentication,
authorization and accounting markets in Europe and to leverage its
European expertise to introduce and promote the Company's
identification, authentication, authorization and accounting products
to the North American and other global markets. Enterprises that
allow remote access to proprietary databases or information, or need
to ensure secure data transmission for purposes of electronic
commerce (including via the Internet), are potential customers for
the Company's security products. The Company intends to pursue these
potential customers through its growing network of distributors and
resellers.

Expand Marketing Channels. The Company intends to recruit and
support a network of value added resellers worldwide that specialize
in both vertical (banking, financial, health, telecommunications and
government) markets and horizontal (remote access and Internet
application) markets. By undertaking these activities, the Company
intends to address and fulfill the requirements of the growing remote
access market that is in need of advanced identification,
authentication, authorization and accounting products.

Some of the distributors and resellers that have entered into
agreements to distribute the Company's products in various strategic
markets include:

EUROPE NORTH AND SOUTH AMERICA ASIA

Concord-Eracom Nederland BV All Tech Data Systems, Inc. HorizonSystems
(Netherlands) (Midwestern United States) (Hong Kong)

Telindus Unis Lumin HUCOM
(Belgium) (Canada) (Japan)

Secureware Excelsys, SA
(France) (Chile)

Sirnet AB Latin Ware Ltda.
(Scandinavia) (Colombia)

Q&I Electronics Sistemas Efficientes SA
(Netherlands) (Guatemala)

Develop Strategic Relationships. To accomplish its strategic
goals, the Company has established and is developing strategic
relationships with other vendors of complementary security products
and may seek to acquire complementary assets or businesses. Also, the
Company has identified vendors of security or remote access products
that relied solely on static passwords that the Company believes its
products can enhance. During 1998, the Company entered into a
strategic partnership with Lernout & Hauspie Speech Products NV
("L&H"), a worldwide market leader in speech and linguistic
technologies, products, and services.

The Company also has entered into co-development agreements with
certain companies to gain access to technology critical to the
acceptance and adoption of the Company's technology and products. As
an example, the Company entered into a co-development agreement with
SHIVA Corp., a leader in remote access communications equipment,
pursuant to which the Company licensed from SHIVA Corp. a generic
security server. The resulting product, VACMan, enables the Company's
technology and products to be inserted into virtually any
organization that allows remote dial-in access to its computer
networks.

The Company's Security Products

The Company's family of hardware products include
time-synchronous response only, challenge/response and
time-synchronous challenge/response user authentication token devices
or security tokens. As of December 31, 1998, the Company had over 2.6
million security tokens (AccessKey II, AuthentiCard, Digipass 300 and
Digipass 500) in use. In addition, the Company offers a smartcard
security token that uses the challenge/ response mode and the X.509
certificate authentication standard. The Company also designs,
develops and markets encryption chips and encryption boards through a
division called Cryptech. The primary customers of the Cryptech
products are OEMs of telecommunications equipment that require real
time encryption.

All the Company's security tokens can be used with its software
authentication server, VACMan, to provide a complete identification,
authentication, authorization and accounting security system. VACMan
supports each of the Company's security devices and permits users to
centralize their security systems in a single server or network of
servers. It is designed for small, medium and large enterprises and
Internet service providers, and it provides a centralized and
flexible solution for managing network access. VACMan is scalable for
large remote access systems and a single server can support numerous
distributed network access servers.

The Company also offers numerous additional products to extend
the security services of VACMan/Server to platforms and/or
applications that do not yet support the RADIUS protocol. Examples of
such products are VACMan/Client NT, VACMan/Client IIS (Microsoft Web
Server), and VACMan/Client Solaris. In addition the Company offers
workstation software to enhance network connections when using
advanced products like Digipass 300 or VACMan/CryptaPak. These
products have unique workstation requirements to generate a terminal
flash pattern for the security tokens and to communicate to a
smartcard reader attached to the workstation in the case of
VACMan/CryptaPak.

The Company also provides a software development kit ("SDK")
that can be used by other vendors or by clients to build RADIUS
support into their products or applications. This SDK enables them to
perform one integration project and gain support for all RADIUS
compliant security servers. The SDKs are written in the C programming
language and can be used in numerous operating system environments
such as MVS, VMS, UNIX, Windows, NetWare and DOS. The SDKs enable the
Company's strategic partners to integrate the Company's products into
their own product offerings.

Intellectual Property and Proprietary Rights

The Company relies on a combination of patent, copyright,
trademark and trade secret laws, as well as employee and third-party
non-disclosure agreements to protect its proprietary rights. In
particular, the Company holds several patents in the United States
and a corresponding patent in certain European countries, which cover
certain aspects of its technology. The majority of its patents cover
the Company's AccessKey II, Digipass 300, Digipass 500 and
AuthentiCard tokens. The U.S. patents expire between 2003 and 2010;
the European patent expires in 2008. The Company believes these
patents to be valuable property rights and relies on the strength of
its patents and trade secret law to protect its intellectual property
rights. To the extent that the Company believes its patents are being
infringed upon, it intends to assert vigorously its patent protection
rights, including but not limited to, pursuing all available legal
remedies.

While the Company believes that its patents are material to its
future success, there can be no assurance that the Company's present
or future patents, if any, will provide a competitive advantage. It
also may be possible for others to develop products with similar or
improved functionality that will not infringe upon the Company's
intellectual property rights. Furthermore, to the extent that the
Company believes that its proprietary rights are being violated, and
regardless of its desire to do so, it may not have adequate financial
resources to engage in litigation against the party or parties who
may infringe on its proprietary technology.

In November 1998, the Company was served with a lawsuit filed
against it by Security Dynamics Technologies, Inc. alleging patent
infringement. While the Company believes that it is protected by its
patents and that this lawsuit was without merit, it was determined to
be in the best interests of the Company to resolve this lawsuit in a
timely manner. Therefore, on April 6, 1999, Security Dynamics
Technologies, Inc., the Company and VASCO Data Security, Inc.
announced settlement on confidential terms of the claims that each of
the companies had raised in litigation filed during 1998. In
addition, the Company is from time to time involved in litigation
incidental to the conduct of its business. Except for the foregoing
lawsuit, the Company is not a party to any other 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.

Research and Development

The Company's research and development efforts are concentrated
on product enhancement, new technology development and related new
product introductions. The Company employs 11 full-time engineers
and, from time to time, independent engineering firms to conduct
non-strategic R&D efforts on its behalf. For the fiscal years ended
December 31, 1996, 1997 and 1998, the Company expended $575,000,
$1,802,000, and $1,788,000, respectively, on R&D, representing
approximately 5.6%, 14.6%, and 11.9% of consolidated revenues for
1996, 1997 and 1998, respectively.

Production

The Company's security hardware products are manufactured by
third parties pursuant to purchase orders issued by the Company. Its
hardware products are comprised primarily of commercially available
electronic components which are purchased globally. The Company's
software products are controlled in-house by Company personnel and
can be produced either in-house or by several outside sources in
North America and in Europe. At December 31, 1998, the Company had
firm purchase orders from customers for an aggregate of 464,000
AccessKey II, AuthentiCard, Digipass 300 and Digipass 500 security
token units, exclusive of the units shipped under those orders as of
that date.

With the exception of the AccessKey II token, the Company's
security tokens utilize commercially available programmable
microprocessors, or chips. The Company uses two microprocessors, made
by Samsung and Epson, for the various hardware products produced
other than the AccessKey II token. The Samsung microprocessors are
purchased from Samsung Semiconductor in Belgium, and the Epson
microprocessors are purchased from Alcom Electronics NV/SA, also
located in Belgium. The microprocessors are the only components of
the Company's security tokens that are not commodity items readily
available on the open market. While there is an inherent risk
associated with each supplier of microprocessors, the Company
believes having two sources reduces the overall risk.

AccessKey II uses a custom-designed and fabricated
microprocessor which is currently available from a single source,
Micronix Integrated Systems, in the United States. The Company does
not have a long-term contract with Micronix, but rather submits
blanket purchase orders for the AccessKey II microprocessor.
AccessKey II production was reduced during 1998 and ceased full
production during the first quarter of 1999, as production of
Digipass 300 increased, which employs a widely available
microprocessor.

Orders of microprocessors and some other components generally
require a lead time of 12-16 weeks. The Company attempts to maintain
a sufficient inventory of all parts to handle short term spikes in
orders. Large orders that would significantly deplete the Company's
inventory are typically required to be placed with more than 12 weeks
of lead time, allowing the Company to attempt to make appropriate
arrangements with its suppliers.

The Company purchases the majority of its product components and
arranges for shipment to third parties for assembly and testing in
accordance with design specifications. The Company's three security
token products are assembled exclusively by two independent
companies, each of which is based in Hong Kong. Purchases from one of
the companies are made on a purchase order by purchase order basis.
Purchases from the other company are under a contract that extends to
January 21, 2000, with automatic one-year renewals and subject to
termination on six months notice. Each of these companies assembles
the Company's security tokens at facilities in mainland China. One of
the companies also maintains manufacturing capacity in Hong Kong.
Equipment designed to test product at the point of assembly is
supplied by the Company and periodic visits are made by Company
personnel for purposes of quality assurance, assembly process review
and supplier relations.

Competition

The market for computer and network security solutions is very
competitive and, like most technology-driven markets, is subject to
rapid change and constantly evolving products and services. The
industry is comprised of many companies offering hardware, software
and services that range from simple locking mechanisms to
sophisticated encryption technologies. The Company believes that
competition in this market is likely to intensify as a result of
increasing demand for security products. The Company's competition
comes from a number of sources, including (i) software operating
systems suppliers and application software vendors that incorporate a
single-factor static password security system into their products,
and (ii) token-based password generator vendors promoting response
only and/or challenge/ response technology, such as ActivCard, Inc.,
AXENT Technologies, Inc. CRYPTOCard, Inc., Leemah DataCom Security
Corporation, Racal-Guardata, Inc., Secure Computing Corp., and
Security Dynamics Technologies, Inc.

In some cases, these vendors also support the Company's products
and those of its competitors. The Company also may face competition
in the future from these and other parties that develop computer and
network security products based upon approaches similar to or
different from those employed by the Company.

The Company believes that the principal competitive factors
affecting the market for computer and network security products
include name recognition, technical features, ease of use,
quality/reliability, level of security, customer service and support,
distribution channels and price. Although the Company believes that
its products currently compete favorably with respect to such
factors, other than name recognition in certain markets, there can be
no assurance that the Company can maintain its competitive position
against current and potential competitors, especially those with
significantly greater financial, marketing, service, support,
technical and other competitive resources.

Many of the Company's present and potential competitors have
significantly greater financial, technical, marketing, purchasing and
other resources than the Company, 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 the Company's
prospective customers. Accordingly, it is possible that new
competitors or alliances may emerge and rapidly acquire significant
market share.

The Company's 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
Company 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 the Company for market
share.

Sales and Marketing

The Company's computer and network security products are
marketed primarily through an indirect sales channel and distribution
network and, to a lesser extent, directly to end-users. The Company
markets its products primarily in North America, Europe and
Asia-Pacific through a combination of value-added resellers, original
equipment manufacturers, independent distributors and direct sales
efforts. A sales staff of 20 coordinates sales through the
distribution network and makes direct sales calls either alone or
with sales personnel of vendors of computer systems. The sales staff
also provides product education seminars to sales personnel of
vendors and distributors with whom the Company has working relations
and to potential end-users of the Company's products.

In January of 1997, the Company introduced the VASCO Advantage
Reseller ("VAR") program. The goal of this program is to expand the
Company's marketing channels by engaging companies already proficient
in reselling computer network products and security solutions to
distribute the Company's products. The Company works with these
value added resellers, resellers, OEM's and distributors
(collectively referred to as "Resellers") through its United States
and European operating subsidiaries, VDSI and VDS NV/SA. VDSI, which
is primarily responsible for North America, South America and Japan,
started in 1997 with one Reseller. Since January 1, 1997,
arrangements have been made with 54 additional Resellers, for a total
of 55. VDS NV/SA, which is generally responsible for developing sales
in the remainder of the world, had an existing base of 17 Resellers
prior to the announcement of the VAR program. Since January 1, 1997,
VDS NV/SA has engaged an additional 44 Resellers, for a total of 61.

The Company's 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. While the
Company believes its products are designed to meet the regulatory
standards of foreign markets, any inability to obtain foreign
regulatory approvals on a timely basis could have a material adverse
effect on the Company's financial condition or results of operations.

The Company's products are subject to export restrictions and
controls as administered by the National Security Agency, the
Department of State and the Department of Commerce. Encryption
products are eligible for export depending upon the level of
encryption technology incorporated into the product. U.S. export laws
also prohibit the export of encryption products to a number of
specified hostile countries. Until recently, the Company did not need
to obtain U.S. export licenses for its products. However,
VACMan/CryptaPak, introduced to the Company product line in August
1997, requires a License Exception (i.e., authorization to export,
under stated conditions, subject to Export Administration
Regulations). The Company believes it is able to obtain License
Exceptions for its VACMan/CryptaPak product for sales to
international banking and financial institutions.

The Company's core authentication products, AccessKey II,
Digipass 300, and Digipass 500 do not, nor are they likely to, fall
under U.S. encryption export control regulations. Although all of the
Company's authentication products utilize encryption technologies,
the products cannot read and encrypt client data. Thus, they are not
subject to the U.S. encryption export control regulations.

Similarly, VDS NV/SA, the Belgian operating subsidiary of the
Company, is subject to export licensing requirements under Belgian
law. The inability of VDS NV/SA to obtain required approvals or
licenses under Belgian law also could have a material adverse effect
on the Company's financial condition or results of operations.
The Belgian export of VDS NV/SA's cryptographic products,
consisting of DES and RSA microprocessors and PC/DES and RSA cards
(including software development kit(s)), is subject to European
Community regulations. VDS NV/SA's cryptographic products are
considered to be "goods of dual use" under those regulations, i.e.,
goods that can be used for both civil and military purposes. As such,
a national individual export license is required for their export,
except to Luxembourg and the Netherlands. Only the VDS NV/SA products
that perform encryption of data for confidentiality reasons require
an individual export license, and VDS NV/SA has obtained such
licenses for the export of these products.

VDS NV/SA, as owner and exporter of the cryptographic products,
must apply to the Belgian Ministry of Economic Affairs for an export
license for each company to which it exports such products. An export
license is valid for one customer for one year from the date of
issue. It can be reused for several consecutive deliveries to that
customer until the total export quantity, as indicated on the
license, has been exhausted. If the quantity is not completely
exported during the one year license period, the license can be
renewed once for another year. VDS NV/SA applies for such licenses
for customers that wish to purchase cryptographic products.

Customers and Markets

Customers for the Company's security products include, to some
extent, businesses that purchase products directly from the Company
for use by their employees, clients or vendors, but the majority are
value-added resellers or distributors of related security products or
services who in turn sell to other businesses.

To date, virtually all of the Company's security products have
been sold in Europe. Sales to one European distributor, Sirnet,
accounted for 20% of the Company's consolidated revenues in 1998.
Additionally, Rabo Bank and Concord-Eracom Nederland NV each
accounted for approximately 16% and 13% of the Company's total
revenues, respectively. The Company is aware of the risks associated
with this degree of customer concentration and expects to reduce its
reliance on these customers in 1999 and beyond.

Backlog

At December 31, 1998, the Company had firm purchase orders from
customers for an aggregate of $9,567,000 of Authenticard, Digipass
300 and Digipass 500 security token units, exclusive of the units
already shipped under such purchase orders as of December 31, 1998.
This compares to a balance of $8,643,000 as of December 31, 1997.

Employees

As of December 31, 1998, the Company employed 54 full-time
employees and 6 full-time consultants. Of these, 27 were located in
North America and 33 were located in Europe. Of the 60 total, 35 were
involved in sales, marketing and customer support, 13 in product
production, research and development and 12 in administration.

Item 2 - Properties

The Company's corporate offices and North American
administrative, sales and marketing, research and development and
support facilities are located in the United States in an office
complex in Oakbrook Terrace, Illinois, a western suburb of Chicago.
These facilities are leased through November 15, 1999, and consist of
approximately 10,000 square feet. The Company believes that the
Oakbrook Terrace facilities will be adequate for its present growth
plans.

The Company's European administrative, sales and marketing,
research and development and support facilities are located in
Belgium in an industrial park in a southwestern suburb of Brussels.
These facilities consist of approximately 10,000 square feet of
office space which are occupied under a lease expiring in July of
1999. Upon the termination of the current lease, the Company has
arranged a lease for facilities consisting of approximately 20,000
square feet of office space located in a suburb of Brussels, for a
term of six years. This lease had not yet been signed.

Item 3 _ Legal Proceedings

During 1998, the Company was served with a lawsuit filed against
it by Security Dynamics Technologies, Inc. alleging patent
infringement. On April 6, 1999, Security Dynamics Technologies,
Inc., the Company and VASCO Data Security, Inc. announced a
settlement on confidential terms of the claims that each of the
companies had raised in litigation filed last year.

In addition, the Company is from time to time involved in
litigation incidental to the conduct of its business. Except for the
foregoing lawsuit, the Company is not a party to any other 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 1998, through solicitation of proxies or otherwise.

PART II

Item 5 - Market for Registrant's Common Equity and Related
Stockholder Matters

There was no established public market for the Common Stock in
1997. On March 20, 1998, the Common Stock was approved for trading
on the NASD Electronic Bulletin Board system under the symbol "VDSI."

On April 14, 1999, the closing sale price for the Common Stock
on the Over-the-Counter Bulletin Board was $4.125 per share. Such
Over-the-Counter market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not
necessarily represent an actual transaction. On March 31, 1999,
there were approximately 1,500 holders of record of the Common Stock.

Prior to March 23, 1998, shares of VASCO Corp. common stock were
quoted on the OTC-BB under the symbol "VASC." Since March 23, 1998,
the Common Stock has been quoted on the OTC-BB under the symbol
"VDSI." The following table sets forth the high and low closing bid
quotations for the securities and periods indicated within the past
two fiscal years.

VASCO Corp. common stock High Low
1997
First Quarter 5 7/8 3 7/16
Second Quarter 4 5/8 2 1/4
Third Quarter 5 7/16 2 3/8
Fourth Quarter 7 2 15/16

1998
First Quarter 7 1/4 4 3/16
Second Quarter 12 11/32 5 3/8
Third Quarter 7 1/4 2 3/4
Fourth Quarter (through October 27, 1998) 3 7/16 2 3/4

Common Stock
1998
First Quarter 6 4
Second Quarter 9 3
Third Quarter 7 1/8 3
Fourth Quarter 4 2 1/2

On October 28, 1998, the last sale price quoted on the OTC BB
was 3 1/4. The above quotations represent prices between dealers and
do not include retail markups or markdowns or commissions. They may
not necessarily represent actual transactions.

The Company has not paid any dividends on its Common Stock since
incorporation. Dividends were paid relating to the Company's Series
B Preferred Stock, which was converted to Common Stock in September
1997. Restrictions or limitations on the payment of dividends may be
imposed under the terms of credit agreements or other contractual
obligations. In the absence of such restrictions or limitations, the
declaration and payment of dividends will be at the sole discretion
of the Board of Directors of the Company and subject to certain
limitations under the General Corporation Law of the State of
Delaware. The timing, amount and form of dividends, if any, will
depend, among other things, on the Company's results of operations,
financial condition, cash requirements, plans for expansion and other
factors deemed relevant by the Board of Directors. The Company
intends to retain any future earnings for use in its business and
therefore does not anticipate paying any cash dividends in the
foreseeable future.

Item 6 - Selected Financial Data
(in thousands, except per share data)(1)(2)

Year Ended December 31,
---------------------------------------------
1994 1995 1996 1997(2) 1998
---- ---- ---- ------- ----

Statement of Operations
Data:
Total revenues $2,693 $3,695 $10,192 $12,302 $15,016
Operating income(loss) 192 (534) (8,658)(3) (3,935)(4) (1,210)
Net income (loss)
available to
common stockholders 30 (465) (9,349)(3) (5,998)(4) (3,649)
Basic and diluted
income (loss) per
common share - (0.03) (0.53)(3) (0.31)(4) (0.18)

Shares used in computing
per share amounts 14,260 14,817 17,533 19,106 20,431

December 31,
---------------------------------------------
1994 1995 1996 1997 1998
Balance Sheet Data: ---- ---- ---- ---- ----

Cash $ 38 $ 745 $ 1,814 $ 1,898 $ 1,523
Working capital 764 1,074 4,902 (555) (3,086)
Total assets 2,111 2,414 12,368 8,376 9,101
Long term obligations,
less current portion 60 7 9,114 8,443 8,436
Common stock subject to
redemption - 371 742 495 -
Stockholders' equity
(deficit) 1,364 966 (1,205) (6,865) (9,646)

For a discussion of factors that affect the comparability of the
financial information set forth above, such as significant
acquisitions undertaken by the Company, the disposition of the
Company's VASCO Performance Systems line of business in 1996, and the
significant costs incurred during 1997 related to the Exchange Offer,
see Item 7 _ "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
___________________________
(1) Represents the financial information of VASCO Corp. prior to
March 11, 1998, as the Company had not begun operations until the
Exchange Offer.

(2) Includes the results of operations of Lintel Security from March
1996 and Digipass from July 1996; see "Financial Statements."

(3) Includes a pretax charge for acquired in-process research and
development of $7,351.

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

Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations

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

On March 11, 1998, VASCO Data Security International, Inc. (the
"Company") successfully completed its offer (the "Exchange Offer") to
exchange the VASCO Corp.'s shares, options, and warrants for the
Company's shares, options and warrants. Because the Company was a
non-operating subsidiary of VASCO Corp. prior to the completion of
the Exchange Offer (which occurred on March 11, 1998), the discussion
of results contained herein relates to the results of VASCO Corp. and
its subsidiaries for periods prior to March 11, 1998 and the Company
after March 11, 1998. As previously noted, VASCO Corp. merged into
the Company effective October 28, 1998.

OVERVIEW

VASCO designs, develops, markets and supports open standards-
based hardware and software security systems which manage and secure
access to information assets. VASCO's original corporate predecessor
was founded in 1984, and VASCO entered the data security market in
1991 when it acquired a controlling interest in what is today one of
VASCO's two operating subsidiaries, VASCO Data Security, Inc. ("VDS")
(formerly known as "ThumbScan, Inc."), a company that designs,
develops and sells security tokens, primarily to European customers.
In 1996, VASCO began developing and marketing open standards-based
security systems by introducing a hardware and software package,
VACMan, that is based on industry-accepted remote access protocols.

Revenue and Earnings. The majority of sales made by VDS and VDS
NV/SA are in the European markets, although the Company intends to
actively pursue additional markets outside of Europe, particularly
Asia and North and South America.

Revenues from sales of security tokens, specifically the
AccessKey II and Digipass tokens, continue to represent the majority
of the Company's total revenues. In excess of 80% of VDS's sales for
1996, 1997 and 1998 were comprised of security token devices, with
Concord-Eracom Nederland BV accounting for 97%, 92% and 70% of VDS's
sales in 1996, 1997 and 1998, respectively. On a consolidated basis,
the percentages for 1996, 1997 and 1998 were 44%, 16% and 13%,
respectively, including revenues relating to the Lintel Security and
Digipass operations from their respective acquisition dates in 1996.
It is expected that consolidated sales to other customers and markets
will increase and, assuming this occurs, the degree of concentration
attributable to this major customer will decrease. However, the
Company expects that this major customer will continue to be a
meaningful contributor to the Company's revenues and earnings for the
foreseeable future. In 1998, for example, Concord-Eracom Nederland BV
placed an additional $2.5 million order with VDS. Consequently, the
unforeseen loss of this customer's business, or the inability to
maintain reasonable profit margins on sales to this customer, may
have an adverse effect on the Company's results of operations and
financial condition.

Although the Company believes it is likely that sales of
security tokens, including the Digipass 300, will continue to account
for a majority of the Company's total revenues for the foreseeable
future, the Company also believes that revenues from sales of its
other hardware and software data security products, including the
additional product offerings made possible by the Lintel Security and
Digipass acquisitions, will continue to increase in the future.

Research and Development. The Company is devoting its capital
and other resources to enhancing its existing security products and
developing new products to provide enterprise-wide hardware and
software security solutions. Costs of research and development,
principally the design and development of hardware and software prior
to the determination of technological feasibility, are expensed as
incurred on a project-by-project basis. The Company's 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.

Once technological feasibility has been established, ongoing
development costs incurred prior to actual sales of the subject
product are capitalized in accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to Be Sold, Leased or Otherwise Marketed." Product
development costs are capitalized on a product-by-product basis and
are amortized by the greater of (i) the ratio that current gross
revenues for a product bear to the total of current and anticipated
future gross revenues for that product or (ii) the straight-line
method over the remaining estimated economic life of the product. The
remaining estimated economic life of these products are reviewed at
least quarterly.

Management has concluded that, in today's rapidly evolving
technology markets and with the expanding state of the computer and
network security industry in general, it may be impractical to
anticipate product life cycles in excess of two years. Historically,
however, the Company's products have experienced significantly longer
product lives than two years.

Variations in Operating Results. The Company's quarterly
operating results have in the past varied and may in the future vary
significantly. Factors affecting operating results include: the level
of competition; the size, timing, cancellation or rescheduling of
significant orders; market acceptance of new products and product
enhancements; new product announcements or introductions by the
Company's competitors; adoption of new technologies and standards;
changes in pricing by the Company or its competitors; the ability of
the Company to develop, introduce and market new products and product
enhancements on a timely basis, if at all; component costs and
availability; the Company's success in expanding its sales and
marketing programs; technological changes in the market for data
security products; foreign currency exchange rates; and general
economic trends and other factors.

In addition, the Company has experienced, and may experience in
the future, seasonality in its business. The seasonal trends have
included higher revenue in the last quarter of the calendar year and
lower revenue in the next succeeding quarter. The Company believes
that revenue has tended to be higher in the last quarter due to the
tendency of certain customers to implement or complete changes in
computer or network security prior to the end of the calendar year.
In addition, revenue has tended to be lower in the summer months,
particularly in Europe, when many businesses defer purchase
decisions. Because the Company's operating expenses are based on
anticipated revenue levels and a high percentage of the Company's
expenses are fixed, a small variation in the timing of recognition of
revenue could cause significant variations in operating results from
quarter to quarter.

Currency Fluctuations. The majority of the supply and sales
transactions of VASCO Data Security, Inc. are denominated in U.S.
dollars, whereas many of the supply and sales transactions of VDS
NV/SA are denominated in various foreign currencies. In order to
reduce the risks associated with fluctuations in currency exchange
rates, VDS NV/SA began in September 1997 to buy U.S. dollars based on
three to six months estimated future needs for U.S. dollars, has
developed price lists denominated in both U.S. dollars and foreign
currencies, and endeavors to denominate its new supply and sales
transactions in U.S. dollars. During 1997, VDS NV/SA purchased
$300,000 in U.S. dollars to cover purchases of supplies. This balance
proved sufficient to meet VDS NV/SA's needs during 1998 as well. VDS
NV/SA has also continued to match the timing of delivery, amount of
product and the currency denomination of purchase orders received
from vendors with sales orders to customers.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated,
certain consolidated financial data as a percentage of revenues for
the years ended December 31, 1996, 1997 and 1998.

Percentage of Revenue
Year Ended December 31,
--------------------------
1996 1997 1998
---- ---- ----
Revenues 100.0% 100.0% 100.0%
Cost of goods sold 57.6 51.1 46.3
---- ---- ----
Gross profit 42.4 48.9 53.7
Operating costs:
Sales and marketing 13.8 27.5 29.1
Research and development 5.6 14.6 11.9
General and administrative 35.8 38.8 20.8
Acquired in-process research
and development 72.1 - -
---- ---- ----
Total operating costs 127.3 80.9 61.8
----- ---- ----
Operating loss (84.9) (32.0) (8.1)
Interest expense (3.4) (9.3) (9.7)
Other expense, net (0.4) (1.8) (2.0)
---- ---- ----
Loss before income taxes (88.8) (43.1) (19.8)
Provisions for income taxes 1.4 4.9 4.6
---- ---- ----
Net loss (90.7) (48.0) (24.4)
==== ==== ====

The following discussion is based upon the Company's consolidated
results of operations for the years ended December 31, 1998, 1997 and
1996. References to "VASCO" represent the consolidated entity.
References to "VASCO NA" represent VASCO Corp. and VDS, excluding the
acquisition of Lintel Security and Digipass. References to "VASCO
Europe" mean the operations of Lintel Security and Digipass following
their acquisition by VASCO. (Percentages in the discussion are
rounded to the closest full percentage point.)

1998 COMPARED TO 1997

The following discussion and analysis should be read in conjunction
with VASCO's Consolidated Financial Statements for the years ended
December 31, 1998 and 1997.

Revenues

VASCO's consolidated revenues for the year ended December 31,
1998 were $15,016,000, an increase of $2,714,000, or 22%, as compared
to the year ended December 31, 1997. VASCO Europe contributed
$12,230,000 or 81% of total consolidated revenues, with VASCO NA
contributing the remaining $2,786,000 or 19%. This increase is due
to a strong performance from international operations, as the demand
for Digipass 300 and Digipass 500 continues to grow, resulting in
increased unit sales, as well as increasing orders with smaller
quantities, resulting in less volume discounting on revenues. In
addition, favorable currency exchange rates benefited the Company.

Cost of Goods Sold

VASCO's consolidated cost of goods sold for the year ended
December 31, 1998 was $6,949,000, an increase of $662,000, or 11%, as
compared to the year ended December 31, 1997. VASCO Europe's cost of
goods sold was $5,550,000 or 80% of total consolidated cost of goods
sold and VASCO NA was $1,399,000 or 20%. This increase is consistent
with the increase in revenues for the year. The Company continues to
benefit from efficiencies in the manufacturing process, as well as
the increasing demand for products with a more favorable cost
structure.

Gross Profit

VASCO's consolidated gross profit for the year ended December
31, 1998 was $8,067,000, an increase of $2,051,000, or 34%, over the
year ended December 31, 1997. This represents a gross margin of 54%,
as compared to 1997's consolidated gross margin of 49%. The increase
in gross margin is due to efficiencies in manufacturing related to
increasing volumes, an increase in the mix of higher margin products,
as well as increasing orders with smaller quantities, resulting in
less volume discounting on revenues.

Sales and Marketing Expenses

Consolidated sales and marketing expenses for the year ended
December 31, 1998 were $4,368,000, an increase of $987,000, or 29%,
over 1997. This increase can be attributed to increased sales
efforts including, in part, increased travel costs, headcount, and an
increase in marketing activities, including the development the new
VASCO logo, Internet web page and other efforts.

Research and Development Expenses

Consolidated R&D costs for the year ended December 31, 1998 were
$1,788,000, a decrease of $14,000, or 1%, as compared to the year
ended December 31, 1997. This decrease can be attributed to higher
spending in 1997 related to the acquisition/development of the VACMan
product line, as well as a reduction in employees as compared to
1997, with increased use of temporary employees in 1998.

General and Administrative Expenses

Consolidated general and administrative expenses for the year
ended December 31, 1998 were $3,120,000, a decrease of $1,648,000, or
34%, over 1997. This decrease can be attributed to the fact that the
Company was preparing for the Exchange Offer during 1997, thus
generating significant legal, accounting and printing expenses; the
Exchange Offer was completed during March 1998. In addition,
economies of scale began to be realized during 1997 as a result of
the combination of the operations of Lintel Security and VASCO Data
Security. The Company also had a favorable experience with regard to
bad debt recovery and a reduction of certain legal fees associated
with the Exchange Offer, which was recorded during 1998.

Operating Loss

VASCO's consolidated operating loss for the year ended December
31, 1998 was $1,210,000, compared to the consolidated operating loss
of $3,935,000 for 1997, a decrease of $2,725,000, or 69%. Of the
1998 loss, VASCO NA contributed a loss in the amount of $2,163,000
and VASCO Europe contributed income in the amount of $953,000.

Interest Expense

Consolidated interest expense in 1998 was $1,458,000 compared to
$1,148,000 in 1997. The increase can be attributed to average
borrowings in 1998 being higher than those of the previous year. See
"Liquidity and Capital Resources" below.

Income Taxes

VASCO recorded tax expense for the year ended December 31, 1998
of $687,000, which consisted of a tax benefit of $2,500 for VASCO NA
and tax expense of $689,500 for VASCO Europe.

At December 31, 1998, the Company has United States net
operating loss carryforwards approximating $7,434,000 and foreign net
operating loss carryforwards approximating $1,092,000. Such losses
are available to offset future taxable income at VASCO Data Security
International, Inc. and its U.S. subsidiary and expire in varying
amounts beginning in 2002 and continuing through 2018. In addition,
if certain substantial changes in the Company's ownership should
occur, there would be an annual limitation on the amount of the
carryforwards which could be utilized.

Dividends and Accumulated Deficit

VASCO paid dividends of $0 and $82,000 during the years ended
December 31, 1998 and 1997, respectively. The 1997 dividend payments
were attributable to 9,000 shares of VASCO Series B Preferred Stock
issued in 1994. During 1997, all 9,000 shares of VASCO Series B
Preferred Stock were converted into VASCO Data Security
International, Inc. Common Stock.

VASCO began 1998 with an accumulated deficit of $15,902,000. As
a result of the 1998 net loss, this deficit has increased to
$19,550,000.

1997 COMPARED TO 1996

The following discussion and analysis should be read in conjunction
with VASCO's Consolidated Financial Statements for the years ended
December 31, 1997 and 1996.

Revenues

VASCO's consolidated revenues for the year ended December 31,
1997 were $12,302,000, an increase of $2,110,000, or 21%, as compared
to the year ended December 31, 1996. VASCO Europe contributed
$9,518,000, or 77%, of total consolidated revenues, with VASCO NA
contributing the remaining $2,784,000, or 23%. Revenues (and other
operating results) attributable to VASCO Europe for 1996 are included
only from the time of acquisition of Lintel Security and of Digipass.
The increase in revenues can be attributed to the full-year effect of
the acquisitions, as compared to a partial year in 1996, partially
offset by a temporary reduction in shipments to Concord-Eracom
Nederland BV during 1997. Concord-Eracom Nederland BV represented
approximately $4,200,000 in revenue for 1996, as compared to
$2,000,000 in 1997. VPS, the former technical and training unit
which was sold in August of 1996, had revenues of $204,000 in 1996
and accounted for 4% of VASCO's revenues in 1996.

Cost of Goods Sold

VASCO's consolidated cost of goods sold for the year ended
December 31, 1997 was $6,287,000, an increase of $416,000, or 7%, as
compared to the year ended December 31, 1996. VASCO Europe's cost of
goods sold was $4,929,000, accounting for 78% of the consolidated
cost of goods sold. The overall increase in cost of goods sold is
primarily attributable to the inclusion of VASCO Europe for the
entire year 1997. However, the cost of goods sold for security
products as a percent of revenue decreased at a slightly quicker pace
than revenues for security products. This is due to certain
improvements in the manufacture of the products, as well as economies
of scale being realized as the 1996 acquisitions of Lintel Security
and Digipass were fully integrated.

Gross Profit

VASCO's consolidated gross profit for the year ended December
31, 1997 was $6,015,000, an increase of $1,694,000, or 39%, over
1996. This represents a consolidated gross margin of 49%, as compared
to 1996's consolidated gross margin of 42%. The increase in gross
margin is due to certain improvements in the manufacture of the
products, as well as economies of scale being realized as the 1996
acquisitions of Lintel Security and Digipass were fully integrated.

Sales and Marketing Expenses

Consolidated sales and marketing expenses for the year ended
December 31, 1997 were $3,381,000, an increase of $1,976,000, or
141%, over 1996. The increase can be attributed to the addition of
VASCO Europe for the full year 1997; increased sales efforts
including, in part, increased travel costs; an increase in marketing
activities, including print media campaigns and other efforts, and an
increased presence at trade shows.

Research and Development Expenses

Consolidated R&D costs for the year ended December 31, 1997 were
$1,802,000, an increase of $1,228,000, or 214%, as compared to the
year ended December 31, 1996. R&D costs represented 15% of
consolidated revenues for 1997 as compared to 6% for 1996. The
increase is due to the addition of R&D headcount, both in the U.S.
and Europe, and to the acquisition of the VACMan product from Shiva
Corporation and the related integration efforts surrounding it. R&D
efforts are undertaken by both VASCO NA and VASCO Europe on behalf of
the consolidated group of companies. Whereas VASCO NA is primarily
responsible for the development of software products, VASCO Europe is
responsible for hardware development. Consequently, management of the
Company believes it is not meaningful to address R&D costs separately
at the operating company level.

VASCO expensed, as cost of goods sold, $0 and $180,000 in 1997
and 1996, respectively, reflecting the amortization of capitalized
development costs. As of December 31, 1997 and 1996, VASCO did not
carry any product development costs on its books as an asset. There
were no product development costs capitalized in 1997 or 1996.

General and Administrative Expenses

Consolidated general and administrative expenses for the year
ended December 31, 1997 were $4,768,000, an increase of $1,120,000,
or 31%, over 1996. The majority of this increase can be attributed to
the legal, accounting and printing costs associated with the
preparation of the Exchange Offer held by the Company during the
first quarter of 1998. In addition, the full-year impact of the
Lintel Security and Digipass acquisitions and the amortization of
intangibles associated with those acquisitions increased general and
administrative expenses in 1997.

Acquired In-process Research and Development

During 1996, VASCO expensed $7,351,000 pertaining to the in-
process research and development acquired in the Lintel Security and
Digipass acquisitions. Based upon independent appraisals,
approximately 67% of the acquisition premium has been expensed in
accordance with U.S. Generally Accepted Accounting Principles. As of
December 31, 1997, there remains a net balance of $2,314,000
representing the intangible assets related to the acquisitions, which
are carried on VASCO's books and amortized over an additional 18-66
months. Amortization expenses amounted to $1,083,000 and $440,000 for
the years ended December 31, 1997 and 1996, respectively.

Operating Loss

VASCO's consolidated operating loss for the year ended December
31, 1997 was $3,935,000, compared to the consolidated operating loss
of $8,658,000 for 1996. Of the 1997 loss, VASCO NA contributed a loss
in the amount of $4,130,000 and VASCO Europe contributed income in
the amount of $195,000. The 1996 consolidated operating loss included
a write-off of acquired in-process research and development in the
amount of $7,351,000 and $440,000 of amortization expense relating to
intangible assets in 1996. The 1996 operating loss, before the write-
off and the amortization, was $867,000.

VASCO's 1997 operating loss, excluding the amortization of
intangibles, was attributable to continued investment in R&D
(primarily for Digipass 300), sales and marketing investments in
North America, the expenses for development of corporate
infrastructure, such as sales personnel and administrative staff, and
the legal, accounting and printing costs incurred during 1997
associated with the preparation of the Exchange Offer held by the
Company during the first quarter of 1998.

Interest Expense

Consolidated interest expense in 1997 was $1,148,000 compared to
$346,000 in 1996. The increase can be attributed to average
borrowings in 1997 being substantially above those levels of the
previous year. See "Liquidity and Capital Resources" below.

Income Taxes

VASCO recorded tax expense for the year ended December 31, 1997
of $200,000 for VASCO NA and $407,000 for VASCO Europe. The tax
expense recorded for VASCO NA represents the revaluation (write-down)
of deferred tax assets. As of December 31, 1997, VASCO reflected a
net deferred tax asset of $83,000, which represented the amount that
management deemed would more likely than not be realized. The net
deferred tax asset was net of a valuation allowance of $831,000,
which was established during 1996 and adjusted during 1997,
considering the effects of reversing deferred tax liabilities,
projected future earnings, which were revised substantially as a
result of the acquisitions of Lintel Security and Digipass, and tax
planning strategies.

Dividends and Accumulated Deficit

VASCO paid dividends of $82,000 and $108,000 during the years
ended December 31, 1997 and 1996, respectively. These dividend
payments were attributable to 9,000 shares of VASCO Series B
Preferred Stock issued in 1994. During 1997, all 9,000 shares of
VASCO Series B Preferred Stock were converted into VASCO Data
Security International, Inc. Common Stock. VASCO began 1997 with an
accumulated deficit of $9,903,000. As a result of the 1997 net loss,
this deficit has increased to $15,902,000.

RECENT DEVELOPMENTS

On April 6, 1999, Security Dynamics Technologies, Inc., RSA Data
Security, Inc., the Company and VASCO Data Security, Inc. announced
the settlement on confidential terms of the claims that each of the
companies had raised in litigation filed last year.

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

LIQUIDITY AND CAPITAL RESOURCES

Since inception, VASCO has financed its operations through a
combination of the issuance of equity securities, private borrowings,
short-term commercial borrowings, cash flow from operations, and
loans from Mr. T. Kendall Hunt, VASCO's Chief Executive Officer and
one of the stockholders of the Company's original corporate
predecessor.

In 1995, VASCO borrowed $130,000 from Mr. Hunt, resulting in a
total loan payable balance of $190,000 at the end of 1995. This loan
was repaid in 1996 from the proceeds of private placements during
1996.

During the second quarter of 1996, VASCO placed additional units
consisting of 666,666 shares of VASCO common stock and 137,777
warrants, each of which entitled the holder to purchase one share of
VASCO common stock at $4.50. The private placement of shares and
warrants generated gross proceeds of $3,000,000. In addition, in the
same transaction, VASCO issued a $5,000,000 convertible note due on
May 28, 2001. The note bears interest at 9%, with interest payable to
the holder on a quarterly basis. The holder may, at its option, elect
to receive interest payments in cash or Common Stock. In calculating
the shares of VASCO common stock to be issued in lieu of cash
interest, the average closing price for shares of VASCO common stock
for the previous 20 trading days is used. In the event VASCO receives
funds equal to or greater than $30,000,000 from a public offering of
its Common Stock, the holder of this note has the right to require
VASCO to pay all amounts due and owing under the note within 30 days
of receipt by VASCO of notice from the holder of exercise of this
right. Total issue fees and costs of $170,000 related to the equity
portion of this transaction have been netted against the $3,000,000
of proceeds from the equity private placement. In addition, 55,555
shares of VASCO common stock and 8,889 VASCO Warrants, each of which
entitles the holder to purchase one share of VASCO common stock at
$4.50, were issued as commissions related to the placement. These
warrants were exchanged pursuant to the Exchange Offer and now
represent warrants for the Company's Common Stock.

The proceeds from the $8,000,000 private placement ($3,000,000
equity and $5,000,000 debt) were used to make the first installment
of $4,800,000 toward the Digipass purchase, to satisfy one-time
expenses related to the Lintel Security and Digipass acquisitions, to
retire VASCO's debt to its commercial lender and to Mr. Hunt, and to
fund working capital requirements in general.

In 1996, VASCO raised additional funds in a private placement of
units consisting of 237,060 shares of VASCO common stock and 35,329
VASCO Warrants, each of which entitles the holder to purchase one
share of VASCO common stock at $4.50. Total issue fees and costs of
$47,885 were netted against the $1,066,770 in total proceeds from the
placement in VASCO's financial statements. In addition, 16,489 shares
of VASCO common stock were issued as commissions related to the
placement. These warrants were exchanged pursuant to the Exchange
Offer and now represent warrants for the Company's Common Stock.

Effective in June 1997, VASCO established a bridge loan with
Generale Bank in the amount of $2,500,000, evidenced by five
convertible notes in the amount of $500,000 each. Upon completion of
the Exchange Offer, the Company became obligated for all obligations
under the loan and the notes. These notes bear interest at a rate of
3.25%, payable quarterly, and matured on September 30, 1998, at which
time 116% of the principal amount was repaid from the proceeds of a
short-term borrowing facility secured by the Company with KBC Bank.
The KBC Bank facility represents a three-month revolver, renewable
for additional three-month terms, with a corresponding interest rate
of 6.48%. This facility is anticipated to be repaid from the
proceeds of a private placement that the Company expects to complete
during the second quarter of 1999.

The net effect of 1997 activity resulted in an increase in cash
of $84,000, resulting in a cash balance of $1,898,000 at December 31,
1997, compared to $1,814,000 at the end of 1996. VASCO's working
capital at December 31, 1997 was ($555,000), a decrease of
$5,457,000, or 111%, from $4,902,000 at the end of 1996. The majority
of the change is attributable to a decrease in all current asset
categories with the exception of cash, with current liabilities
remaining consistent from year to year. VASCO's current ratio was
0.91 to 1.00 at December 31, 1997, compared to 2.32 to 1.00 at the
end of 1996.

VDSE entered into a convertible loan agreement with Banque
Paribas Belgique S.A. effective August 1997, in order to refinance
the $3.4 million payment due December 31, 1997 in connection with
VASCO's acquisition of Digipass. The terms of the agreement provide
that the $3.4 million principal amount is convertible, at the option
of the lender, into shares of the Company's Common Stock. This loan
bears interest at the rate of 3.25%, payable annually, and matures on
September 30, 2002. The loan is convertible, commencing on the
earlier of January 1, 1999 or the date of a public offering of the
Company's shares on the EASDAQ and/or NASDAQ and terminating on
August 31, 2002, at a conversion price equal to the per share public
offering price, provided, however, that if no such offering has
occurred prior to January 1, 1999, and the loan is converted after
such date but prior to a public offering, the conversion price is the
average closing market price for shares of the Company's Common Stock
on the NASD Electronic Bulletin Board system for the 20 trading days
prior to the date of the notice of conversion, less 10%. In the event
a public offering is completed, the lender may at its option (by
written notice within seven days after receipt by the Company of
proceeds of the public offering) require the principal amount of the
loan to be repaid in cash, in which case additional special interest
is payable as follows: $680,000 if repayment is on January 1, 1999 or
later. As part of this transaction, Mr. Hunt entered into a pledge
agreement with Banque Paribas Belgique S.A. pursuant to which he
pledged, as collateral for the VDSE convertible note, 1,416,666 of
his shares of common stock of the Company, which number of shares is
subject to adjustment based on the market value of the shares.

On March 31, 1998, the Company entered into a loan agreement
with Lernout & Hauspie Speech Products N.V. ("L&H") in the amount of
$3 million, bearing interest at 9.5%, payable quarterly, with an
original maturity of January 4, 1999. The maturity of this note has
been extended to coincide with a private placement of the Company's
equity which is currently underway. This loan is convertible at the
option of the holder into shares of the Company's common stock based
upon the average closing price of VASCO Data Security International,
Inc.'s common stock for the 10 trading days prior to March 11, 1998,
the date the Exchange Offer closed.

The net effect of 1998 activity resulted in a decrease in cash
of $375,000, resulting in a cash balance of $1,523,000 at December
31, 1998, compared to $1,898,000 at the end of 1997. VASCO's working
capital at December 31, 1998 was ($3,086,000), a decrease of
$2,531,000, or 456%, from ($555,000) at the end of 1997. The majority
of the change is attributable to a 26% increase in current assets,
with current liabilities increasing 64%, mainly due to the current
maturities of long-term debt. VASCO's current ratio was -0.70 to 1.00
at December 31, 1998, compared to -0.91 to 1.00 at the end of 1997.

In April 1999, the Company completed a private placement of
Common Stock in the amount of $11.5 million. The transaction
represented a sale of the Company's Common Stock to European
institutional investors at a price of $3.50 per share. A total of
3,285,714 shares of Common Stock were issued as a part of this
transaction. The Company believes that its current cash balances and
anticipated cash generated from operations will be sufficient to meet
its anticipated cash needs through June 2000. Continuance of the
Company's operations beyond June 2000, however, will depend on the
Company's ability to obtain adequate financing. The Company has
entered into engagement letters with Artesia Bank and Bank DeGroof
for a possible future public offering.

The Company intends to seek acquisitions of businesses, products
and technologies that are complementary or additive to those of the
Company. There can be no assurance that any such acquisition will be
made.

Year 2000 Considerations

Many existing computer systems and software products are coded
to accept only two digits entries in the date code field with respect
to year. With the year 2000 less than one year away, the date code
field in these systems and products must be adjusted to allow for a
four digit year or otherwise modified so that they recognize "00" to
indicate the year 2000 rather than the year 1900. Based upon its
current assessments, which are based in part on certain
representations of third party service and product providers, the
Company does not expect that it will experience a significant
disruption of its operations as a result of the Year 2000.

The Company plans to continue to identify, assess and to resolve
all material Year 2000 issues by the end of 1999. The Company is
developing contingency plans to address significant internal and
external Year 2000 issues as they are identified. These contingency
plans are expected to be complete by the end of 1999. Even with the
effort to address the Year 2000 issue made by the Company to date,
there can be no assurance that the systems of other entities on which
the Company relies, including the Company's internal systems and
proprietary software, will be remediated in a timely fashion, or that
a failure to remediate by another entity and/or the Company, would
not have a material effect on the Company's results of operations.

The Company has incurred approximately $150,000 to date in
addressing Year 2000 issues, and believes that no additional material
expenses will be incurred related to the Year 2000 issue. The Company
has completed its assessment of products and mission critical systems
for Year 2000 readiness and believes no material expenses will be
incurred in the future.

Additionally, the Company believes that the purchasing patterns
of customers and potential customers may be affected by Year 2000
issues as companies expend significant resources to upgrade their
current software systems for Year 2000 compliance. This, in turn,
could result in reduced funds available to be spent on other
technology applications, such as those offered by the Company, which
could have a material adverse effect on the Company's business and
results of operations.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

During 1998, the Financial Accounting Standards Board issued
SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities," which will be effective for the Company's fiscal year
2000. The Company is currently assessing the impact of this new
statement, but does not expect any material effect on its
consolidated financial position, liquidity, or results of operations.

Item 7A - Quantitative and Qualitative Disclosures About Market Risk.

Approximately 80% of the Company's business is conducted outside
the United States in Europe and Asia/Pacific. The majority of
business operations are transacted in foreign currencies. As a
result, the Company has exposure to foreign exchange fluctuations.
The Company is affected by both foreign currency translation and
transaction adjustments. Translation adjustments result from the
conversion of the foreign subsidiaries' balance sheets and income
statements to U.S. dollars at year-end exchange rates and weighted
average exchange rates, respectively. Translation adjustments
resulting from this process are recorded directly into stockholders'
equity. Transaction adjustments result from currency exchange
movements when a foreign subsidiary transacts business in a currency
that differs from its local currency. These transactions are recorded
as gains or losses in the Company's statement of operations.

The Company's foreign exchange exposure was minimized in 1998 as
the majority of the Company's foreign subsidiaries' business
transactions were spread across approximately 40 different countries
and currencies. This geographic diversity reduces the risk to the
Company's operating results. Also, the Company performs periodic
reviews of outstanding balances and settles intercompany accounts to
minimize foreign exchange transaction gains and losses.

The Company has minimal interest rate risk. The Company's $15
million debt is made up of fixed rate notes, ranging from 3.25% to
9.5%, which are not subject to market fluctuations. The maturities of
these notes range from 1999 to 2002 (see Note 1 of Notes to
Consolidated Financial Statements related to fair value of financial
instruments).

Item 8 - Financial Statements and Supplementary Data

The information in response to this item is included in the
Company's consolidated financial statements, together with the report
thereon of KPMG LLP, appearing on pages F-1 through F-18 of this Form
10-K, and in Item 7 under the heading "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Item 9 - Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure

None.

PART III

Item 10 - Directors and Executive Officers of the Registrant

The sections entitled "Election of Directors" and "Section 16(a)
Beneficial Ownership Report Compliance" contained in the Company's
Proxy Statement for the Annual Meeting of Stockholders to be held on
June 15, 1999, are incorporated herein by reference.

Item 11 - Executive Compensation

The section entitled "Executive Compensation" contained in the
Company's Proxy Statement for the Annual Meeting of Stockholders to
be held on June 15, 1999, is incorporated herein by reference.

Item 12 - Security Ownership of Certain Beneficial Owners and
Management

The section entitled "Security Ownership of Certain Beneficial
Owners and Management" contained in the Company's Proxy Statement for
the Annual Meeting of Stockholders to be held on June 15, 1999, is
incorporated herein by reference.

Item 13 - Certain Relationships and Related Transactions

None.

PART IV

Item 14 - Exhibits, Financial Statement Schedules and Reports on Form
8-K

a. (1) The following consolidated financial statements and notes
thereto, and the related independent auditors' report, are included
on pages F-1 through F-18 of this Form 10-K:

Consolidated Balance Sheets as of December 31, 1997 and 1998

Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997 and 1998

Consolidated Statements of Comprehensive Income for the Years
Ended December 31, 1996, 1997 and 1998

Consolidated Statements of Stockholders' Equity (Deficit) for
the Years Ended December 31, 1996, 1997 and 1998

Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998

Notes to Consolidated Financial Statements

Independent Auditors' Report

(2) The following financial statement schedule of the Company
is included on page S-1of 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 below:

EXHIBIT INDEX

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.

+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.

+10.9 Office Lease by and between VASCO Data Security
International, Inc. and LaSalle National Bank, not
personally, but as Trustee under Trust Agreement dated
September 1, 1997, and known as Trust Number 53107,
dated July 22, 1985.

+10.10 Lease Agreement by and between TOPS sa and Digipass sa
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).

+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.

+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.

21 Subsidiaries of Registrant.

23 Consent of KPMG LLP.

27 Financial Data Schedule.
__________________________
+ 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.

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

VASCO Data Security International, Inc. will furnish any of the
above exhibits to its stockholders upon written request addressed to
the Secretary at the address given on the cover page of this Form 10-
K. The charge for furnishing copies of the exhibits is $.25 per
page, plus postage.

(b) Reports on Form 8-K

No reports on Form 8-K have been filed by the Registrant during
the quarter ended December 31, 1998.

VASCO Data Security International, Inc.
CONSOLIDATED BALANCE SHEETS

December 31, December 31,
1997 1998
---- ----

ASSETS
Current assets:
Cash $ 1,897,666 $ 1,523,075
Accounts receivable, net of allowance for
doubtful accounts of $429,000 and
$55,000 in 1997 and 1998 2,458,451 3,376,218
Inventories, net 1,001,294 1,272,327
Prepaid expenses 86,426 692,326
Deferred income taxes 83,000 83,000
Other current assets 221,572 277,322
----------- -----------
Total current assets 5,748,409 7,224,268

Property and equipment
Furniture and fixtures 488,338 580,427
Office equipment 322,434 468,975
----------- -----------
810,772 1,049,402
Accumulated depreciation (497,381) (691,806)
----------- -----------
313,391 357,596
Goodwill, net of accumulated amortization of
$198,000 and $327,000 in 1997 and 1998 704,124 575,211
Other assets 1,609,901 943,821
----------- -----------
Total assets $ 8,375,825 $ 9,100,896
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Current maturities of long-term debt $ 3,185,400 $ 6,528,867
Accounts payable 1,083,965 1,144,506
Customer deposits 426,914 519,585
Other accrued expenses 1,606,810 2,117,599
----------- -----------
Total current liabilities 6,303,089 10,310,557

Long-term debt, including stockholder note of
$5,000,000 in 1997 and 1998 8,442,946 8,435,903
Common stock subject to redemption 494,668 -

Stockholders' equity (deficit):
Preferred stock, 500,000 shares authorized,
none issued - -
Common stock, $.001 par value - 75,000,000
shares authorized; 20,132,968 shares
issued and outstanding in 1997;
20,805,697 shares issued and
outstanding in 1998 20,133 20,806
Additional paid-in capital 9,186,726 9,797,068
Accumulated deficit (15,901,575) (19,550,419)
Accumulated other comprehensive income-
cumulative translation adjustment (170,162) 86,981
----------- -----------
Total stockholders' equity (deficit) (6,864,878) (9,645,564)
----------- -----------

Total liabilities and stockholders'
equity (deficit) $ 8,375,825 $ 9,100,896
=========== ===========

See accompanying notes to consolidated financial statements.

VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS

For the Year Ended December 31,
-----------------------------------
1996 1997 1998
---- ---- ----

Revenue:
Data security products and services $ 9,988,885 $ 12,302,185 $ 15,015,927
Training and consulting 203,600 - -
----------- ------------ ------------
Total revenues 10,192,485 12,302,185 15,015,927

Cost of goods sold:
Data security products and services 5,678,223 6,286,688 6,949,308
Training and consulting 193,245 - -
----------- ------------ ------------
Total cost of goods sold 5,871,468 6,286,688 6,949,308
----------- ------------ ------------

Gross profit 4,321,017 6,015,497 8,066,619
----------- ------------ ------------
Operating costs:
Sales and marketing 1,405,453 3,380,777 4,368,398
Research and development 574,766 1,801,575 1,787,893
General and administrative 3,647,760 4,768,378 3,120,307
Acquired in-process research
and development 7,350,992 - -
----------- ------------ ------------
Total operating costs 12,978,971 9,950,730 9,276,598
----------- ------------ ------------
Operating loss (8,657,954) (3,935,233) (1,209,979)

Interest expense (346,248) (1,148,183) (1,457,627)
Other expense, net (42,407) (226,423) (294,236)
----------- ------------ ------------
Loss before income taxes (9,046,609) (5,309,839) (2,961,842)
Provision for income taxes 194,000 606,579 687,002
----------- ------------ ------------
Net Loss (9,240,609) (5,916,418) (3,648,844)
Preferred stock dividends (108,160) (81,900) -
----------- ------------ ------------
Net loss available to
common stockholders $(9,348,769) $ (5,998,318) $ (3,648,844)
=========== ============ ============

Basic and diluted net loss per
common share $ (0.53) $ (0.31) $ (0.18)
=========== ============ ============
Weighted average common shares
outstanding 17,533,369 19,105,684 20,430,692
=========== ============ ============

See accompanying notes to consolidated financial statements.

VASCO Data Security International, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Year Ended December 31,
---------------------------------------
1996 1997 1998
---- ---- ----

Net loss $ (9,240,609) $ (5,916,418) $ (3,648,844)

Other comprehensive income (loss) -
cumulative translation adjustment (105,056) (65,106) 257,143
------------ ------------ ------------

Comprehensive loss $ (9,345,665) $ (5,981,524) $ (3,391,701)
============ ============ ============

See accompanying notes to consolidated financial statements.

VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

Series A Series B Cum
Pref Stock Pref Stock Common Stock Accumulated Transl Treasury Stock Total
Description Shares Amt Shares Amt Shares Amount APIC Deficit Adj. Shares Amount Equity
- ----------- ------- ----- ----- --- ---------- ------ --------- ----------- -------- ------- -------- ----------

Bal at 12/31/95 317,181 $3,172 9,000 $ 90 15,793,575 $15,794 $1,508,534 $ (554,488) - 287,923 $ (7,109) $ 965,993

Net loss - - - - - - - (9,240,609) - - - (9,240,609)
Cash div paid on
preferred B - - - - - - - (108,000) - - - (108,000)
Dividends payable
on pref. A upon
conversion - - - - - - - (160) - - - (160)
Exercise of stock
options - - - - 24,000 24 5,215 - - - - 5,239
Issuance of common
stock - - - - 1,161,773 1,162 4,252,240 - - - - 4,253,402
Issuance of common
stock in connection
with Lintel
acquisition - - - - 140,651 141 3,387,769 - - (287,923) 7,109 3,395,019
Conversion of Series A
pref. stock (200,000)(2,000) - - 1,333,333 1,333 667 - - - - -
Cumulative translation
adjustment - - - - - - - - (105,056) - - (105,056)
Common stock subject
to redemption - - - - - - (371,000) - - - - (371,000)
------- ----- ----- -- ---------- ------ --------- ----------- --------- ------- -------- ----------
Bal at 12/31/96 117,181 1,172 9,000 90 18,453,332 18,454 8,783,425 (9,903,257) (105,056) - - (1,205,172)

Net loss - - - - - - - (5,916,418) - - - (5,916,418)
Cash div paid on
preferred B - - - - - - - (81,900) - - - (81,900)
Exercise of stock
options - - - - 189,375 189 42,281 - - - - 42,470
Cancellation of common
stock - - - - (16,489) (17) - - - - - (17)
Issuance of common
stock - - - - 83,714 83 418,079 - - (32,504) 227,528 645,690
Conversion of Series A
pref. stock (117,181) (1,172) - - 778,383 779 391 - - (2,824) 19,768 19,766
Conversion of Series B
preferred stock - - (9,000) (90) 644,653 645 (555) - - - - -
Repurchase of common
stock - - - - - - - - - 35,328 (247,296) (247,296)
Legal fees associated
with sale of stock - - - - - - (56,895) - - - - (56,895)
Cumulative translation
adjustment - - - - - - - - (65,106) - - (65,106)
------- ----- ----- -- ---------- ------ --------- ----------- --------- ------- -------- ----------
Bal at 12/31/97 - - - - 20,132,968 20,133 9,186,726 (15,901,575) (170,162) - - (6,864,878)

Net loss - - - - - - - (3,648,844) - - - (3,648,844)
Cumulative translation
adjustment - - - - - - - - 257,143 - - 257,143
Exercise of stock
options - - - - 658,257 658 115,689 - - - - 116,347
Exercise of stock
warrants - - - - 14,472 15 (15) - - - - -
Expiration of put
option - - - - - - 494,668 - - - - 494,668
------- ----- ----- -- ---------- ------ --------- ----------- --------- ------- -------- ----------

Bal at 12/31/98 - $ - - $- 20,805,697 $20,806 $9,797,068 $(19,550,419) $86,981 - $ - $(9,645,564)
======= ===== ===== == ========== ====== ========= =========== ========= ======= ======== ==========

See accompanying notes to consolidated financial statements.

VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Year Ended December 31,
-------------------------------------
1996 1997 1998
---- ---- ----

Cash flows from operating
activities:
Net loss $(9,240,609) $(5,916,418) $(3,648,844)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Acquired in-process research
and development 7,350,992 - -
Depreciation and amortization 728,734 1,248,807 994,483
Interest paid in shares of
common stock 118,750 418,196 -
Deferred income taxes 162,000 200,000 -
Loss on disposal of fixed assets - - 5,113
Changes in current assets and
current liabilities, net of
acquisitions:
Accounts receivable, net (1,067,374) 784,167 (917,767)
Inventories, net 578,143 1,181,449 (271,033)
Other current assets
and prepaid expenses (279,940) 563,867 (661,750)
Accounts payable 459,068 (861,679) 60,541
Customer deposits 1,022,195 (595,281) 92,671
Other accrued expenses (1,728,397) 948,726 510,789
--------- ----------- ---------
Net cash used in operations (1,896,438) (2,028,166) (3,835,797)
--------- ----------- ---------
Cash flows from investing activities:
Acquisition of Lintel/Digipass (4,461,144) - -
Additions to property and
equipment (283,142) (127,646) (248,708)
--------- ----------- ---------
Net cash used in investing
activities (4,744,286) (127,646) (248,708)
--------- ----------- ---------
Cash flows from financing activities:
Series B preferred stock dividends (108,000) (81,900) -
Net proceeds from issuance of
common stock 4,133,605 (56,895) -
Proceeds from exercise of
stock options 5,238 42,470 116,347
Repurchase of common stock - (247,261) -
Proceeds from issuance of debt 4,986,096 2,716,141 6,236,424
Repayment of debt (1,202,178) (67,564) (2,900,000)
--------- ----------- ----------
Net cash provided by financing
activities 7,814,761 2,304,991 3,452,771
--------- ----------- ----------

Effect of exchange rate changes on
cash (105,056) (65,106) 257,143
--------- ----------- ----------
Net increase (decrease) in cash 1,068,981 84,073 (374,591)
Cash, beginning of year 744,612 1,813,593 1,897,666
--------- ----------- ----------
Cash, end of year $ 1,813,593 $ 1,897,666 $ 1,523,075
========= =========== ==========

Supplemental disclosure of cash
flow information:
Interest paid $ 51,929 $ 53,865 $ 878,892
Income taxes paid $ 120,319 $ 415,480 $ 709,661

Supplemental disclosure of noncash
investing and financing activities:
Fair value of assets acquired from
Lintel/Digipass 12,003,644
Cash paid (4,461,144)

Notes payable, common stock and
warrants issued 7,542,500

Common stock issued upon
conversion of Series A pref stock $ 2,000 $ 1,172 $ -
=========== =========== ===========

Common stock issued upon
conversion of Series B pref stock $ - $ 90 $ -
=========== =========== ===========

See accompanying 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, VASCO Data Security, Inc., and VASCO Data Security
NV/SA (the Company), offer a variety of computer security products
and services. The Company's patented and proprietary hardware and
software products provide computer security, Advanced Authentication
Technology and RSA/DES encryption for financial institutions,
industry and government. The primary market for these products is
Europe.

Use of Estimates

The preparation of financial statements in conformity with
generally accepted accounting principles 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.

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.

Revenue Recognition

Revenues from the sale of computer security hardware and
imbedded software are recorded upon shipment. No significant
obligations exist with regard to delivery or customer acceptance
following shipment.

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. The
cost and accumulated depreciation of property sold or retired are
removed from the respective accounts and the resultant gains or
losses, if any, are included in current operations.

Software Costs

The Company capitalizes software development costs in accordance
with Statement of Financial Accounting Standards (SFAS) No. 86.
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. Unamortized capitalized costs determined to be in
excess of the net realizable value of a product are expensed at the
date of such determination.

The Company expensed $180,275, $0 and $0 in 1996, 1997 and 1998,
respectively, for the amortization of capitalized software costs.

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 and Long-Lived Assets

The following disclosures of the estimated fair value of
financial instrument are made in accordance with the requirements of
SFAS No. 107, "Disclosures and Fair Value of Financial Instruments."
The estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation
methodologies. The fair values of the Company's financial
instruments were not materially different from their carrying amounts
at December 31, 1997 and 1998, except for notes payable and long-term
debt, for which the fair value is not determinable.

On January 1, 1996, the Company adopted SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of," under which the Company has reviewed
long-lived assets and certain intangible assets and determined, based
on estimated undiscounted cash flows, that their carrying values as
of December 31, 1998 are recoverable in future periods.

Stock-Based Compensation

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

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.

Goodwill

Goodwill is amortized on a straight-line basis over the expected
period to be benefited, which is seven years. Adjustments to the
carrying value of goodwill are made if the sum of expected future
undiscounted net cash flows from the business acquired is less than
the book value of goodwill.

Loss Per Common Share

Basic earnings per share is based on the weighted average number
of shares outstanding and excludes the dilutive effect of unexercised
common stock equivalents. Diluted earnings per share is based on the
weighted average number of shares outstanding and includes the
dilutive effect of unexercised common stock equivalents. Because the
Company reported a net loss for the years ended December 31, 1996,
1997 and 1998, per share amounts for basic and diluted are the same,
and, therefore, have been presented under the basic method only.

Had the Company reported net earnings for the years ended
December 31, 1996, 1997 and 1998, the weighted average number of
shares outstanding would have potentially been increased by the
following common equivalent securities (not assuming the effects of
applying the treasury stock method to outstanding stock options or
the if-converted method to convertible securities):

1996 1997 1998
---- ---- ----

Stock options................ 1,661,632 1,945,257 1,475,500
Warrants .................... 928,578 1,056,922 1,004,034
Convertible notes (June 1996) 518,595 518,595 416,667
Convertible notes (July 1997)* - 657,895 -
Convertible notes (August 1997)* - 893,632 1,123,387
Convertible notes (March 1998) - - 528,048
--------- --------- ---------
3,108,805 5,072,301 4,547,636
========= ========= =========

* Due to the contingent nature of the conversion feature of these
notes, a 20-day average market price was used to calculate the number
of potentially dilutive shares.

Additionally, net earnings applicable to common stockholders for
the years ended December 31, 1996, 1997 and 1998 would have been
increased by adding back interest expense related to the convertible
notes of $265,450, $980,250 and $1,394,475, respectively.

Note 2 - Acquisitions

Effective March 1, 1996, the Company acquired a 15% interest in
Lintel NV (Lintel). On June 1, 1996, the Company acquired the
remaining 85% of Lintel. Lintel, located in Brussels, Belgium, was a
developer of security technologies for personal computers, computer
networks and telecommunications systems, using cryptographic
algorithms such as DES and RSA. The results of Lintel's operations
are included in the Company's consolidated statement of operations
from March 1, 1996 with minority interest being reflected in other
expense in the consolidated statement of operation for the period
from March 1, 1996 to June 1, 1996. The purchase price was
$4,432,000, consisting of $289,482 in cash, $747,500 in 8%
convertible notes payable due May 30, 1998 and convertible to common
stock at a rate of $7.00 per share, 428,574 shares of the Company's
common stock valued at $7.00 per share, and 100,000 purchase warrants
for the Company's common stock at an exercise price of $7.00 per
share. The warrants were recorded at their fair value on the date of
grant.

The acquisition of Lintel was accounted for as a purchase and,
accordingly, the acquired assets have been recorded at their
estimated fair values at the date of the acquisition. Acquired in-
process research and development in the amount of $2,900,000 was
expensed during 1996 in conjunction with the acquisition, based upon
an independent third-party valuation. Goodwill related to this
transaction was $387,000, which is being amortized over a period of
seven years.

Effective July 1, 1996, the Company acquired Digipass s.a.
(Digipass). Digipass, located in Belgium, was a developer of
security technologies for personal computers, computer networks and
telecommunications systems using the DES cryptographic algorithm.
Prior to the Company's acquisition of Digipass, the assets of the
interactive voice response (IVR) business of Digiline SA were
transferred to Digipass. Digipass' IVR products are used primarily
in telebanking applications and in corporate authentication and
access control technology. The purchase price was $8,200,000, with
$4,800,000 being paid at the effective date of acquisition, and the
balance of $3,400,000 in the form of a note, which was paid in August
1997.

The acquisition of Digipass was accounted for as a purchase and,
accordingly, the acquired assets and liabilities have been recorded
at their estimated fair values at the date of the acquisition.
Acquired in-process research and development in the amount of
$4,451,000 was expensed during 1996, based upon an independent third-
party valuation. Goodwill related to this transaction was $491,000,
which is being amortized over a period of seven years. The results
of operations for Digipass have been included in the consolidated
statement of operations subsequent to July 1, 1996.

Other assets, resulting from the acquisitions of Lintel and
Digipass, are comprised of the following at December 31, 1997 and
1998 (net of accumulated amortization of $1,318,000 and $1,984,000 as
of December 31, 1997 and 1998, respectively):

December 31,
---------------------
1997 1998
---- ----

Software and hardware technology... $ 988,417 $ 436,417
Workforce ......................... 200,388 163,737
Customer lists .................... 421,096 343,667
---------- ----------
$1,609,901 $ 943,821
========== ==========

Software and hardware technology is being amortized over a
period of three to four years while workforce and customer lists are
being amortized over a period of seven years. Amortization of these
assets was $374,892, $943,207 and $666,079 for the years ended
December 31, 1996, 1997 and 1998, respectively. Included in the 1997
amortization is a write-down in the amount of $234,493 related to the
workforce of Digipass, due to attrition realized during the year.

Note 3 - Inventories

Inventories, consisting principally of hardware and component
parts, are stated at the lower of cost or market. Cost is determined
using the first-in-first-out (FIFO) method.

Inventories are comprised of the following:

December 31,
-------------------
1997 1998
---- ----

Component parts ..................... $ 569,922 $ 407,597
Work-in-process and finished goods... 595,372 993,730
Obsolescence reserves ............... (164,000) (129,000)
---------- ----------
$1,001,294 $1,272,327
========== ==========

The Company uses multiple suppliers for the microprocessors used
in the production of hardware products, as well as for the assembly
of the products. The microprocessors are the only components of the
Company's hardware devices that would be considered non-commodity
items and may not be readily available on the open market. There is,
however, an inherent risk associated with each supplier of
microprocessors. In order to increase orders of microprocessors, a
lead time of twelve weeks is typically needed. The Company maintains
a sufficient inventory of all component parts to handle short-term
spikes in order quantities.

Note 4 - Other Accrued Expenses

Other accrued expenses are comprised of the following:

December 31,
--------------------
1997 1998
---- ----

Accrued expenses ............... $ 609,271 $ 852,428
Accrued interest ............... 657,799 860,957
Accrued payroll ................ 171,231 223,369
Accrued dividends .............. 168,509 180,845
---------- ----------
$1,606,810 $2,117,599
========== ==========

Note 5 - Income Taxes

At December 31, 1998, the Company has United States net
operating loss carryforwards approximating $7,434,000 and foreign net
operating loss carryforwards approximating $1,092,000. Such losses
are available to offset future taxable income at VASCO Data Security
International, Inc. and its U.S. subsidiary and expire in varying
amounts beginning in 2002 and continuing through 2018. In addition,
if certain substantial changes in the Company's ownership should
occur, there would be an annual limitation on the amount of the
carryforwards which could be utilized.

Pretax loss from continuing operations was taxed in the
following jurisdictions:

For the Year Ended
December 31,
---------------------------------------
1996 1997 1998
---- ---- ----

Domestic ........... $(1,205,853) $(4,655,220) $(3,032,689)
Foreign ............ (7,840,756) (654,619) 70,847
------------ ------------ ------------
$(9,046,609) $(5,309,839) $(2,961,842)
============ ============ ============

The provision for income taxes consists of the following:

For the Year Ended
December 31,
1996 1997 1998
---- ---- ----

Current:
Federal ........... $ - $ - $ -
State ............. - - (2,514)
Foreign ........... 31,670 406,579 689,516

Deferred:
Federal ........... $ 142,182 $ 175,176 $ -
State ............. 20,148 24,824 -
Foreign ........... - - -
--------- --------- ---------
Total $ 194,000 $ 606,579 $ 687,002
========= ========= =========

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

For the Year Ended
December 31,
--------------------------------------
1996 1997 1998
---- ---- ----

Expected tax benefit at the
statutory rate.......................$(3,075,847) $(1,805,345) $(1,007,000)
Increase (decrease) in income taxes
resulting from:
State tax expense, net of fed benefit. (56,414) (144,937) (142,800)
Foreign taxes at rates other than 34%. 163,107 149,549 665,000
Change in valuation allowance......... 631,000 1,779,000 1,035,000
Nondeductible acquired in-process tech 2,499,337 - -
Nondeductible expenses................ 2,831 622,257 100,000
Other, net ........................... 29,986 6,055 36,802
---------- ----------- -----------
Total $ 194,000 $ 606,579 $ 687,002
========== =========== ===========

The deferred income tax balances are comprised of the following:

December 31,
---------------------------
1997 1998
---- ----

Deferred tax assets:
U.S. net operating loss carryforwards $1,833,000 $2,886,000
Foreign net oper loss carryforward... 412,000 439,000
Inventory ........................... 44,000 25,000
Accounts receivable ................. 149,000 11,000
Accrued expenses .................... - 128,000
Deferred revenue .................... - 13,000
Fixed assets ........................ 30,000 22,000
Other ............................... 25,000 6,000
--------- ---------
Total gross deferred income tax assets. 2,493,000 3,530,000
Less valuation allowance ............ (2,410,000) (3,445,000)
--------- ---------
83,000 85,000
Deferred tax liabilities:
Fixed assets ........................ - (2,000)
--------- ----------
Net deferred income taxes ............. $ 83,000 $ 83,000
========= ==========

The net change in the total valuation allowance for the years
ended December 31, 1996, 1997 and 1998 was an increase of $631,000,
$1,779,000 and $1,035,000, 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 assessment was performed considering the scheduled
reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies. The Company has determined that
it is more likely than not that $83,000 of deferred tax assets will
be realized. The remaining valuation allowance of $3,445,000 is
maintained on deferred tax assets which the Company has not
determined to be more likely than not realizable as of December 31,
1998. This valuation allowance will be reviewed on a regular basis
and adjustments made as appropriate.

Note 6 - Debt

Debt consists of the following:

December 31,
------------------------
1997 1998
---- ----

Convertible stockholder note, interest payable at 9% $ 5,000,000 $ 5,000,000
Convertible stockholders' notes, interest
payable at 8% ................................... 636,921 -
Convertible note, interest payable at 3.25%......... 3,400,000 3,400,000
Convertible note, interest payable at 3.25%......... 2,500,000 -
Convertible note, interest payable at 9.5%.......... - 3,000,000
Revolving line of credit, interest payable at 6.48%. - 3,000,000
Short-term credit facility, interest payable at 8.1% - 450,000
Installment notes payable .......................... 91,425 114,770
----------- -----------
11,628,346 14,964,770
Less current maturities ............................ (3,185,400) (6,528,867)
----------- -----------
Long-term debt ..................................... $ 8,442,946 $ 8,435,903
=========== ===========

On March 31, 1998, the Company entered into a loan agreement
with Lernout & Hauspie Speech Products N.V. ("L&H") in the amount of
$3 million, bearing interest at 9.5%, payable quarterly, with an
original maturity of January 4, 1999. The maturity of this note has
been extended to coincide with a private placement of the Company's
equity during the second quarter of 1999. This loan is convertible
at the option of the holder into shares of the Company's common stock
based upon the average closing price of VASCO Data Security
International, Inc.'s common stock for the 10 trading days prior to
March 11, 1998, the date the Exchange Offer closed. This loan was
funded in April 1998.

In December 1998, the Company entered into a short-term credit
facility with a European bank. This facility, bearing interest at a
rate of 8.1%, provided for $450,000 in funds to allow the Company to
extend and expand its licensing agreement with Lernout & Hauspie
Speech Products N.V. This facility was repaid during January 1999
and was terminated at that time.

In June 1997, the Company entered into a new financing agreement
with a European bank. The new agreement provides for $2.5 million in
financing, with a maturity of September 30, 1998, bears interest at a
rate of 3.25% annually and is convertible into common stock of the
Company at the option of the bank, at conversion prices as specified
in the agreement. As of the maturity date of September 30, 1998, per
the terms of the agreement, 116% of the principal amount was repaid
from the proceeds of a short-term borrowing facility secured by the
Company with KBC Bank. The KBC Bank facility represents a three-
month revolver, renewable for additional three-month terms, with a
corresponding interest rate of 6.48%. This facility is expected to be
repaid from the proceeds of a private placement that the Company
expects to complete during the second quarter of 1999.

In August 1997, the Company renegotiated the guarantee related
to the final payment for the 1996 acquisition of Digipass into a term
loan in the amount of $3.4 million. The note matures on September
30, 2002 and bears interest at a rate of 3.25% annually. In the event
a public offering is completed, the lender may at its option require
the principal amount of the loan to be repaid in cash, in which case
additional special interest is payable as follows: $340,000 if
repayment is on or before June 30, 1998, $510,000 if repayment is
between July 1, 1998 and December 31, 1998 and $680,000 if repayment
is on January 1, 1999 or later. In addition, the note is convertible
into common stock of the Company at the option of the bank, at a
conversion prices as specified in the agreement. The Company has
accrued $510,000 in special interest as of December 31, 1998. As part
of this transaction, T. Kendall Hunt, the Company's Chairman/CEO,
entered into a pledge agreement with this financial institution
pursuant to which he pledged, as collateral for the convertible note,
1,416,666 of his shares of common stock of the Company, which number
of shares is subject to adjustment based on the market value of the
shares.

During 1996, the Company acquired two companies located in
Europe (see Note 2). To facilitate the first acquisition, Lintel,
one component of the purchase price was represented by two
convertible notes, each payable in the amount of $373,750 ($747,500
total) due May 30, 1998. The notes are convertible at the holders'
option at a rate of $7.00 per share of common stock. During 1996 and
1997, these notes were paid down by $33,750 and $76,829,
respectively. Each of these notes bears an interest rate of 8%, with
interest payments made on a quarterly basis. At the holders' option,
the interest may be paid either in cash or in common stock of the
Company. In calculating the shares of common stock to be issued in
lieu of cash interest, the average closing price for the Company's
common stock for the previous 20 trading days is used. These notes
were repaid upon maturity.

During 1996, the Company continued to raise capital privately,
including a private placement consisting of the issuance of 666,666
shares of common stock and a $5,000,000 convertible note due May 29,
2001. The note bears interest at 9%, with interest payable to the
holder on a quarterly basis. The holder may, at its option, elect to
receive interest payments in cash or common stock. In calculating
the shares of common stock to be issued in lieu of cash interest, the
average closing price for the Company's common stock for the previous
20 trading days is used.

Aggregate maturities of debt at December 31, 1998 are as
follows:

1999 ............................... $6,528,867
2000 ............................... 35,903
2001 ............................... 5,000,000
2002 and thereafter ................ 3,400,000
----------
Total .................... $14,964,770
==========

Interest expense to stockholders was $265,565, $507,100 and
$497,795 for the years ended December 31, 1996, 1997 and 1998,
respectively.

Note 7 - Stockholders' Equity

Preferred Stock

The Company has the authority to issue 500,000 shares of
preferred stock. As of December 31, 1997, 317,181 of these shares
had been designated Series A, 8% convertible preferred stock and
9,500 had been designated Series B, 12% convertible preferred stock.
The remaining 173,319 shares were undesignated.

The Series A, 8% convertible preferred stock (Series A Shares)
consisted of 317,181 shares that carried a cumulative dividend,
payable upon conversion, of 8% per annum. During 1996, 200,000
Series A Shares were converted into 1,333,333 shares of common stock;
the remaining 117,181 Series A Shares were converted into 781,207
shares of common stock during 1997.

The Series B, 12% convertible preferred stock (Series B Shares)
consisted of 9,000 shares that carried a cumulative dividend, payable
monthly, of 12% per annum based on a liquidation value of $100 per
share. On September 17, 1997, all 9,000 Series B Shares were
converted into 644,653 shares of common stock.

As a result of the above, the 500,000 authorized shares of
preferred stock were undesignated as of December 31, 1998.

Common Stock

During 1995, the Company privately placed 108,676 equity units,
each consisting of two shares of common stock reissued from treasury
with one warrant to purchase one share of common stock at $6.00.
Included in the 108,676 equity units are 53,000 equity units subject
to redemption, at the option of the holder, at a price of $7.00 per
share, or $14.00 per equity unit. In March 1997, 17,664 of these
equity units (representing 35,328 shares of common stock and 17,664
warrants) were redeemed at $14.00 per equity unit, with 70,667
warrants to purchase one share of common stock at $5.19 being issued
to the holders of the redeemed units. The "put" option related to
the remaining 35,336 equity units expired in March 1998.

During 1998, the Company issued 658,257 shares of common stock
as a result of the exercise of options under the Company's stock
option plan (see Note 8) generating total proceeds of $116,347;
14,472 shares of common stock were issued as a result of the exercise
of the Company's stock warrants, under the cashless exercise
provision contained within the warrant itself.

In July 1997, the Company reissued 2,824 shares of common stock
from treasury and 778,383 original issue shares in conjunction with
the conversion of the 117,181 Series A Shares (see Preferred Stock
above). Additionally, in September 1997, the Company issued 644,653
shares of common stock in conjunction with the conversion of the
9,000 Series B Shares (see Preferred Stock above).

Additional common stock transactions during 1997 were as
follows: 189,375 shares of common stock were issued as a result of
the exercise of options under the Company's incentive stock option
plan (see Note 8) for total proceeds of $42,470; 16,489 shares of
common stock that had been issued in December 1996 were subsequently
canceled; and 116,218 shares of common stock were issued in lieu of
interest related to the $5,000,000 convertible note placed during
1996 (see Note 6).

During 1996, the Company reissued 287,923 shares of treasury
stock, issued 140,651 shares of common stock and 100,000 warrants to
purchase one share of common stock at $7.00 as a part of the
acquisition of Lintel (see Note 2). The warrants were recorded at
their fair value on the date of grant. In addition, the Company
continued to raise money through private placements of its common
stock. In the first quarter of 1996, the Company privately placed
167,482 shares of common stock and 83,741 warrants to purchase one
share of common stock at $6.00, generating $284,720 in net proceeds.
The warrants are exercisable at the option of the holder, however,
the Company maintains the right to require exercise of the warrants
30 days prior to a public offering of the Company's stock.

During the second quarter of 1996, the Company placed 666,666
shares of common stock with 137,777 warrants to purchase one share of
common stock at $4.50. Total issue fees and costs of $170,000 have
been netted against $3,000,000 of proceeds from the placement in the
Company's financial statements. In addition, 55,555 shares of common
stock and 8,889 warrants to purchase one share of common stock at
$4.50 were issued as commissions related to the placement.

The Company raised additional funds in 1996 in a private
placement of 237,060 shares of common stock with 35,329 warrants to
purchase one share of common stock at $4.50. Total issue fees and
costs of $47,885 have been netted against the $1,066,770 in total
proceeds from the placement in the Company's financial statements.
In addition, 16,489 shares of common stock were issued as commissions
related to the placement, but were canceled in 1997.

Additional common stock transactions during 1996 were as
follows: 1,333,333 shares of common stock were issued pursuant to
the conversion of 200,000 shares of Series A preferred stock; 24,000
shares of common stock were issued as a result of the exercise of
options under the Company's incentive stock option plan (see Note 8)
for total proceeds of $5,238; and 20,021 shares of common stock were
issued in lieu of an interest payment in the amount of $118,750
related to the private debt placement that occurred during 1996 (see
Note 6).

Note 8 - Stock Option Plan

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

The Option 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 vested 20% on
the first anniversary of the grant, with an additional 20% vesting on
each subsequent anniversary of the grant.

The Option 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 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 may contain vesting requirements and/or restrictions as
determined by the Compensation Committee at the time of grant.

The Option Plan is authorized to issue options representing up
to 5,000,000 shares of the Company's common stock.

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

For the Year Ended December 31,
------------------------------------------
1996 1997 1998
---- ---- ----

Net loss available to common
stockholders:
As reported ............ $ (9,348,769) $ (5,998,318) $ (3,648,844)
Pro forma .............. (9,542,493) (6,271,420) (3,993,763)
Net loss per common share-
basic and diluted:
As reported ............ $ (0.53) $ (0.31) $ (0.18)
Pro forma .............. (0.54) (0.33) (0.20)

For purposes of calculating the compensation cost consistent
with SFAS No. 123, the fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions used for grants in
fiscal 1996, 1997 and 1998: dividend yield of 0%; expected
volatility of 50%; risk free interest rates ranging from 4.00% to
6.80%; and expected lives of five years.

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

Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average
Fair Value
Weighted Weighted of
Options Average Options Average Options
Outstanding Price Exercisable Price Granted
----------- ----- ----------- ----- -------

Outstanding at
December 31, 1995 1,425,382 $ 0.20 1,232,257 $ 0.20
Granted................ 335,000 4.65 $ 2.43
Exercised.............. (24,000) 0.23
Forfeited.............. (74,750) 2.14
--------- -------
Outstanding at
December 31, 1996...... 1,661,632 1.01 1,299,757 0.57
Granted................ 512,500 4.18 $ 1.95
Exercised.............. (189,375) 0.22
Forfeited.............. (39,500) 3.91
--------- -------
Outstanding at
December 31, 1997...... 1,945,257 1.85 1,460,629 1.29
Granted................ 245,250 5.09 $ 2.55
Exercised.............. (658,257) 0.18
Forfeited.............. (56,750) 4.25
--------- -------
Outstanding at
December 31, 1998..... 1,475,500 $ 3.05 1,088,375 $ 2.48
========= ======= ========= ======

The following table summarizes information about stock options
outstanding at December 31, 1998:

Options Outstanding Options
Exercisable
--------------------------- ---------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
of Contractual Exercise of Exercise
Range of Exercise Price Shares Life Price Shares Price
- ----------------------- ------ ---------- ----- -------- -------

$2.50 - 6.00 ........ 963,000 8.35 years $ 4.55 575,875 $ 4.49
$0.1875 - 0.25 ...... 512,500 3.59 years $ 0.22 512,500 $ 0.22

Note 9 - Employee Benefit Plan

The Company maintains a contributory profit sharing plan
established pursuant to the provisions of Section 401(k) of the
Internal Revenue Code which provides benefits for eligible employees
of the Company. The Company made no contributions to the plan during
the years ended December 31, 1996, 1997 and 1998.

Note 10 - Geographic and Customer Information

During each of the last three fiscal years, the Company has
operated in only one industry segment. During 1996, 1997 and 1998,
sales to one customer (a reseller of the Company's product)
aggregated approximately $4,297,000, $1,994,000 and $1,950,000
respectively, representing 44%, 16% and 13% of the total revenues,
respectively. Accounts receivable from this customer represented 40%
and 60% of the Company's gross accounts receivable balance at
December 31, 1997 and 1998, respectively. Sales to unaffiliated
customers are based upon the point of sale versus the location of the
customer. However, United States sales to unaffiliated customers
includes export sales from the Company's United States operations to
unaffiliated customers in the Netherlands of approximately
$4,297,000, $1,994,000 and $1,950,000 for the years ended December
31, 1996, 1997 and 1998, respectively.

Information regarding geographic areas for the year ended
December 31, 1996 is as follows:

United Belgium Total
States
------ ------- -----

Sales to unaffiliated customers $ 4,774,000 $ 5,418,000 $ 10,192,000

Long-lived assets 270,000 3,478,000 3,748,000

Information regarding geographic areas for the year ended
December 31, 1997 is as follows:

United Belgium Total
States
------ ------- -----

Sales to unaffiliated customers $ 2,784,000 $ 9,518,000 $ 12,302,000

Long-lived assets 285,000 2,432,000 2,717,000

Information regarding geographic areas for the year ended
December 31, 1998 is as follows:

United Belgium Total
States
------ ------- -----

Sales to unaffiliated customers $ 2,785,000 $12,231,000 $ 15,016,000

Long-lived assets 257,000 1,721,000 1,978,000

Note 11 - Commitments and Contingencies

The Company leases office space and equipment under operating
lease agreements expiring at various times during 1999.

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

Year Amount
1999 ................................ $147,380

Rent expense under operating leases aggregated approximately
$158,000, $213,000 and $285,000 for the years ended December 31,
1996, 1997 and 1998, respectively.

During a period of time extending from the mid-1980s to the mid-
1990s the Company engaged in certain matters that were not in
compliance with requisite corporate law. There have been no lawsuits
asserted or filed against the Company related to these matters.
Management cannot assess the likelihood that a lawsuit would be filed
nor can management estimate a potential range of loss.

The Company is subject to legal proceedings and claims which
have arisen in the ordinary course of its business and have not been
finally adjudicated. These actions, when ultimately concluded and
determined, will not, in the opinion of management, have a material
adverse impact on the financial position, results of operations and
liquidity of the Company.

Note 12 - Subsequent Events

On April 6, 1999, Security Dynamics Technologies, Inc., RSA Data
Security, Inc., the Company and VASCO Data Security, Inc. announced
settlement on confidential terms of the claims that each of the
companies had raised in litigation filed last year.

On April 14, 1999, the Company completed a private placement of
Common Stock in the amount of $11.5 million. The transaction
represented a sale of the Company's Common Stock to European
institutional investors at a price of $3.50 per share. A total of
3,285,714 shares of Common Stock were issued as a part of this
transaction.

INDEPENDENT AUDITORS' REPORT

The Stockholders and Board of Directors
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, 1997 and 1998 and the related
statements of operations, comprehensive income, stockholders' equity
(deficit), and cash flows for each of the years in the three-year
period ended December 31, 1998.
In connection with our audits of the consolidated financial
statements, we have also audited the consolidated financial statement
schedule as listed in the accompanying index. 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 generally
accepted auditing standards. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the
financial position of VASCO Data Security International, Inc. and
subsidiaries as of December 31, 1997 and 1998, and the results of
their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also, in our opinion, the
related consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set
forth therein.

/s/ KPMG LLP

Chicago, Illinois
March 12, 1999, except for Note 12
which is as of April 15, 1999

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 Balance
Off
- ---------------------------- ---------- ---------- -------- --------

Year ended December 31, 1996 $ 182,000 $ 346,000 $ (76,000) $ 452,000
Year ended December 31, 1997 452,000 97,000 (120,000) 429,000
Year ended December 31, 1998 429,000 (272,000) (102,000) 55,000

Beginning Obsolescence Inventory Ending
Reserve for Obsolete Balance Expense Written Balance
Inventories Off
- ---------------------------- ---------- ---------- -------- --------

Year ended December 31, 1996 $ 114,000 $ 40,000 $ - $ 154,000
Year ended December 31, 1997 154,000 101,000 (91,000) 164,000
Year ended December 31, 1998 164,000 35,000 70,000) 129,000

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 April 15, 1999.

VASCO Data Security International, Inc.

/s/ T. Kendall Hunt
T. Kendall Hunt
Chairman of the Board, Chief Executive
Officer and President

Pursuant to the requirements of the Securities Exchange Act of
1934, this Report has been signed by the following persons on behalf
of the Registrant in the capacities indicated on April 15, 1999.

POWER OF ATTORNEY

Each of the undersigned, in his capacity as an officer or
director, or both, as the case may be, of VASCO Data Security
International, Inc. does hereby appoint T. Kendall Hunt and Gregory
T. Apple, 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, 1998 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 Chairman of the Board,
Chief Executive Officer
T. Kendall Hunt and President and Director
(Principal Executive Officer)

/s/ Gregory T. Apple Vice President and Treasurer
Gregory T. Apple (Principal Financial Officer
and Principal Accounting
Officer)

/s/ Robert E. Anderson Director
Robert E. Anderson

/s/ Michael P. Cullinane Director
Michael P. Cullinane

/s/ Pol Hauspie Director
Pol Hauspie

/s/ Mario A. Houthooft Director
Mario A. Houthooft

/s/ Forrest D. Laidley Director
Forrest D. Laidley

/s/ Michael A. Mulshine Director
Michael A. Mulshine