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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, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________TO _________
Commission file number 000-24389
VASCO DATA SECURITY INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 36-4169320
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
1901 SOUTH MEYERS ROAD, SUITE 210
OAKBROOK TERRACE, ILLINOIS 60181
(Address of Principal Executive Offices)(Zip Code)
Registrant's telephone number, including area
code:
(630) 932-8844
Securities registered pursuant to Section 12(b)
of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes__X__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes__ No _X_
As of June 30, 2004, the aggregate market value of voting and non-voting
common equity (based upon the last sale price of the Common Stock as reported on
Nasdaq on June 30, 2004) held by non-affiliates of the registrant was
$48,685,000 at $2.15 per share.
As of March 24, 2005, there were 35,317,625 common shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
INDEX
PAGE
PART I
Item 1. Description of Business 3
Item 2. Properties 13
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 14
Item 6. Selected Consolidated Financial Data 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 33
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures 34
Item 9A. Controls and Procedures 34
Item 9B. Other Information 34
PART III
Item 10. Directors and Executive Officers of the Registrant 35
Item 11. Executive Compensation 37
Item 12. Security Ownership of Certain Beneficial Owners and Management 40
Item 13. Certain Relationships and Related Transactions 42
Item 14. Principal Accountants Fees and Services 42
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8K 42
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE F-1
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PART I
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K, including "Management's Discussion and
Analysis of Financial Condition and Results of Operations," contains
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 concerning, among other things, the prospects,
developments and business strategies for the Company (as defined) and its
operations, including the development and marketing of certain new products and
the anticipated future growth in certain markets in which the Company currently
markets and sells its products or anticipates selling and marketing its products
in the future. These forward-looking statements (i) are identified by their use
of such terms and phrases as "expected," "expects," "believe," "believes,"
"will," "anticipated," "emerging," "intends," "plans," "could," "may,"
"estimates," "should," "objective" and "goals" and (ii) are subject to risks and
uncertainties and represent the Company's present expectations or beliefs
concerning future events. The Company cautions that the forward-looking
statements are qualified by important factors that could cause actual results to
differ materially from those in the forward-looking statements, including (a)
risks of general market conditions, including demand for the Company's products
and services, competition and price levels and the Company's historical
dependence on relatively few products, certain suppliers and certain key
customers, and (b) risks inherent to the computer and network security industry,
including rapidly changing technology, evolving industry standards, increasing
numbers of patent infringement claims, changes in customer requirements, price
competitive bidding, changing government regulations and potential competition
from more established firms and others. Therefore, results actually achieved may
differ materially from expected results included in, or implied by, these
statements.
ITEM 1 - DESCRIPTION OF BUSINESS
VASCO Data Security International, Inc. was incorporated in Delaware in
1997 and is the successor to VASCO Corp., a Delaware corporation. Our principal
executive offices are located at 1901 South Meyers Road, Suite 210, Oakbrook
Terrace, Illinois 60181 and the telephone number at that address is (630)
932-8844. Our principal offices in Europe are located at Koningin Astridlaan
164, B-1780 Wemmel (Belgium) and the telephone number at that address is
32(0)2/456.98.10. Unless otherwise noted, references in this Annual Report to
"VASCO," "Company," "company, " "we," "our," and "us" refer to VASCO Data
Security International, Inc. and its subsidiaries.
Additional information on the Company, its products and its results may
be found on the Company's web site at www.vasco.com.
GENERAL
The Company, through its operating subsidiaries, designs, develops,
markets and supports open standards-based hardware and software security systems
that manage and secure access to information assets. We design, develop, market
and support patented "Identity Authentication" products for e-business and
e-commerce. Our products enable secure financial transactions to be made over
private enterprise networks and public networks, such as the Internet. VASCO's
Identity Authentication software is delivered via its Digipass security
products, small "calculator" hardware devices carried by an end user, or in a
software format on mobile phones, other portable devices, and PCs. The Digipass
devices, most of which incorporate an electronic signature capability, guarantee
the integrity of electronic transactions and data transmissions. Some of the
Digipass units are compliant with the Europay MasterCard Visa ("EMV") standard
and are compatible with MasterCard's new smart card.
- -----------------
This report contains the following trademarks of the Company, some of
which are registered: VASCO, AccessKey, VACMan Server and VACMan/CryptaPak,
AuthentiCard, Digipass, and Digipass Pack.
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For user access control, VASCO's VACMAN Server products limit
application access to designated Digipass users. Digipass and VACMAN combine to
provide greater flexibility and a more affordable means than competing products
of authenticating to any network, including the Internet.
VASCO's target markets are the applications and their several hundred
million users that utilize fixed passwords as security. VASCO's time-based
system generates a "one-time" password that changes with every use. As a result,
when compared to fixed passwords, it substantially reduces the risk of
unauthorized access to the application.
At the end of fiscal 2004, VASCO had shipped approximately 13.5 million
Digipass units since its inception. Our security solutions are sold worldwide
through our direct sales force, as well as through distributors, resellers and
systems integrators. We currently have more than 1,500 customers in more than 80
countries. Representative customers of our products include Rabobank Nederland,
ING Bank, Fortis Bank, Wachovia, Daimler Chrysler, Volvo and CoStar Group. In
2004, the Company sold to 543 new accounts of which 70 were banks and 473 were
corporate network access customers.
COMPANY BACKGROUND
Our predecessor company, VASCO Corp., entered the data security
business in 1991 through the acquisition of a controlling interest in ThumbScan,
Inc., which we renamed VASCO Data Security, Inc. in 1993. In 1996, we began an
expansion of our computer security business by acquiring Lintel Security NV/SA,
a Belgian corporation, which included assets associated with the development of
security tokens and security technologies for personal computers and computer
networks. In addition, in 1996, we acquired Digipass NV/SA, a Belgian
corporation, which was also a developer of security tokens and security
technologies and whose name we changed to VASCO Data Security NV/SA in 1997.
On March 11, 1998, we completed a registered exchange offer with the
holders of the outstanding securities of VASCO Corp. Since the exchange offer,
we have engaged in four acquisitions and one disposition. In May 1999, we
acquired the assets of SecureWare SA, a French company, for a combination of our
stock and cash totaling approximately $1.4 million. In October 1999, we acquired
Intellisoft Corp. for stock and cash totaling approximately $8 million with the
cash being distributed to dissenting shareholders. In August 2000, we acquired
Invincible Data Systems (IDS) for a total of 322,565 shares of Common Stock.
We acquired Identikey Ltd. ("Identikey") in March 2001, a privately
held international security software company headquartered in Brisbane,
Australia. Under the terms of the purchase agreement, more than 90 percent of
the outstanding capital stock of Identikey was exchanged for 366,913 shares of
Common Stock. The remaining 10% of Identikey has been acquired at various times
with the final purchase completed in January 2003 in exchange for 126,426 shares
of Common Stock and $23,362 in cash.
In July 2003, we sold our interest in the VACMAN Enterprise business
unit, which assets were acquired in the Intellisoft transaction, to SecureD
Services, Inc. ("SSI"). Under the terms of the agreement, the Company received a
senior secured promissory note with a face value of approximately $1.1 million,
valued at $1.0 million by an independent valuation firm, and $2 million of
Convertible Preferred Stock from SSI, valued at $0.6 million by an independent
valuation firm, in exchange for the VACMAN Enterprise assets. The promissory
note bears a 6% interest rate and is payable in 36 equal and consecutive monthly
payments. The Preferred Stock includes a 6% cumulative stock dividend, payable
quarterly, and can be converted into SSI's common stock at defined intervals
beginning July 1, 2005. In accordance with Statement of Financial Accounting
Standard (SFAS) No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets", the assets and liabilities of this business unit have been
disaggregated from the operational assets and liabilities of the Company and
have been reported as results of discontinued operations. Prior periods have
been restated to conform to this presentation.
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INDUSTRY BACKGROUND
The growth in electronic banking and electronic commerce, and the
increasing use and reliance upon proprietary or confidential information by
businesses, government and educational institutions that is remotely accessible
by many users, has made information security a paramount concern. We believe
that enterprises are seeking solutions that will continue to allow them to
expand access to data and financial assets while maintaining network security.
Internet and Enterprise Security. With the advent of personal computers
and distributed information systems in the form of wide area networks,
intranets, local area networks and the Internet, as well as other direct
electronic links, many organizations have implemented applications to enable
their work force and third parties, including vendors, suppliers and customers,
to access and exchange data and perform electronic transactions. As a result of
the increased number of users having direct and remote access to such enterprise
applications, data and financial assets have become increasingly vulnerable to
unauthorized access and misuse.
Individual User Security. In addition to the need for enterprise-wide
security, the proliferation of personal computers, personal digital assistants
and mobile telephones in both the home and office settings, combined with
widespread access to the Internet, have created significant opportunities for
electronic commerce by individual users such as electronic bill payment, home
banking and home shopping.
Fueled by well-publicized incidents, including misappropriation of
credit card information and denial of service attacks, there is a growing
perception among many consumers that there is a risk involved in transmitting
information via the Internet. These incidents and this perception may hamper the
development of consumer-based electronic commerce. Accordingly, we believe that
electronic commerce will benefit from the implementation of improved security
measures that accurately identify users and reliably encrypt data transmissions
over the Internet. Most banks in European countries are expected to issue smart
cards (credit cards with a micro-chip) that are compliant with the EMV standard
starting in 2005.
Components of Security. Data and financial asset security, and secured
access to and participation in on-line commerce, generally consist of the
following components:
o Encryption: Maintains data privacy by converting information into
an unreadable pattern and allowing only authorized parties to
decrypt the data. Encryption can also maintain data integrity by
creating digital signatures for transmitted data, enabling the
recipient to check whether the data has been changed since or
during transmission.
o 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.
o Access Control: Software that provides authentication,
authorization, and accounting functions, controlling a user's
access to only that data or the financial assets which he or she
is authorized to access, and that keeps track of a user's
activities after access has been granted.
o Administration and Management Tools: Software that sets,
implements, and monitors security policies, the access to which is
typically regulated by access control systems. These tools are
extremely important to the overall effectiveness of a security
system.
The most effective security policies employ most, if not all, of the
above components. Most companies, however, only implement a patchwork of these
components, which could result in their security systems being compromised.
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THE VASCO SOLUTION
The Company has found that, to date, most approaches to network security,
including Internet security, have been limited in scope and have failed to
address all of the critical aspects of data security. We believe that an
effective enterprise-wide solution must address and assimilate issues relating
to the following:
o Speed and ease of implementation, use, and administration;
o Reliability;
o Interoperability with diverse enterprise environments, existing
customer applications, and the security infrastructure;
o Scalability; and
o Overall cost of ownership.
Accordingly, we have adopted the following approach to data security:
o In designing our products, we have sought to incorporate all
industry-accepted, open, and non-proprietary protocols. This
permits interoperability between our products and the multiple
platforms, products, and applications widely in use.
o We have designed our products and services to minimize their
integration effort with, and disruption of, existing legacy
applications and the security infrastructure. We provide customers
with easier implementations and a more rapid means of implementing
security across the enterprise, including the Internet. With
security being a critical enabling technology for on-line business
initiatives, speed and ease of security implementation has become
crucial to an organization's success.
o We design our products and services to have a lower total cost of
security ownership than competing products and services. We have
found that product improvements and tools that lower a customer's
total cost of ownership create differentiating sales and marketing
tools, and also help in the development of a highly loyal customer
base that is open to new solutions that we offer.
As a result of this approach, we believe that we are positioned to be a
leading provider of our open standards-based software and hardware security
solutions.
VASCO'S STRATEGY
We believe we have one of the most complete lines of security products
and services for Identity Authentication available in the market today and we
intend to become a leading worldwide provider of these products and services. A
key element of our growth strategy is to demonstrate to an increasing number of
distributors, resellers and systems integrators that, by incorporating our
security products into their own products, they can more effectively
differentiate themselves in their marketplaces and increase the value of their
products. In addition, we will demonstrate to our corporate users that our
products provide mission critical security to their internal and external
security infrastructures. Following this active marketing and promotion effort,
we will work with these resellers and integrators to support their sales of
solutions that include our products. Also, we plan to expand our direct sales
marketing program to new and existing blue chip customers. Further, we intend
to:
Increase Sales and Marketing Efforts Worldwide. We intend to increase
sales of our security products and services in our established European markets
and to actively increase our sales and support presence and marketing efforts in
North America, South America, Asia/Pacific, Australia and the Middle East. We
plan to:
o Market new services and products to our existing customers by
providing testimonial evidence of user experiences from other
customers;
o Launch a Europe, Middle East, North American and Asia marketing
campaign to raise awareness of our solutions among the
distributors and resellers of popular third party software
products and to establish relationships with them whereby they
become resellers of our products and solutions;
6
o Form additional strategic relationships with resellers and vendors
of complementary, innovative security products and systems; and
o Develop a marketing and sales infrastructure, largely in the form
of new resellers, distributors, and solution providers, in new
markets.
Continue Innovation. We intend to continue to enhance and broaden our
line of security products to meet the changing needs of our existing and
potential customers by:
o Building on our core software and hardware security expertise,
such as expanding our technology for use on different platforms
(like mobile phones and personal digital assistants);
o Acquiring complementary technologies or businesses; and
o Developing additional applications for our products in areas that
may include securing the exchange of data in the
business-to-business field and providing security for Internet
gambling and lottery transactions, among others.
VASCO'S PRODUCTS
Digipass Product Line
Our Digipass product line, which exists as a family of authentication
devices as well as extensive software libraries, provides a flexible and
affordable means of authenticating users to any network, including the Internet.
Security can be broken into three factors:
o What the user has (the Digipass device itself);
o What the user knows (the PIN code to activate the Digipass); and
o Who the user is (biometrics).
The Digipass family is currently based on the first two factors. Using
the Digipass system, in order to enter a remote system or to digitally sign data
the user needs the:
o Hardware device (the token) itself so that if he or she does not
physically have the token, he or she will not be able to log on to
the system; and
o PIN code for the token so if the user does not know the
appropriate code, he or she will not be able to use the
applications stored inside.
Both of these factors help to make sure that a natural person is
authenticating (or signing), instead of a computer or another device. These
factors also enable very high portability for security anytime, anywhere and
anyhow.
Digipasses calculate dynamic passwords, also known as one-time
passwords, to authenticate users on a computer network and for a variety of
other applications. There are several models of the Digipass, each of which has
its own distinct characteristics depending on the platform that it uses and the
functions it performs. However, the Digipass family is designed to work together
and customers can switch their users' devices without requiring any changes to
the customers' existing infrastructure. In addition, these devices can be used
to calculate digital signatures, also known as electronic signatures or message
authentication codes, to protect electronic transactions and the integrity of
the contents of such transactions.
In addition, Digipass technology is designed to operate on non-VASCO
platforms such as a desktop PC or laptop. Digipass technology is also available
for personal digital assistants (PDA), mobile phones and smart cards. For users
of mobile phones, Digipass's Authentication Server generates one-time passwords
that are sent to the mobile telephone user by SMS (Short Messaging System).
7
Digipass technology combines the benefits of both traditional password
tokens (authentication and digital signatures) with smart card readers. They
both bring portability to smart cards and allow secure time-based algorithms.
A VASCO-secured system has the features needed to secure both today and
tomorrow's IT resources.
DIGIPASS AT WORK
[DIGIPASS GRAPHIC]
The above illustration shows the various steps in the Digipass
initialization process. In the first step, the devices are initialized with
their unique set of secrets and keys per device. These secrets are stored in an
encrypted way on a compact disk or diskette that is sent to the application
owner (for example, the information technology manager in an organization or the
security department of a bank). These compact disk or diskettes are one way of
safely transporting the Digipass secrets to the host computer.
The files on CD, Memory Stick or diskettes will be used to read all the
necessary secrets and other data from the delivered Digipasses into a database.
Then the application owner will assign those Digipass secrets to the end-users.
This assignment is based on the serial number of the Digipass and the identity
of the end-user. The Digipass is then shipped to the end-user together with a
manual and the protected PIN-code, on a secure PIN-mailer, is sent by a separate
shipment.
8
Using a Digipass requires a connection to the host (server) computer
that knows the parameters of the end-user's Digipass. Every time the user sends
a dynamic password or digital signature to the host computer, the computer will
retrieve all the necessary information from the database and will check the
validity of the password or signature. After the host has checked the validity
of the dynamic password or signature, it will notify the end-user of the
correctness or incorrectness of the validity check.
Digipass security devices are not terminal dependent and do not require
any specific software platform since they only interact with a person.
Currently, the Digipass is used in many applications, the largest of
which is banking. Banking applications include:
o Corporate banking through direct dial-up, as well as over the
Internet, and
o Retail banking to secure transactions made through the use of a
dial-up connection with a personal computer, the traditional phone
system, the Internet, and wireless phones and other communication
devices such as personal digital assistants.
Another significant application for the Digipass is to secure access to
corporate networks for home-based, traveling and other remote users. Finally,
Digipasses are increasingly being used in a variety of e-commerce applications
where the user is part of a pre-defined user group. We intend to expand the use
of the Digipass to other groups of users and applications, including electronic
commerce transactions directed at the general public.
Digipass Pack
Digipass Pack is a bundling of VASCO Digipass Go 1 or Go 3 tokens and VACMAN
Middleware, offering strong identity authentication to Small and Medium Sized
Enterprises ("SME"s). Although the packs contain standard Digipass Go 1/Go 3
tokens, combinations with other Digipass models are possible. Digipass Pack is
compliant with server security products of VASCO Solution Partners, like CITRIX,
Netscreen, Check Point, and CISCO and is marketed via VASCO's regional channel
partners (Distributors).
[DIGIPASS PACK IMAGE]
VACMAN Product Line
The VACMAN Product line incorporates a range of strong authentication
utilities and solutions designed to allow organizations to add Digipass strong
authentication into their existing networks and applications.
Designed to provide the greatest flexibility, while not compromising on
functionality or security, VACMAN solutions are designed to integrate with most
popular hardware and software. Once integrated, the VACMAN components become
largely transparent to the users minimizing rollout and support issues.
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VACMAN Controller
Designed by specialists in "system entry" security, VACMAN Controller
makes it easy to administer a high level of access control. The user simply adds
a field to his or her existing user database, describing the unique Digipass
token assigned to the user. VACMAN Controller takes it from there, automatically
authenticating the logon request using the security sequence the user specifies,
whether it's a one-time password using either response-only or a
challenge/response authentication scheme or an electronic signature.
VACMAN Controller allows the user the freedom to provide secure remote
access to virtually any type of application. VACMAN Controller is a library
requiring only a few days to implement in most systems and supports all Digipass
functionality. Once linked to an application, VACMAN Controller automatically
handles login requests from any users you've authorized to have a Digipass
token.
VACMAN Middleware
VACMAN Middleware brings strong user authentication to existing
RADIUS-based environments, while seamlessly integrating with other current
infrastructure technology. Many companies already use RADIUS servers and/or
firewalls to provide a way to centrally manage all remote connections to the
corporate IT infrastructure. VACMAN Middleware allows administrators to
positively identify remote users before granting remote access to sensitive
corporate data and applications.
Logically, VACMAN Middleware is installed between the RADIUS client
(NAS, RAS or firewall) and the existing RADIUS server or servers. Once
installed, VACMAN Middleware functions transparently, adding strong, two-factor,
authentication without otherwise affecting the operation of the server or other
network components.
With a range of automated administration features such as Dynamic User
Registration, automatic assignment of Digipass devices and the ability to bulk
manage users, VACMAN Middleware provides transparent strong authentication
without adding significantly to the administration load.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS AND LICENSES
We rely on a combination of patent, copyright, trademark and trade
secret laws, as well as employee and third-party non-disclosure agreements to
protect our proprietary rights. In particular, we hold several patents in the
United States and a corresponding patent in certain European countries, which
cover certain aspects of our technology. The majority of our patents cover our
Digipass family of security tokens. The U.S. patents expire between 2005 and
2010 and the European patent expires in 2008. We believe these patents to be
valuable property rights and we rely on the strength of our patents and on trade
secret law to protect our intellectual property rights. To the extent that we
believe our patents are being infringed upon, we intend to assert vigorously our
patent protection rights, including but not limited to, pursuing all available
legal remedies.
RESEARCH AND DEVELOPMENT
Our research and development efforts historically have been, and will
continue to be, concentrated on product enhancement, new technology development
and related new product introductions. We employ 16 full-time engineers and,
from time to time also engage independent engineering firms to conduct
non-strategic research and development efforts on our behalf. For the fiscal
years ended December 31, 2004, 2003 and 2002, we expended $2,835,000, $2,281,000
and $2,341,000, respectively, on research and development, representing
approximately 9%, 10% and 13% of consolidated revenues for 2004, 2003 and 2002,
respectively.
While management is committed to enhancing our current product
offerings and introducing new products, we cannot be certain that our research
and development activities will be successful. Furthermore, we may not have
sufficient financial resources to identify and develop new technologies and
bring new products to market in a timely and cost effective manner, and we
cannot ensure that any such products will be commercially successful if and when
they are introduced.
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PRODUCTION
Our security hardware products are manufactured by third parties
pursuant to purchase orders that we issue. Our hardware products are made
primarily from commercially available electronic components that are purchased
globally. Our software products are produced either in-house or by several
outside sources primarily in Australia and Europe.
The security tokens utilize commercially available programmable
microprocessors, or chips. We use two microprocessors, made by Samsung, for the
various hardware products we produce. The Samsung microprocessors are purchased
from Samsung Semiconductor in France. The microprocessors are the only
components of our security tokens that are not commodity items readily available
on the open market.
Orders of microprocessors and some other components generally require a
lead-time of 12-16 weeks. We attempt to maintain a sufficient inventory of all
parts to handle short-term increases in orders. Large orders that would
significantly deplete our inventory are typically required to be placed with
more than 12 weeks of lead-time, allowing us to attempt to make appropriate
arrangements with our suppliers.
We purchase the majority of our product components and arrange for
shipment to third parties for assembly and testing in accordance with our design
specifications. Our security token products are assembled by one of two
independent companies with headquarters in Hong Kong and production facilities
in China. Purchases from these companies are made on a volume purchase order
basis. These companies commit to very high production standards, and as a
result, they also have major production contracts with companies such as Sony
and Samsung. Equipment designed to test product at the point of assembly is
supplied by us and periodic visits are made by our personnel for purposes of
quality assurance, assembly process review and supplier relations.
There can be no assurance that we will not experience interruptions in
the supply of either the component parts that are used in our products or
fully-assembled token devices in general. In the event that the flow of
components or finished product was interrupted, there could be a considerable
delay in finding suitable replacement sources for those components, as well as
in replacement assembly subcontractors with the result that our business and
results of operations could be adversely affected.
COMPETITION
The market for computer and network security solutions is very
competitive and, like most technology-driven markets, is subject to rapid change
and constantly evolving products and services. In the corporate network access
market segment, our main competitor is RSA Security. In the e-banking market
segment, our main competitors are ActivCard, Xiring, Todos and Kobil. There are
many other companies such as Computer Associates, Rainbow and Aladdin that offer
authentication hardware, software and services that range from simple locking
mechanisms to sophisticated encryption technologies. We believe that competition
in this market is likely to intensify as a result of increasing demand for
security products.
We believe that the principal competitive factors affecting the market
for computer and network security products include the strength and
effectiveness of the solution, technical features, ease of use,
quality/reliability, customer service and support, name recognition, customer
base, distribution channels and price. Although we believe that our products
currently compete favorably with respect to such factors, other than name
recognition in certain markets, there can be no assurance that we can maintain
our competitive position against current and potential competitors, especially
those with significantly greater financial, marketing, service, support,
technical and other competitive resources.
Many of our present and potential competitors have significantly
greater financial, technical, marketing, purchasing and other resources than we
do, and as a result, may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion and sale of products, or to deliver
competitive products at a lower end-user price. Current and potential
competitors have established or may establish cooperative relationships among
themselves or with third parties to increase the ability of their products to
address the needs of our prospective customers. Accordingly, it is possible that
new competitors or alliances may emerge and rapidly acquire significant market
share.
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Our products are designed to allow authorized users access to a
computing environment, in some cases using patented technology as a replacement
for the static password. Although certain of our security token technologies are
patented, there are other organizations that offer token-type password
generators incorporating challenge-response or response-only approaches that
employ different technological solutions and compete with us for market share.
SALES AND MARKETING
Our security solutions are sold through our direct sales force, as well
as through distributors, resellers and systems integrators. A sales staff of 20
coordinates our sales through both our sales channels and these strategic
partners' sales channels and makes direct sales calls either alone or with sales
personnel of vendors of computer systems. Our sales staff also provides product
education seminars to sales and technical personnel of vendors and distributors
with whom we have working relationships and to potential end-users of our
products.
Part of our expanded selling effort includes approaching our existing
strategic partners to find additional applications for our security products. In
addition, our marketing plan calls for the identification of new business
opportunities that may require enhanced security over the transmission of
electronic data or transactions where we do not currently market our products.
Our efforts also include the preparation and dissemination of white papers
prepared by our support engineers that explain how we believe our security
products can add value or otherwise be beneficial.
CUSTOMERS AND MARKETS
Customers for our products include some of the world's most recognized
names:
BANKING/FINANCIAL SERVICES OTHER
-------------------------- -----
Rabobank Nederland Ementor
ABN Amro Bank DaimlerChrysler
SNS Bank US Coast Guard
ING Bank University of Groningen
Fortis Bank European Commission
Mandiri Bank, Indonesia CoStar Group
SEB Sweden Volvo
Den Norske Bank Norway
BNL, Italy
HSBC, Brazil
Swedbank
Wachovia, USA
Zagrebacka Banka
For the years 2004, 2003 and 2002, the Company's top 10 customers
contributed 60%, 71% and 67%, respectively, of total worldwide revenues. Sales
to Rabobank Nederland, Ementor and Fortis Bank each exceeded 10% of the
Company's revenue in 2004. Rabobank Nederland and Fortis Bank were the only
customers to exceed 10% of the Company's revenue in 2003 and Rabobank Nederland
was the only customer to exceed 10% of the Company's revenue in 2002.
A significant portion of our sales is denominated in various foreign
currencies that could impact results of operations. To minimize exposure to
risks associated with fluctuations in currency exchange rates, we attempt to
match the timing of delivery, amount of product and the currency denomination of
purchase orders from vendors with sales orders to customers. For additional
information regarding how currency fluctuations can affect our business, please
refer to Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations and Item 7A - Quantitative and Qualitative Disclosures
About Market Risk.
12
We also experience seasonality in our business. These seasonal trends
are most notable in the summer months, particularly in Europe, when many
businesses defer purchase decisions.
FINANCIAL INFORMATION RELATING TO FOREIGN AND DOMESTIC OPERATIONS
See Note 14 to VASCO Notes to Consolidated Financial Statements for a
breakdown of revenues and long-lived assets between U.S. and foreign operations.
EMPLOYEES
As of February 28, 2005, we had 112 full time employees. Of these, 14
were located in North America, 77 were located in Europe, 16 were located in
Australia and 5 located in Asia/Pacific. Of the total, 55 were involved in
sales, marketing and customer support, 14 in operations, 28 in research and
development and 15 in administration.
AVAILABLE INFORMATION
We are subject to the informational requirements of the Securities
Exchange Act of 1934. We therefore file periodic reports and other information
with the Securities and Exchange Commission ("SEC"). Such reports may be
obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street
NW, Washington, D.C. 20549, or by calling the SEC at (800) SEC-0330. In
addition, the SEC maintains an internet site (www.sec.gov) that contains
reports, proxy information statements and other information regarding issuers
that file electronically.
Our filings under the Exchange Act (including annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all
amendments to these reports) are also available free of charge on the Company's
website at www.vasco.com.
ITEM 2 - PROPERTIES
Our corporate office is located in the United States in an office
complex in Oakbrook Terrace, Illinois, a suburb of Chicago. This facility is
leased through May 31, 2010, and consists of approximately 5,100 square feet.
Our sales office in the United States in located in Westborough,
Massachusetts, a suburb of Boston. This facility is leased through February 28,
2009, and consists of approximately 3,900 square feet.
Our European administrative, sales and marketing, research and
development and support facilities are located in a suburb of Brussels, Belgium.
These facilities consist of approximately 29,560 square feet of office space
that are occupied under a lease expiring on September 30, 2011. We believe that
these facilities are adequate for our present growth plans.
We have two offices located in Australia. One office is located in a
suburb of Brisbane, consisting of approximately 3,600 square feet under a lease
expiring on January 3, 2010. The second office, which is a sales office, is
located in Sydney, consisting of approximately 700 square feet under a lease
expiring on October 3, 2007.
We have two sales offices in the Asia/Pacific region. One sales office
is located in an office complex in Singapore, consisting of approximately 3,300
square feet under a lease expiring on October 14, 2005. The second sales office
is located in Shanghai, China consisting of approximately 1,238 square feet
under a lease expiring on November 30, 2006.
13
ITEM 3 - LEGAL PROCEEDINGS
The Company is from time to time involved in litigation incidental to
the conduct of its business. The Company is currently not a party to any lawsuit
or proceeding which, in the opinion of management, is likely to have a material
adverse effect on the Company's business, financial condition or results of
operations.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of 2004, through solicitation of proxies or otherwise.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On March 20, 1998, the Company's Common Stock was approved for trading
on the NASD Electronic Bulletin Board system under the symbol "VDSI." On April
7, 2000, the Common Stock was listed on the Nasdaq National Market in the United
States under the trading symbol "VDSI." In February 2003, the Common Stock was
moved from the Nasdaq National Market to the Nasdaq SmallCap Market and
continued trading under the symbol "VDSI."
On March 24, 2005, the closing sale price for the Common Stock on the
Nasdaq was $6.56 per share. Such market quotations reflect inter-dealer prices,
without retail mark-up, markdown or commission and may not necessarily represent
an actual transaction. On February 28, 2005, there were approximately 2,400
holders of record of the Common Stock.
On July 15, 2003, the Company issued 2 million shares of its Common
Stock to Ubizen N.V. as part of the consideration given in exchange for all of
the Company's Series C Convertible Preferred Stock and Purchase Warrants owned
by Ubizen.
On September 11, 2003, the Company sold 800 shares, with a stated value
of $10,000 per share, of its Series D 5% Cumulative Convertible Voting Preferred
Stock and 600,000 warrants to purchase Common Stock to various accredited
investors. The Series D Preferred is convertible into 4,000,000 shares of Common
Stock. The warrants have an exercise price of $3.47 per share. The proceeds from
the sale, $8,000,000 gross and approximately $7,260,000 net, were used for
general corporate purposes. The Series D Stock was convertible into Common Stock
at any time and the warrants can be exercised at any time from the date of issue
until September 10, 2008, at which time the warrants expire. As of February 28,
2005, all of the Series D Preferred stock had been converted to Common Stock and
there were 426,750 warrants outstanding.
The following table sets forth the high and low closing bid quotations
for the Common Stock for the periods indicated. [OBJECT OMITTED]
14
HIGH LOW
---- ---
2005
- ----
First Quarter (through March 24, 2005) .......................... $ 9.14 $ 5.50
2004
- ----
Fourth Quarter ................................................... $ 6.92 $ 2.17
Third Quarter .................................................... 2.55 1.81
Second Quarter ................................................... 3.38 1.92
First Quarter .................................................... 2.99 1.83
2003
- ----
Fourth Quarter ................................................... $ 3.15 $ 2.15
Third Quarter .................................................... 3.20 1.17
Second Quarter ................................................... 1.70 0.89
First Quarter .................................................... 1.74 0.22
The Company has not paid any dividends on its Common Stock since
incorporation. Restrictions or limitations on the payment of dividends may be
imposed under the terms of credit agreements or other contractual obligations of
the Company. In the absence of such restrictions or limitations, the declaration
and payment of dividends will be at the sole discretion of the Board of
Directors and subject to certain limitations under the General Corporation Law
of the State of Delaware. The timing, amount and form of dividends, if any, will
depend, among other things, on the Company's results of operations, financial
condition, cash requirements, plans for expansion and other factors deemed
relevant by the Board of Directors. The Company intends to retain any future
earnings for use in its business and therefore does not anticipate paying any
cash dividends in the foreseeable future.
See Item 12 for a description of securities authorized for issuance
under our equity compensation plan.
15
ITEM 6 - SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)(1)
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------ ------------ ------------ ------------ ------------
Statements of Operations Data:
Total revenues $ 29,893 $ 22,866 $ 17,370 $ 22,690 $ 21,502
Operating income (loss) from continuing operations 5,552(2) 1,123 (4,898)(2) (10,788)(2) (2,441)
Net income (loss) from continuing operations 3,253 761 (5,293) (9,717) (4,002)
Net income (loss) from discontinued operations - 638 754 (2,317) (159)
Net income (loss) 3,253 2,756 (4,539) (12,034) (4,162)
Net income (loss) available to common stockholders 3,021(3) (1,715)(4) (5,703)(5) (13,198)(5) (4,744)
Basic and diluted income (loss) per common share
from continuing operations $ 0.09(3) $ (0.13)(4) $ (0.22)(5) $ (0.39)(5) $ (0.17)
Shares used in computing per share amounts 33,128 29,270 28,348 28,169 27,341
Balance Sheet Data:
Cash $ 8,138 $ 4,817 $ 2,616 $ 6,342 $ 13,833
Working capital (deficiency) 10,055 5,218 (587) 6,672 14,307
Total assets 20,250 13,383 11,133 17,451 29,313
Long-term obligations, less current portion - - - 3,668 3,764
Stockholders' equity 13,031 8,943 2,811 7,147 17,348
- ---------------------
(1) Years prior to 2003 have been restated to reflect the results of the VACMAN
Enterprise business unit, which was sold in the third quarter of 2003, and
reflected as a discontinued operation.
(2) Includes restructuring expenses (recovery) of $(32) in 2004, $320 in 2002
and $3,970 in 2001.
(3) Includes the impact of preferred stock dividend of $232.
(4) Includes the impact of a beneficial conversion feature of $3,720 related to
the issuance of Series D Convertible Preferred Stock in the third quarter
of 2003, preferred stock accretion of $630 and preferred stock dividends of
$121.
(5) Includes the impact of preferred stock accretion of $1,164.
(6) Includes the impact of preferred stock accretion of $582.
16
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion is based upon the Company's consolidated
results of operations for the years ended December 31, 2004, 2003 and 2002
(percentages in the discussion are rounded to the closest full percentage point)
and should be read in conjunction with our consolidated financial statements
included elsewhere in this Form 10-K.
We design, develop, market and support identity authentication products
that reduce the risk of loss from unauthorized transactions by validating a
person's identity using a one-time password and obtaining a legally-enforceable
digital signature, if needed, for financial transactions. Our products are used
currently in a wide variety of applications including, but not limited to,
Internet banking, Internet brokerage, e-commerce applications dealing with web
or mobile access and various corporate network access applications. As evidenced
by our current customer base, our products are purchased by companies and,
depending on the business application, are distributed to either their employees
or its customers. Those customers may be other businesses or, as an example in
the case of Internet banking, the banks' retail customers.
Our target market is any business process that uses some form of
electronic interface where the owner of that process is at risk if unauthorized
users can gain access to its process and either obtain proprietary information
or execute transactions that are not authorized. Our products can not only
increase the security associated with accessing the business process, thereby
reducing the losses from unauthorized access, but also, in many cases, can
reduce the cost of the process itself by automating activities that were
previously performed manually.
Industry Growth: We believe that, while there are no accurate
measurements of the total industry's size, the industry growth rate is
increasing and will continue to grow at a significant rate into the foreseeable
future. Growth is being driven by new government regulations, growing awareness
of the impact of identity theft, and the growth in commerce that is transacted
electronically. The issues driving the growth are global issues and the rate of
adoption in each country is a function of that country's culture, the
competitive position of businesses operating in those countries, the country's
overall economic conditions and the degree to which businesses and consumers
within the country use technology. Examples of regulations that have been
enacted in the U.S. recently that support industry growth include the Health
Insurance Portability and Accountability Act (HIPAA) and the Sarbanes-Oxley Act
of 2002.
Economic Conditions: The Company's revenues may vary significantly with
changes in the economic conditions in the countries in which it sells products
currently. With the Company's current concentration of revenues in Europe and
specifically in the banking/finance vertical market, significant changes in the
economic outlook for the European banking market, may have a significant effect
on the revenues of the Company. During difficult economic periods, our customers
often delay the rollout of existing applications and defer purchase decisions
related to the implementation of our product in new applications.
Currency Fluctuations. In 2004, approximately 90% of the Company's
revenue and approximately 79% of its operating expenses were generated/incurred
outside of the United States. In 2003, approximately 93% of the Company's
revenue and approximately 75% of its operating expenses were generated/incurred
outside of the United States. As a result, changes in currency, especially the
Euro to U.S. Dollar, can have a significant impact on revenue and expenses. To
minimize the net impact of currency the Company attempts to denominate its
billings in a currency such that it would provide a hedge against the operating
expenses being incurred in that currency. In addition, the Company denominates
the majority of our supply contracts in U.S. dollars.
In 2004, the Euro strengthened approximately 10% and the Australian
Dollar strengthened approximately 15% against the U.S. Dollar. The Euro
strengthened approximately 20% and the Australian Dollar strengthened
approximately 18% against the U.S. Dollar in 2003. The Company estimates that
the strengthening of the two currencies in 2004 compared to 2003 resulted in an
increase in revenues of approximately $1,089,000 and an increase in operating
expenses of approximately $1,106,000. The Company estimates that the
strengthening of the two currencies in 2003 compared to 2002 resulted in an
increase in revenues of approximately $1,460,000 and an increase in operating
expenses of approximately $1,630,000.
17
Gains and losses resulting from foreign currency transactions are
included in the consolidated statements of operations. Foreign exchange
transaction losses aggregating $538,000 are included in other non-operating
income (expense) for 2004. Foreign exchange transaction gains aggregating
$146,000 and $77,000 are included in other non-operating income (expense) for
2003 and 2002, respectively.
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 generated a surplus of
$687,000 and $134,000 in 2004 and 2003, respectively, and are included as a
separate component of stockholders' equity.
REVENUE
Revenues by Geographic Regions: We sell the majority of our products in
European countries with significant sales in the United States and other
countries, primarily Australia and Asia/Pacific. The breakdown of revenue in
each of our major geographic areas was as follows:
YEAR EUROPE UNITED STATES OTHER COUNTRIES TOTAL
- ------------------------- ----------------------- --------------------- --------------------- -----------------------
Total Revenue:
2004 $ 24,245,000 $ 3,105,000 $ 2,543,000 $ 29,893,000
2003 19,201,000 1,498,000 2,167,000 22,866,000
2002 14,658,000 1,423,000 1,289,000 17,370,000
Percent of Total:
2004 81% 10% 9% 100%
2003 84% 7% 9% 100%
2002 84% 8% 8% 100%
Total revenues in 2004 increased $7,027,000 or 31% over 2003. The
increase was primarily attributable to increased volumes from existing customers
of approximately $5,157,000, an increase from net new customers (customers with
revenues in 2004 that had no revenue in 2003 less customers with revenue in 2003
that had no revenue in 2004) of approximately $781,000 and the benefit from
changes in the currency rate of approximately $1,089,000.
Total revenues in 2003 increased $5,496,000 or 32% over 2002. Revenues
generated in Europe were $4,543,000, or 31% higher than 2002. The increase was
primarily attributable to increased volumes from existing customers of
approximately $2,055,000, an increase from net new customers (customers with
revenues in 2003 that had no revenue in 2002 less customers with revenue in 2002
that had no revenue in 2003) of approximately $1,118,000 and the benefit from
changes in the currency rate of approximately $1,370,000. The increase in
revenues from other countries primarily reflects revenues from new customers in
2003 and benefits from currency of approximately $90,000.
We expect to increase our penetration of the U.S. market by adding
sales-related staff, expanding our distribution channels and to actively pursue
additional markets, particularly in Asia, South America and the Middle East in
2005.
18
Revenues by Target Market: Revenues are generated currently from two
primary markets, banking/finance ("Banking") and corporate network access
("CNA") through the use of both direct and indirect sales channels. The
breakdown of revenue between the two primary markets is as follows:
YEAR BANKING CNA TOTAL
- ------------------------- ----------------------- --------------------- ----------------------
Total Revenue:
2004 $ 23,977,000 $ 5,916,000 $ 29,893,000
2003 17,725,000 5,141,000 22,866,000
2002 14,169,000 3,201,000 17,370,000
Percent of Total:
2004 80% 20% 100%
2003 78% 22% 100%
2002 82% 18% 100%
Revenues from the Banking market increased $6,252,000 or 35% in 2004
over 2003 and revenues from the CNA market increased $775,000 or 15% in the same
period. The increase in revenues in both markets is attributable, in part, to
the development of the indirect sales channel, which includes distributors,
resellers, and solution partners. The number of distributors increased to 39 at
the end of 2004 from 29 at the end of 2003. The indirect sales channel
supplements the Company's direct sales force in the Banking market and is the
primary source of revenues in the CNA market.
Revenues from the Banking market increased $3,556,000 or 25% in 2003
over 2002 and revenues from the CNA market increased $1,940,000 or 61% in the
same period. The increase in revenues in both markets is attributable, in large
part, to the aforementioned indirect sales channel.
The amounts shown above for CNA currently include revenues generated in
the e-commerce market. We expect that the e-commerce market will be an important
source of future revenue for the Company as our products will not only provide a
higher level of security for purchases made over the Internet, they can also
help protect our customers' revenue stream by making it more difficult for
subscribers to our customers' Internet services to share passwords.
19
GROSS PROFIT AND OPERATING EXPENSES
The following table sets forth, for the periods indicated, certain
consolidated financial data as a percentage of revenues for the years ended
December 31, 2004, 2003 and 2002.
PERCENTAGE OF REVENUE
YEAR ENDED DECEMBER 31,(a)
---------------------------------------------
2004 2003 2002
------------ ----------- ------------
Revenues 100.0% 100.0% 100.0%
Cost of goods sold 30.7 39.4 41.2
------------ ----------- ------------
Gross profit 69.3 60.6 58.8
Operating costs:
Sales and marketing 30.6 30.6 45.8
Research and development 9.5 10.0 13.5
General and administrative 10.7 15.0 26.1
Non-cash compensation (recovery) - 0.1 (0.3)
Restructuring expenses (0.1) - 1.9
------------ ----------- ------------
Total operating costs 50.7 55.7 87.0
------------ ----------- ------------
Operating income (loss) from continuing operations 18.6 4.9 (28.2)
Interest income (expense) 0.4 (0.3) (1.6)
Other income (expense), net (1.8) 0.5 0.1
------------ ----------- ------------
Income (loss) before income taxes 17.2 5.1 (29.7)
Provision for income taxes 6.3 1.8 0.8
------------ ----------- ------------
Net income (loss) from continuing operations 10.9 3.3 (30.5)
============ =========== ============
(a) Excludes results of discontinued operations. See footnote 12 to the
financial statements for more detail information regarding discontinued
operations.
Gross Profit
2004 Compared to 2003
Consolidated gross profit for the year ended December 31, 2004 was
$20,709,000, an increase of $6,853,000, or 49%, from the year ended December 31,
2003. Gross profit as a percentage of revenue was 69% in 2004, as compared to
61% in 2003. The increase in the gross profit as a percentage of revenue
reflects the change in mix of orders within the banking market, the reduction in
the average cost of each Digipass unit sold and the beneficial impact of
currency.
The change in mix within the banking market reflected the impact of new
customers added in 2004 and 2003 and resulted in a reduction in the average
quantity ordered and an increase in the average sales price per unit. In 2004,
the average quarterly order size for the banking market decreased 35%, from
approximately 17,000 units to 11,000 units, and the average selling price per
unit increased 9%, from approximately $8.20 per unit to $8.95 per unit. New
banking customers generally order smaller quantities at the beginning of the
relationship as they implement pilot programs and, later, increase their orders
as they roll the program out to their broader customer base. Orders for smaller
quantities have higher sales prices and higher gross margins.
20
The average manufacturing cost per Digipass unit sold declined
approximately 18% in 2004 as compared to 2003. The decline in the average cost
per unit reflected a reduction in the manufacturing cost of most all units as
well as a change in mix of specific products sold.
As previously noted, the Company's purchases of inventory are
denominated in U.S. dollars. Also, as previously noted, the Company denominates
a portion of its sales in Euros in order to offset the effects of currency on
operating expenses. As the Euro and Australian dollars strengthened during the
year, revenues from sales made in Euros and Australian Dollars increased, as
measured in U.S. dollars, without the corresponding increase in cost of goods
sold. The benefit from changes in currency rates as noted above was
approximately $1,089,000 and represents an improvement in the gross profit rate
of approximately 1.2 percentage points.
2003 Compared to 2002
Consolidated gross profit for the year ended December 31, 2003 was
$13,856,000, an increase of $3,646,000, or 36%, from the year ended December 31,
2002. Gross profit as a percentage of revenue was 61% in 2003, as compared to
59% in 2002. The increase in the gross profit as a percentage of revenue
reflects the beneficial impact of currency and the increase in CNA revenues as a
percentage of total revenues, partially offset by a decline in the average sales
price of the Digipass units sold due to a change in mix of revenues within the
Banking market.
As previously noted, the Company's purchases of inventory are
denominated in U.S. dollars. Also, as previously noted, the Company denominates
a portion of its sales in Euros in order to offset the effects of currency on
operating expenses. As the Euro and Australian Dollars strengthened during the
year, revenues from sales made in Euros and Australian Dollars increased, as
measured in U.S. dollars, without the corresponding increase in cost of goods
sold. The benefit from changes in currency rates as noted above was
approximately $1,460,000 and represents an improvement in the gross profit rate
of approximately 2.7 percentage points.
Consolidated gross profits, as a percentage of revenue, benefited in
2003 as revenues from the CNA market increased from 18% to 22% of total revenue.
Gross profits as a percentage of revenue on sales made to the Banking and CNA
markets were approximately 55% and 84%, respectively, in 2003. The difference in
the margin percentages between the two markets reflects the fact that orders
from the Banking market are substantially larger than orders from the CNA market
and that the Company provides volume purchase discounts.
Gross profit as a percentage of revenue was adversely impacted by the
change in mix of sales within the Banking segment. While the Company did not
change its standard pricing in 2003, the mix of sales within the markets
impacted the gross profit percentage. In 2003, the Company received more orders
from its larger strategic Banking customers, which have a lower average selling
price, reflecting the larger order size. As a result, the margin within the
Banking market in 2003 was lower than in 2002.
Sales and Marketing Expenses
2004 Compared to 2003
Consolidated sales and marketing expenses for the year ended December
31, 2004 were $9,160,000, an increase of $2,173,000, or 31%, from 2003. The
stronger Euro increased sales and marketing expense approximately $729,000 in
2004. Excluding the impact of changes in exchange rates, sales and marketing
expenses increased approximately $1,444,000 or 21% from 2003.
The increase, excluding currency, was primarily due to an increase in
average headcount and related compensation expenses, an increase in marketing
programs and materials, and an increase in travel. The average full-time sales
and marketing employee headcount increased 6% to 50 in 2004 from 47 in 2003. At
year-end 2004, the Company employed 61 full-time sales and marketing employees,
reflecting its increased investment in an effort to accelerate its sales growth.
21
2003 Compared to 2002
Consolidated sales and marketing expenses for the year ended December
31, 2003 were $6,987,000, a decrease of $969,000, or 12%, from 2002. This
decrease was primarily due to the decrease in compensation-related expenses, a
reduction in advertising and printed marketing materials, and a reduction in
travel. The average full-time sales and marketing employee headcount declined
10% to 47 in 2003 from 52 in 2002. The reduction in sales and marketing was
partially offset by the increased strength of the Euro.
Research and Development Expenses
2004 Compared to 2003
Consolidated research and development costs for the year ended December
31, 2004 were $2,835,000, an increase of $554,000, or 24%, as compared to the
year ended December 31, 2003. The stronger Euro and Australia Dollar increased
research and development expenses approximately $255,000 in 2004. Excluding the
impact of changes in exchange rates, research and development expenses increased
approximately $299,000 or 13% from 2003.
The increase primarily reflects higher compensation-related expense.
Average full-time research and development employee headcount in 2004 was 18
compared to 17 in 2003.
2003 Compared to 2002
Consolidated research and development costs for the year ended December
31, 2003 were $2,281,000, a decrease of $60,000, or 3%, as compared to the year
ended December 31, 2002. The reduction reflects lower fees paid to third parties
and lower compensation partially offset by the strengthening of the Euro and
Australian Dollar. Average full-time research and development employee headcount
in 2003 was 17 compared to 16 in 2002.
General and Administrative Expenses
2004 Compared to 2003
Consolidated general and administrative expenses for the year ended
December 31, 2004 were $3,194,000, a decrease of $230,000, or 7%, from 2003. The
stronger Euro increased general and administrative expense approximately
$123,000 in 2004. Excluding the impact of changes in exchange rates, general and
administrative expenses decreased approximately $353,000 or 10% from 2003.
This decrease can be principally attributed to reduced spending on
legal and other professional services, the collection of cash on accounts upon
which a reserve had been established in prior years, and a reduction in
depreciation and amortization expenses which was partially offset by increased
compensation-related expenses. Average full-time general and administrative
employee headcount in 2004 was 11 compared to 10 in 2003.
2003 Compared to 2002
Consolidated general and administrative expenses for the year ended
December 31, 2003 were $3,424,000, a decrease of $1,118,000, or 25%, from 2002.
This decrease can be principally attributed to lower headcount, reduced spending
on professional services, the collection of cash on accounts upon which a
reserve had been established in prior years, a reduction in depreciation and
amortization expenses, a reduction in travel expenses and a reduction in
office-related expenses such as rent and telephone. Average full-time general
and administrative employee headcount in 2003 was 10 compared to 12 in 2002. The
reduction in general and administrative expenses were partially offset by legal
expenses associated with the ActivCard litigation, which was settled in the
fourth quarter of 2003, and the impact of the strengthening of the Euro.
22
Because our operating expenses are based on anticipated revenue levels
and a high percentage of our expenses are fixed, a small variation in the timing
of recognition of revenue could cause significant variations in operating
results from quarter to quarter.
Restructuring Expenses
In 2004, the Company reversed $32,000 of the restructuring reserve that
had been established in prior years. The adjustment was a result of
renegotiating its headquarters lease in 2004.
There were no restructuring expenses for the year ended December 31,
2003 as compared with $319,000 in 2002. The expense in 2002 reflects changes in
estimates of the reserves established in the fourth quarter of 2001 and
primarily relate to the shutdown of the French operation and excess office space
in the United States.
Interest Income (Expense), Net
Consolidated net interest income (expense) was income of $120,000 in
2004 compared to expense of $80,000 in 2003. This change in expense was
primarily due to the repayment of its term loan in the third quarter of 2003,
the interest earned on the installment note it received as a result of its sale
of the VACMAN Enterprise business in 2003 and an increase in average net cash
balances resulting from its strong operating cash flow throughout 2004. Average
net cash balances were $6,500,000 in 2004, an increase of $4,450,000 or 217%
from $2,050,000 in 2003. The Company's term debt of $3,400,000 and accrued
interest was repaid in full in the third quarter of 2003. The term debt had an
annual interest rate of 6%. The Company invested its cash balances in short-term
money market instruments at nominal rates of interest.
Consolidated net interest expense was $80,000 in 2003 compared to
$270,000 in 2002. This decrease in expense was primarily due to an increase in
average net cash balances, up from an average of $20,000 in 2002 to $2,050,000
in 2003. The Company's term debt of $3,400,000 and accrued interest was repaid
in full in the third quarter of 2003. The term debt had an annual interest rate
of 6%. The Company invested its cash balances in short-term money market
instruments at nominal rates of interest.
Other Income (Expense)
Other income (expense) primarily includes exchange gains (losses) on
transactions that are denominated in currencies other than the subsidiaries'
functional currency. The increase in other expense of $654,000 in 2004 over 2003
primarily reflects an increase in exchange losses of $684,000 during that
period. The exchange losses resulted from the increasing net U.S. Dollar asset
base in Europe in combination with the strengthening Euro. Exchange losses
reflected in other income were more than offset by translation surpluses
recorded in the cumulative translation adjustment account in the equity section
of the balance sheet.
The increase in other income of $100,000 in 2003 over 2002 primarily
reflects an increase in exchange gains of $69,000 during that period.
Income Taxes
Income tax expense for 2004 was $1,880,000 and compares to expense of
$397,000 in 2003. The expense relates primarily to the Belgian operating
subsidiary, whose tax loss carryforwards were fully utilized in 2003. The
effective tax rate in 2004 was 36.6%, an increase of 2.3 percentage points from
34.3% 2003. The Belgian tax loss carryforward utilized in 2003 reduced 2003 tax
expense by approximately $739,000.
Income tax expense for 2003 was $397,000 and compares to expense of
$140,000 in 2002. The expense relates primarily to the Belgian operating
subsidiary, whose tax loss carryforwards were fully utilized in 2003.
At December 31, 2004, the Company has United States net operating loss
carryforwards approximating $26,555,000 and foreign net operating loss
carryforwards approximating $5,295,000. Such losses are available to offset
future taxable income in the respective jurisdictions and expire in varying
amounts beginning in 2005 and continuing through 2024. In addition, if certain
substantial changes in the Company's ownership are deemed to have occurred,
there would be an annual limitation on the amount of the U.S. carryforwards that
could be utilized.
23
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2004, the Company had cash balances totaling $8,220,000
and no outstanding term debt. Cash generated from operating activities was
$2,877,000 during the year ended December 31, 2004. During 2004, we used $94,000
for investing activities and generated $54,000 in financing activities
consisting of proceeds from the exercise of stock options partially offset by
the payment of dividends on our Series D Preferred Stock. Net capital
expenditures, assets purchased less assets sold, were $252,000 for the year
ended December 31, 2004.
Cash generated from operating activities was $2,409,000 during the year
ended December 31, 2003. During 2003, we generated $128,000 from investing
activities and used $267,000 in financing activities consisting of a capital
raise, debt payments and the repurchase of the Company's Series C Convertible
Preferred Stock. Net capital expenditures, assets purchased less assets sold,
generated $16,000 for the year ended December 31, 2003.
In 1997, we entered into a convertible loan agreement with Artesia Bank
N.V., formerly Banque Paribas Belgique S.A. and now doing business as Dexia Bank
("Dexia"), in order to refinance the $3,400,000 payment due December 31, 1997 in
connection with our acquisition of Digipass. The terms of the agreement provided
that the $3,400,000 principal amount was convertible, upon an offering, into
shares of our Common Stock. The original interest was at the rate of 3.25%,
payable annually, and the original maturity date was on September 30, 2002. On
August 9, 2001, the terms of this loan were restructured. Under the revised
terms, the loan was convertible into shares of our Common Stock at the fixed
conversion rate of $7.50 per share, rather than a floating rate based on the
market price of our Common Stock, and the interest rate increased from 3.25% to
6% annually. The loan and accrued interest was repaid in full in September 2003.
In July 2000, the Company issued 150,000 shares of Series C Convertible
Preferred Stock (the "Series C Preferred Stock") and warrants to purchase
1,269,474 shares of Common Stock for cash of $15,000,000 to Ubizen N.V.
("Ubizen"). The preferred stock was convertible into 1,052,632 shares of Common
Stock at any time through July 2003. If not converted by July 2003, the
preferred stock would have been, at the option of the Company, either
repurchased or converted into Common Stock at a rate equal to the average market
price of the Common Stock for 30 consecutive business days on which the common
stock was traded prior to the conversion date less five (5) percent.
In July 2003, the Company reached an agreement with Ubizen whereby it
purchased and redeemed all of the Series C Convertible Preferred Stock and
Common Stock Purchase Warrants owned by Ubizen in exchange for $4,000,000 in
cash and 2,000,000 shares of Common Stock. Under the terms of the Purchase
Agreement, the Company paid $3,000,000 to Ubizen and issued 2,000,000 shares of
Common Stock on July 25, 2003. An additional $1,000,000 was paid to Ubizen in
November 2003. Using the closing price of the Common Stock on July 25, 2003, the
value of the stock issued was $4,000,000. The Common Stock issued by the Company
was subject to a lock-up period wherein the lock-up expired in increments of
500,000 shares each on October 15, 2003, January 15, 2003, April 15, 2003 and
July 15, 2003. Once the lock-up expired, the shares were subject to volume
trading restrictions through January 1, 2005.
On September 11, 2003, the Company sold 800 shares, with a stated
valued of $10,000 per share, of its Series D 5% Cumulative Convertible Voting
Preferred Stock (the "Series D Preferred Stock") and 600,000 warrants to
purchase Common Stock. The Series D Preferred Stock carries a 5% dividend, is
convertible into 4 million shares of Common Stock at a fixed price of $2.00 per
share and will vote with the Common Stock as a class on matters presented to the
stockholders. The net proceeds from the sale totaled $7,260,000 of which
$5,786,000 was allocated to the Series D Preferred Stock and $1,474,000 was
allocated to the warrants based upon their relative fair values. In addition, a
beneficial conversion value was calculated for the Series D Preferred Stock as
the difference between the price of the Common Stock at the transaction date and
the conversion price of the Series D Preferred Stock. The amount of the
beneficial conversion, $3,720,000, is analogous to a dividend and was recorded
to accumulated deficit.
24
The Company maintains an overdraft agreement with Fortis Banque/Bank of
Belgium. Under terms of the agreement, the Company can borrow an amount equal to
80% of its Belgium subsidiary's defined accounts receivable up to a maximum of
2,000,000 Euros. Borrowings under the overdraft agreement accrue interest at an
annual rate of 5.7% and the Company is obligated to pay a quarterly commitment
fee of 0.125%. As of December 31, 2004, 2,000,000 Euros were available under the
overdraft agreement as there were no borrowings outstanding under the agreement.
The assets, excluding inventory, of the Belgian subsidiary secure the agreement
and while it has no specific termination date, it can be terminated with thirty
(30) days notice. The agreement is governed by the General Lending Conditions
for Corporate Customers, registered in Brussels, Belgium on December 20, 2001.
The net effect of 2004 activity resulted in an increase in cash of
$3,321,000 and a total cash balance of $8,138,000 at December 31, 2004, compared
to $4,817,000 at the end of 2003. Our working capital at December 31, 2004 was
$10,055,000, an increase of $4,837,000 from $5,218,000 at December 31, 2003. The
change is primarily attributable to the generation of positive cash flow from
operations in 2004. Our current ratio was 2.42 to 1.0 at December 31, 2004. We
believe that our current cash balances, credit available under our existing
overdraft agreement and the anticipated cash generated from operations,
including the realization of deferred revenue recorded as a current liability
and deposits received on orders of Digipass to be delivered in 2005, will be
sufficient to meet our anticipated cash needs for the next twelve months.
The net effect of 2003 activity resulted in an increase in cash of
$2,201,000 and a cash balance of $4,817,000 at December 31, 2003, compared to
$2,616,000 at the end of 2002. Our working capital at December 31, 2003 was
$5,218,000, an increase of $5,804,000 from a deficit of $586,000 at December 31,
2002. The change is attributable to the generation of positive cash flow from
operations in 2003 and the proceeds of the financing partially offset by the
purchase of the Company's Series C Convertible Preferred Stock and the repayment
of the loan from Dexia. Our current ratio was 2.18 to 1.0 at December 31, 2003.
On February 4, 2005, the Company acquired all of the share capital of
A.O.S. Hagenuk B.V. ("A.O.S.") a private limited liability company organized and
existing under the laws of the Netherlands. The base purchase price was EUR
5,000,000 of which EUR 3,750,000 was paid in cash and the remainder was paid in
the Company's common stock. The common stock will be held in escrow for the
benefit of the seller for a period of twelve (12) months. Six (6) months after
closing, the seller shall have the right to pay EUR 1,250,000 into the escrow
account against release of the common stock. In addition to the base purchase
price, a variable amount related to the gross profits collected on the sales of
certain equipment will be paid to the seller over a period of two (2) years
following the closing. AOS will be a wholly owned subsidiary of the Company,
accounted for using the purchase method in accordance with SFAS No. 141,"
Business Combinations."
On February 17, 2005, the Company, in accordance with the Designation
of Rights and Preferences of the Series D 5% Cumulative Convertible Voting
Preferred Stock (the "Series D Preferred Stock"), issued a call for the
mandatory conversion of all outstanding shares of the Series D Preferred Stock.
All accrued dividends through the conversion date have been paid.
There is risk, however, that our revenue and cash receipts will not be
sufficient to meet the operating needs of the business. If this is the case, we
will need to significantly reduce our workforce, sell certain of our assets,
enter into strategic relationships or business combinations, discontinue some or
all of our operations, or take other similar restructuring actions. While we
expect that these actions would result in a reduction of recurring costs, they
also may result in a reduction of recurring revenues and cash receipts. It is
also likely that we would incur substantial non-recurring costs to implement one
or more of these restructuring actions.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off-balance sheet arrangements.
25
CONTRACTUAL OBLIGATIONS
The Company has the following contractual obligations:
Payments Due by Period
------------------------------------------------------------------------------------
Less than 1-3 3-5 More than
Total 1 year years years 5 years
----------------- --------------- --------------- ---------------- ------------
Long-Term Debt Obligations ................ $ - $ - $ - $ - $ -
Capital Lease Obligations ................. - - - - -
Operating Lease Obligations ............... 6,299,859 1,223,452 3,145,098 1,910,917 20,392
Purchase Obligations ...................... 4,532,259 4,532,259 - - -
Other Long-Term Liabilities Reflected
on the Balance Sheet ................... - - - - -
----------- ----------- ----------- ----------- -----------
Total Contractual Obligations .......... $10,832,118 $ 5,755,711 $ 3,145,098 $ 1,910,917 $ 20,392
=========== =========== =========== =========== ===========
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results
of Operations discusses the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments,
including those related to bad debts, net realizable value of inventory,
investments in SecureD Services, Inc. and intangible assets. Management bases
its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make payments for goods and services. We analyze accounts receivable, customer
credit-worthiness, current economic trends and changes in our customer payment
terms when evaluating the adequacy of the allowance for doubtful accounts. If
the financial condition of our customers deteriorates, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
NET REALIZABLE VALUE OF INVENTORY: We maintain reserves for inventory
where it appears that the carrying cost of the inventory may not be recovered
through subsequent sale of the inventory. We analyze the quantity of inventory
on hand, the quantity sold in the past year, the anticipated sales volume in the
form of sales to new customers as well as sales to previous customers, the
expected sales price and the cost of making the sale when evaluating the
valuation of our inventory. If the sales volume or sales price of a specific
model declines significantly, additional writedowns may be required.
VALUATION OF INVESTMENT IN SECURED SERVICES, INC.: The initial value of
consideration received from SecureD Services, Inc. ("SSI"), in exchange for the
assets of the VACMAN Enterprise business unit, was established by an independent
valuation firm. On an ongoing basis, we review information made available by SSI
through its filings with the Securities and Exchange Commission and its press
releases and consider it within the context of the assumptions made by the
independent valuation firm. We also monitor SSI's compliance with the terms of
the specific investment instruments to which they relate. Considering the
start-up nature of SSI, the highly-competitive environment in which they operate
and the uncertainty associated with SSI's access to additional capital, it may
be that SSI's business prospects will deteriorate and, as a result, require the
Company to reduce the value of its investment in SSI.
26
The investment in SSI as of December 31, 2004 was $1,162,000. While SSI
had remained current on payments related to the notes receivable through
December 31, 2004, the full amount of the investment is at risk if SSI is
unsuccessful in executing their business plan.
VALUATION OF GOODWILL AND OTHER INTANGIBLE ASSETS, AND SOFTWARE
DEVELOPMENT COSTS: We assess the impairment of intangible assets and goodwill
annually and whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors we consider important which could
trigger an impairment review include significant underperformance relative to
expected historical or projected future operating results, significant changes
in the manner of our use of the acquired assets or the strategy for our overall
business, and significant negative industry or economic trends. The Company
assesses the recoverability of its purchased software against estimated future
revenue for the individual products over the estimated remaining economic life
of the software.
When we determine that the carrying value of intangibles and goodwill
may not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business model. Given
the highly competitive environment and frequency of technological changes in our
industry, it is reasonably possible that estimates of anticipated future
revenue, the remaining economic life of the Company's software products, or both
may be reduced significantly.
The total amount of goodwill and other intangible assets as of December
31, 2004 was $1,384,000 and the full amount is at risk of impairment. See
footnotes 1and 2 to the financial statements for more detailed information.
RESEARCH AND DEVELOPMENT: We are devoting substantial capital and other
resources to enhance our existing security products and develop new products to
provide identity authentication security solutions on different platforms and
for different applications. Costs of research and development, principally the
design and development of hardware and software prior to the determination of
technological feasibility, are expensed as incurred on a project-by-project
basis. Our software capitalization policy currently defines technological
feasibility as a functioning beta test prototype with confirmed
manufacturability (a working model), within a reasonably predictable range of
costs. Additional criteria include receptive customers, or potential customers,
as evidenced by interest expressed in a beta test prototype, at some suggested
selling price.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, Inventory Costs: an
amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends guidance in ARB No. 43,
Chapter 4, clarifying the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material. These items are to be
recognized as current-period charges. The Company has no idle facility expense
or wasted material charges. This statement is effective for the Company's 2006
fiscal year. SFAS No. 151 will not have a significant impact on the our results
of operations or financial position.
In December 2004, the FASB issued SFAS No.153, Exchange of Nonmonetary
Assets. This is an amendment of APB Opinion No. 29 and eliminates the exception
for nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows are expected to change significantly as a result of the
exchange. This statement is effective for the Company's 2006 fiscal year.
Adoption of this statement is not expected to have a material impact on our
results of operations or financial position.
27
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), or SFAS
123(R), Share-Based Payment, which replaces SFAS No. 123 and supersedes APB
Opinion No. 25. SFAS 123(R) requires that compensation costs relating to
share-based payment transactions be recognized in the financial statements. The
revised statement is effective as of the first interim period beginning after
June 15, 2005. The Company will adopt the statement on July 1, 2005 as required.
We expect the adoption of SFAS 123(R) will have an adverse impact on our net
income and net income per share. We are currently in the process of evaluating
the extent of such an impact.
CERTAIN FACTORS
There are a number of other factors that could affect future results.
You should carefully consider the following factors as well as other information
contained in this annual report. If any of the following items were to occur,
our business, financial condition or operating results could be materially and
adversely affected.
WE HAD A HISTORY OF OPERATING LOSSES AND HAVE A LARGE ACCUMULATED
DEFICIT.
Although we have reported net income of $3,253,000 and $2,756,000 for
the years ended December 31, 2004 and 2003, respectively, we have incurred net
losses of $4,538,000 for the year ended December 31, 2002 and as of December 31,
2004, our accumulated deficit is $40,672,000.
WE FACE SIGNIFICANT COMPETITION AND IF WE LOSE OR FAIL TO GAIN MARKET
SHARE OUR FINANCIAL RESULTS WILL SUFFER.
The market for computer and network security products is highly
competitive. Our competitors include organizations that provide computer and
network security products based upon approaches similar to and different from
those that we employ such as RSA Security, ActivCard, Rainbow Technologies, and
Aladdin Knowledge Systems. Many of our competitors have significantly greater
financial, marketing, technical and other competitive resources than we do. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements, or to devote greater resources to the
promotion and sale of their products.
TECHNOLOGICAL CHANGES OCCUR RAPIDLY IN OUR INDUSTRY AND OUR DEVELOPMENT
OF NEW PRODUCTS IS CRITICAL TO MAINTAIN OUR REVENUES.
The introduction by our competitors of products embodying new
technologies and the emergence of new industry standards could render our
existing products obsolete and unmarketable. Our future revenue growth and
operating profit will depend in part upon our ability to enhance our current
products and develop innovative products to distinguish ourselves from the
competition and to meet customers' changing needs in the data security industry.
We cannot assure you that security-related product developments and technology
innovations by others will not adversely affect our competitive position or that
we will be able to successfully anticipate or adapt to changing technology,
industry standards or customer requirements on a timely basis.
THE SALES CYCLE FOR OUR PRODUCTS AND TECHNOLOGY IS LONG, AND WE MAY
INCUR SUBSTANTIAL EXPENSES FOR SALES THAT DO NOT OCCUR WHEN ANTICIPATED.
The sales cycle for our products, which is the period of time between
the identification of a potential customer and completion of the sale, is
typically lengthy and subject to a number of significant risks over which we
have little control. If revenue falls significantly below anticipated levels,
our business would be seriously harmed.
A typical sales cycle in the Banking market is often three to six
months and with larger Banking transactions up to eighteen months. Purchasing
decisions for our products and systems may be subject to delay due to many
factors that are not within our control, such as:
o The time required for a prospective customer to recognize the need
for our products;
o The significant expense of many data security products and network
systems;
28
o Customers' internal budgeting processes; and
o Internal procedures customers may require for the approval of
large purchases.
WE HAVE A SIGNIFICANT DEPENDENCE ON MAJOR CUSTOMERS AND LOSING ANY OF
THESE CUSTOMERS COULD RESULT IN A SIGNIFICANT LOSS IN REVENUES.
If we don't find other customers who generate significant future
revenues, the unforeseen loss of one or more of our major customers, or the
inability to maintain reasonable profit margins on sales to any of these
customers, would have a material adverse effect on our results of operations and
financial condition.
OUR SUCCESS DEPENDS ON ESTABLISHING AND MAINTAINING STRATEGIC
RELATIONSHIPS WITH OTHER COMPANIES TO DEVELOP, MARKET AND DISTRIBUTE OUR
TECHNOLOGY AND PRODUCTS AND, IN SOME CASES, TO INCORPORATE OUR TECHNOLOGY INTO
THEIR PRODUCTS.
Part of our business strategy is to enter into strategic alliances and
other cooperative arrangements with other companies in our industry. We
currently are involved in cooperative efforts with respect to incorporation of
our products into products of others, research and development efforts,
marketing efforts and reseller arrangements. None of these relationships are
exclusive, and some of our strategic partners also have cooperative
relationships with certain of our competitors. If we are unable to enter
cooperative arrangements in the future or if we lose any of our current
strategic or cooperative relationships, our business could be harmed. We do not
control the time and resources devoted to such activities by parties with whom
we have relationships. In addition, we may not have the resources available to
satisfy our commitments, which may adversely affect these relationships. These
relationships may not continue, may not be commercially successful, or may
require our expenditure of significant financial, personnel and administrative
resources from time to time. Further, certain of our products and services
compete with the products and services of our strategic partners.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND OUR FAILURE TO OBTAIN
CAPITAL WOULD INTERFERE WITH OUR GROWTH STRATEGY.
Our ability to obtain financing will depend on a number of factors,
including market conditions, our operating performance and investor interest.
These factors may make the timing, amount, terms and conditions of any financing
unattractive. They may also result in our incurring additional indebtedness or
accepting stockholder dilution. If adequate funds are not available or are not
available on acceptable terms, we may have to forego strategic acquisitions or
investments, defer our product development activities, or delay the introduction
of new products.
WE MUST CONTINUE TO ATTRACT AND RETAIN HIGHLY SKILLED TECHNICAL
PERSONNEL FOR OUR RESEARCH AND DEVELOPMENT DEPARTMENT.
The market for highly skilled technicians in Europe, Asia, Australia
and the United States is highly competitive. If we fail to attract, train,
assimilate and retain qualified technical personnel for our research and
development department, we will experience delays in introductions of new or
modified products, loss of clients and market share and a reduction in revenues.
WE FACE A NUMBER OF RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS,
ANY OR ALL OF WHICH COULD RESULT IN A DISRUPTION IN OUR BUSINESS AND A DECREASE
IN OUR REVENUES.
Our business internationally is subject to a number of risks any or all
of which could result in a disruption in our business and a decrease in our
revenues. These include:
o Inconsistent regulations and unexpected changes in regulatory
requirements;
o Difficulties and costs of staffing and managing international
operations;
o Potentially adverse tax consequences;
o Wage and price controls;
29
o Uncertain protection for intellectual property rights;
o Imposition of trade barriers;
o Differing technology standards;
o Uncertain demand for electronic commerce;
o Linguistic and cultural differences;
o Political instability; and
o Social unrest.
WE ARE SUBJECT TO FOREIGN EXCHANGE RISKS, AND IMPROPER MANAGEMENT OF
THAT RISK COULD RESULT IN LARGE CASH LOSSES.
Because a significant number of our principal customers are located
outside the United States, we expect that international sales will continue to
generate a significant portion of our total revenue. We are subject to foreign
exchange risks because the majority of our costs are denominated in U.S.
dollars, whereas a significant portion of the sales and expenses of our European
operating subsidiaries are denominated in various foreign currencies. A decrease
in the value of any of these foreign currencies relative to the U.S. dollar
could affect the profitability in U.S. dollars of our products sold in these
markets. We do not currently hold forward exchange contracts or other hedging
instruments to exchange foreign currencies for U.S. dollars to offset currency
rate fluctuations.
WE HAVE A GREAT DEPENDENCE ON A LIMITED NUMBER OF SUPPLIERS AND THE
LOSS OF THEIR MANUFACTURING CAPABILITY COULD MATERIALLY IMPACT OUR OPERATIONS.
In the event that the supply of components or finished products is
interrupted or relations with either of our principal vendors is terminated,
there could be a considerable delay in finding suitable replacement sources to
manufacture our products at the same cost or at all. The majority of our
products are manufactured by three independent vendors, one headquartered in
Europe and the other two in Hong Kong. Our security tokens are assembled at
facilities in mainland China. The importation of these products from China
exposes us to the possibility of product supply disruption and increased costs
in the event of changes in the policies of the Chinese government, political
unrest or unstable economic conditions in China or developments in the United
States that are adverse to trade, including enactment of protectionist
legislation.
WE DEPEND SIGNIFICANTLY UPON OUR PROPRIETARY TECHNOLOGY AND
INTELLECTUAL PROPERTY AND THE FAILURE TO PROTECT OUR PROPRIETARY RIGHTS COULD
REQUIRE US TO REDESIGN OUR PRODUCTS OR REQUIRE US TO ENTER INTO ROYALTY OR
LICENSING AGREEMENTS, ANY OF WHICH COULD REDUCE REVENUE AND INCREASE OUR
OPERATING COSTS.
We currently rely on a combination of patent, copyright and trademark
laws, trade secrets, confidentiality agreements and contractual provisions to
protect our proprietary rights. We seek to protect our software, documentation
and other written materials under trade secret and copyright laws, which afford
only limited protection, and generally enter into confidentiality and
nondisclosure agreements with our employees and with key vendors and suppliers.
There has been substantial litigation in the technology industry
regarding intellectual property rights, and we may have to litigate to protect
our proprietary technology. We expect that companies in the computer and
information security market will increasingly be subject to infringement claims
as the number of products and competitors increases. Any such claims or
litigation may be time-consuming and costly, cause product shipment delays,
require us to redesign our products or require us to enter into royalty or
licensing agreements, any of which could reduce revenue and increase our
operating costs.
OUR PATENTS MAY NOT PROVIDE US WITH COMPETITIVE ADVANTAGES.
We hold several patents in the United States and a corresponding patent
in some European countries, which cover multiple aspects of our technology. The
U.S. patents expire between 2005 and 2010 and the patent in those European
countries expires in 2008. There can be no assurance that we will continue to
develop proprietary products or technologies that are patentable, that any
issued patent will provide us with any competitive advantages or will not be
challenged by third parties, or that patents of others will not hinder our
competitive advantage.
30
WE ARE SUBJECT TO PRODUCT LIABILITY RISKS.
A malfunction of or design defect in our products which results in a
breach of a customer's data security could result in tort or warranty claims
against us. We do not presently maintain product liability insurance for these
types of claims.
THERE IS SIGNIFICANT GOVERNMENT REGULATION OF TECHNOLOGY EXPORTS AND TO
THE EXTENT WE CANNOT MEET THE REQUIREMENTS OF THE REGULATIONS WE MAY BE
PROHIBITED FROM EXPORTING SOME OF OUR PRODUCTS, WHICH COULD NEGATIVELY IMPACT
OUR REVENUES.
Our international sales and operations are subject to risks such as the
imposition of government controls, new or changed export license requirements,
restrictions on the export of critical technology, trade restrictions and
changes in tariffs. If we become unable to obtain foreign regulatory approvals
on a timely basis our business in those countries would no longer exist and our
revenues would decrease dramatically. Certain of our products are subject to
export controls under U.S. law. The list of products and countries for which
export approval is required, and the regulatory policies with respect thereto
may be revised from time to time and our inability to obtain required approvals
under these regulations could materially adversely affect our ability to make
international sales.
WE EMPLOY CRYPTOGRAPHIC TECHNOLOGY IN OUR AUTHENTICATION PRODUCTS THAT
USES COMPLEX MATHEMATICAL FORMULATIONS TO ESTABLISH NETWORK SECURITY SYSTEMS.
Many of our products are based on cryptographic technology. With
cryptographic technology, a user is given a key that is required to encrypt and
decode messages. The security afforded by this technology depends on the
integrity of a user's key and in part on the application of algorithms, which
are advanced mathematical factoring equations. These codes may eventually be
broken or become subject to government regulation regarding their use, which
would render our technology and products less effective. The occurrence of any
one of the following could result in a decline in demand for our technology and
products:
o Any significant advance in techniques for attacking cryptographic
systems, including the development of an easy factoring method or
faster, more powerful computers;
o Publicity of the successful decoding of cryptographic messages or
the misappropriation of keys; and
o Increased government regulation limiting the use, scope or
strength of cryptography.
ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR
FINANCIAL CONDITION.
We may make investments in complementary companies, products or
technologies. Should we do so, our failure to successfully manage future
acquisitions could seriously harm our operating results. In the event of any
future purchases, we will face additional financial and operational risks,
including:
o Difficulty in assimilating the operations, technology and
personnel of acquired companies;
o Disruption in our business because of the allocation of resources
to consummate these transactions and the diversion of management's
attention from our existing business;
o Difficulty in retaining key technical and managerial personnel
from acquired companies;
o Dilution of our stockholders, if we issue equity to fund these
transactions;
o Assumption of operating losses, increased expenses and
liabilities; and
o Our relationships with existing employees, customers and business
partners may be weakened or terminated as a result of these
transactions.
WE EXPERIENCE VARIATIONS IN QUARTERLY OPERATING RESULTS AND ARE SUBJECT
TO SEASONALITY, BOTH OF WHICH MAY RESULT IN A VOLATILE STOCK PRICE.
31
In the future, as in the past, our quarterly operating results may vary
significantly resulting in a volatile stock price. Factors affecting our
operating results include:
o The level of competition;
o The size, timing, cancellation or rescheduling of significant
orders;
o New product announcements or introductions by current competitors;
o Technological changes in the market for data security products
including the adoption of new technologies and standards;
o Changes in pricing by current competitors;
o Our ability to develop, introduce and market new products and
product enhancements on a timely basis, if at all;
o Component costs and availability;
o Our success in expanding our sales and marketing programs;
o Market acceptance of new products and product enhancements;
o Changes in foreign currency exchange rates; and
o General economic trends.
We also experience seasonality in all markets. These seasonal trends
are most notable in the summer months, particularly in Europe, when many
businesses defer purchase decisions.
A SMALL GROUP OF PERSONS CONTROL A SUBSTANTIAL AMOUNT OF OUR COMMON
STOCK AND COULD DELAY OR PREVENT A CHANGE OF CONTROL.
Our Board of Directors, our officers and their immediate families and
related entities beneficially own approximately 32%, with Mr. T. Kendall Hunt
controlling approximately 30%, of the outstanding shares of our common stock not
including the shares that are issuable (a) upon conversion of our Series D
preferred stock, (b) upon exercise of warrants purchased in conjunction with the
Series D preferred stock or (c) as dividends upon the Series D preferred stock.
If the foregoing categories of shares are included as outstanding shares, the
beneficial ownership percentages are 31% and 29%, respectively. As the Chairman
of the Board of Directors and our largest stockholder, Mr. Hunt may exercise
substantial control over our future direction and operation and such
concentration of control may have the effect of discouraging, delaying or
preventing a change in control and may also have an adverse effect on the market
price of our common stock.
OUR STOCK PRICE MAY BE VOLATILE AND YOU MAY NOT BE ABLE TO RESELL YOUR
SHARES AT OR ABOVE ACCEPTABLE PRICES.
The market price of our common stock may fluctuate significantly in
response to factors, some of which are beyond our control, including the
following:
o Actual or anticipated fluctuations in our operating results;
o Changes in market valuations of other technology companies;
o Announcements by us or our competitors of significant technical
innovations, contracts, acquisitions, strategic partnerships,
joint ventures or capital commitments;
o Additions or departures of key personnel;
o Future sales of common stock;
o Any deviations in net revenues or in losses from levels expected
by the investment community; and
o Trading volume fluctuations.
CERTAIN PROVISIONS OF OUR CHARTER AND OF DELAWARE LAW MAKE A TAKEOVER
OF OUR COMPANY MORE DIFFICULT.
Our corporate charter and Delaware law contain provisions, such as a
class of authorized but unissued preferred stock which may be issued by our
board without stockholder approval, that might enable our management to resist a
takeover of our company. Delaware law also limits business combinations with
interested stockholders. These provisions might discourage, delay or prevent a
change in our control or a change in our management. These provisions could also
discourage proxy contests, and make it more difficult for you and other
stockholders to elect directors and take other corporate actions. The existence
of these provisions could limit the price that investors might be willing to pay
in the future for shares of our common stock.
32
FUTURE ISSUANCES OF BLANK CHECK PREFERRED STOCK MAY REDUCE VOTING POWER
OF COMMON STOCK AND MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE
IN CONTROL.
Our corporate charter authorizes the issuance of up to 500,000 shares
of preferred stock with such designations, rights, powers and preferences as may
be determined from time to time by our Board of Directors, including such
dividend, liquidation, conversion, voting or other rights, powers and
preferences as may be determined from time to time by the Board of Directors
without further stockholder approval. The issuance of preferred stock could
adversely affect the voting power or other rights of the holders of common
stock. In addition, the authorized shares of preferred stock and common stock
could be utilized, under certain circumstances, as a method of discouraging,
delaying or preventing a change in control.
U.S. INVESTORS MAY HAVE DIFFICULTIES IN MAKING CLAIMS FOR ANY BREACH OF
THEIR RIGHTS AS HOLDERS OF SHARES BECAUSE SOME OF OUR ASSETS AND EXECUTIVES ARE
NOT LOCATED IN THE UNITED STATES.
Several of our executives are residents of Belgium, and a substantial
portion of our assets and those of some of our executives are located in
Belgium. As a result, it may not be possible for investors to effect service of
process on those persons located in Belgium, or to enforce judgments against
some of our executives based upon the securities or other laws of jurisdictions
other than Belgium. Moreover, we believe that under Belgian law there exists
certain restrictions on the enforceability in Belgium in original actions, or in
actions of enforcement of judgments rendered against us in courts outside
jurisdictions that are a party to the Brussels Convention on Jurisdiction and
the Enforcement of Judgments in Civil and Commercial Matters (as amended).
Actions for enforcement of such judgments may be successful only if the Belgian
court confirms the substantive correctness of the judgment of such court, and is
satisfied:
o That the judgment is not contrary to the principles of public
policy in Belgium or rules of Belgian public law;
o That the judgment did not violate the rights of the defendant;
o That the judgment is final under applicable law;
o That the court did not accept its jurisdiction solely on the basis
of the nationality of the plaintiff; and
o As to the authenticity of the text of the judgment submitted to
it.
Judgments rendered in the courts of parties to the Brussels Convention
will be enforceable by the courts of Belgium without reexamination of the merits
of the case provided such judgment is final and otherwise satisfies all of the
conditions provided for in this Convention. If proceedings have been brought in
one country, however, new proceedings in another country may be barred.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Exchange Risk - In 2004, approximately 90% of our
business was conducted outside the United States in Europe and Asia/Pacific. A
significant portion of our business operations is transacted in foreign
currencies. As a result, we have exposure to foreign exchange fluctuations. We
are affected by both foreign currency translation and transaction adjustments.
Translation adjustments result from the conversion of the foreign subsidiaries'
balance sheets and income statements to U.S. dollars at year-end exchange rates
and weighted average exchange rates, respectively. Translation adjustments
resulting from this process are recorded directly into stockholders' equity.
Transaction adjustments result from currency exchange movements when a foreign
subsidiary transacts business in a currency that differs from its local
currency. These adjustments are recorded as gains or losses in our statements of
operations. Our foreign subsidiaries' business transactions are spread across
numerous countries and currencies. This geographic diversity reduces the risk to
our operating results.
33
Interest Rate Risk - We have minimal interest rate risk. We have no
outstanding debt and our cash is invested in short-term instruments at current
market rates. If rates were to increase or decrease by one percentage point, the
Company's interest income would increase or decrease approximately $80,000
annually.
Impairment Risk - At December 31, 2004, we had goodwill and other
intangible assets of $1,384,000 related mostly to technology purchased in 2001
as part of our acquisition of Identikey. We will assess the net realizable value
of the intangible assets on a regular basis, but at least annually, to determine
if we have incurred any declines in the value of our capital investment. While
we did not experience impairment during the year ended December 31, 2004, we may
incur impairment charges in future periods.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information in response to this item is included in our
consolidated financial statements, together with the report thereon of KPMG LLP,
appearing on pages F-1 through F-24 of this Form 10-K, and in Item 7 under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A - CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains a system of disclosure controls and procedures
that is designed to ensure that information required to be disclosed by the
Company in this Form 10-K, and in other reports required to be filed under the
Securities Exchange Act of 1934, is recorded, processed, summarized and reported
within the time periods specified in the rules and forms for such filings.
Management of the Company, under the direction of the Company's Chief Executive
Officer and Chief Financial Officer, reviewed and performed an evaluation of the
effectiveness of the Company's disclosure controls and procedures at the end of
the period. Based on that review and evaluation, the Chief Executive Officer and
Chief Financial Officer, along with other key management of the Company, have
determined that the disclosure controls and procedures were and are effective as
designed to ensure that material information relating to the Company and its
consolidated subsidiaries would be made known to them on a timely basis.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls
during the quarter ended December 31, 2004.
ITEM 9B - OTHER INFORMATION
None.
34
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
T. KENDALL "KEN" HUNT -- Mr. Hunt is Chairman of the Board and Chief
Executive Officer. He served as our Chief Executive Officer through June 1999.
He returned as CEO in November 2002. He has been a director since July 1997 and
currently serves a one-year term. He served since 1990 as Chairman and President
of our predecessor, VASCO Corp. He is also affiliated with several high-tech
early-stage companies, serving as a member of their Board of Directors. He is a
co-founder and on the board of Secured Services, Inc., a publicly-held company,
listed on the Nasdaq (Symbol: ssvc). Mr. Hunt is President of the Belgian
Business Club of Chicago. Additionally, he is on the Advisory Board for the
Posse Foundation, an organization dedicated to providing full college
scholarships to urban minority youth leaders through its partnerships with elite
universities across the U.S. He holds an MBA from Pepperdine University, Malibu,
California, 1979, and a BBA from the University of Miami, Florida, 1965. Mr.
Hunt is 61 years old.
MICHAEL P. CULLINANE -- Mr. Cullinane has been a director since April
10, 1998 and currently serves a one-year term. He is the Chairman of our Audit
Committee and a member of our Compensation Committee and our Governance and
Nominating Committee. Mr. Cullinane currently serves as the Executive Vice
President and Chief Operating Officer of Lakeview Technology. Mr. Cullinane
served as the Executive Vice President and Chief Financial Officer and a
director of Divine, Inc. from July 1999 to May 2003. He served as Executive Vice
President, Chief Financial Officer and a director of PLATINUM Technology
International, Inc. from 1988 to June 1999. On February 25, 2003, Divine, Inc.
filed for protection under the federal bankruptcy laws. Mr. Cullinane received a
B.B.A. from the University of Notre Dame, South Bend, Indiana. Mr. Cullinane is
55 years old.
MICHAEL A. MULSHINE -- Mr. Mulshine has been a director since July 1997
and currently serves a one-year term. He served since 1992 as a director of our
predecessor, VASCO Corp. He is the Chairman of our Compensation Committee and a
member of our Audit Committee and our Governance and Nominating Committee. He
is, and since 1979 has been, a principal of Osprey Partners, a management
consulting firm. From 1985 to 2003 he served as a director and corporate
secretary of SEDONA Corporation, a provider of web-based Customer Relationship
Management (CRM) solutions for small and mid-sized financial services companies.
Additionally, Mr. Mulshine is a director of Prediction Systems, Inc., a
privately held software engineering company specializing in the technology of
modeling and simulation. Mr. Mulshine received a B.S. in Electrical Engineering
from Newark College of Engineering of the New Jersey Institute of Technology,
Newark, New Jersey. Mr. Mulshine is 65 years old.
JOHN R. WALTER -- Mr. Walter has been a director since April 2003 and
currently serves a one-year term. He is Chairman of our Governance and
Nominating Committee and is a member of our Audit Committee and our Compensation
Committee. Mr. Walter is Chairman and CEO of Ashlin Management Co., a private
investment and management services firm. Mr. Walter also serves as a director
for Abbott Laboratories, Inc., Deere & Company, Manpower, Inc., and SNP
Corporation of Singapore. Mr. Walter served as President and Chief Operating
Officer of AT&T Corporation from 1996 to 1997. He served as Chairman and CEO of
R.R. Donnelley & Sons Company, a print and digital information management
company, from 1989 through 1996. Mr. Walter received a B.S. degree in management
from Miami University, Oxford, Ohio. Mr. Walter is 58 years old.
EXECUTIVE OFFICERS
JAN VALCKE -- Mr. Valcke is President & Chief Operating Officer. Mr.
Valcke has been an officer of the Company since 1996. From 1992 to 1996, he was
Vice-President of Sales and Marketing of Digipass NV/SA, a member of the
Digiline group. He co-founded Digiline in 1988 and was a member of the Board of
Directors of Digiline. Mr.Valcke received a degree in Science from St. Amands
College in Kortrijk, Belgium. Mr. Valcke is 51 years old.
35
CLIFFORD K. BOWN -- Mr. Bown is Executive Vice President & Chief
Financial Officer. Mr. Bown started his career with KPMG LLP where he directed
the audits for several publicly held companies, including a global leader that
provides integrated and embedded communications solutions. From 1991 to 1993, he
was CFO for publicly held XL/DATACOMP, a $300 million provider of midrange
computer systems and support services in the U. S. and U. K. Mr. Bown also held
CFO positions in two other companies focused on insurance and healthcare from
1995 through 2001. Mr. Bown received a B.S. in Accountancy from the University
of Illinois, Urbana, Illinois, his MBA from the University of Chicago, and he
has a CPA certificate. Mr. Bown is 53 years old.
AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors has determined that Mr. Cullinane, Chairman of
the Audit Committee, Mr. Mulshine, member of the Audit Committee and Mr. Walter,
member of the Audit Committee, each qualify as a financial expert and has
designated each person as a financial expert. Each member of the Audit Committee
has been determined to be independent as defined by The Nasdaq Stock Market,
Inc. and the Securities and Exchange Commission.
SECTION 16(A) BENEFICIAL OWNERSHIP COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires directors
and executive officers, and persons who beneficially own more than 10% of a
registered class of our equity securities, to file reports of ownership and
changes in ownership with the Securities and Exchange Commission and The Nasdaq
Stock Market, Inc. Directors, executive officers and beneficial owners of more
than 10% of the outstanding shares of Common Stock are required by Commission
regulations to furnish us with copies of all Section 16(a) forms that they file.
Based solely on review of the copies of such forms or written representations
that no reports under Section 16(a) were required, and except as previously
disclosed in the Company's proxy statement filed on May 10, 2004, we believe
that for the year period ended December 31, 2004, all of the Company's
directors, executive officers and greater than 10% beneficial owners complied
with Section 16(a) filing requirements applicable to them.
CODE OF ETHICS
The Company has adopted a Code of Ethics that applies to all of its
employees, including its principal executive officer and principal financial
officer. The Code of Ethics, was filed in the prior year and is noted as Exhibit
10.54 herein.
36
ITEM 11 - EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth all compensation awarded to, earned by,
or paid for services rendered to VASCO and our subsidiaries in all capacities
during the three years ended December 31, 2004, 2003 and 2002 for our Chief
Executive Officer, President and Chief Operating Officer and Executive Vice
President, who are the only executive officers of VASCO and our subsidiaries
whose salary and bonus for such year exceeded $100,000 (collectively, the "Named
Executive Officers").
- -------------------------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
- -------------------------------------------------------------------------------------------------------------------------
AWARDS PAYOUTS
----------------------------------------------------------------------
OTHER RESTRICTED SECURITIES
ANNUAL STOCK UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS/SARS PAYOUTS COMPENSATION
POSITION YEAR ($) ($) ($) ($) (#) ($) ($)
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
T. KENDALL HUNT (1) 2004 225,000 90,000 -- -- 125,000 -- --
Chairman and Chief 2003 173,750 -- -- -- 125,000 -- --
Executive Officer 2002 152,627 42,500 -- -- 120,000 -- --
- -------------------------------------------------------------------------------------------------------------------------
JAN VALCKE (2) 2004 321,256 59,310 -- -- 100,000 -- --
President and Chief 2003 277,991 -- -- -- 100,000 -- --
Operating Officer 2002 166,667 40,000 34,889 -- 50,000 -- --
- -------------------------------------------------------------------------------------------------------------------------
CLIFFORD K. BOWN (3) 2004 175,000 60,000 -- -- 50,000 -- --
Executive Vice 2003 150,000 -- -- -- 75,000 -- --
President, Chief 2002 50,600 75,000
Financial Officer and
Secretary
- -------------------------------------------------------------------------------------------------------------------------
(1) Mr. Hunt returned as CEO of the Company on November 20, 2002.
(2) Mr. Valcke was elected President and COO on November 20, 2002. Mr. Valcke
salary and bonus for 2004 were denominated in Euros. The above information
reflects the Euros paid translated into U.S. dollars at the average exchange
rate for the year. Other Annual Compensation primarily includes
employment-related expenses billed by Mr. Valcke as an independent
contractor.
(3) Mr. Bown joined the Company as Executive Vice President and Chief Financial
Officer on August 19, 2002. He was appointed Secretary of the Company as of
October 21, 2002.
37
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth all options granted to the Named
Executive Officers during 2004.
- -----------------------------------------------------------------------------------------------------------------------
INDIVIDUAL GRANTS
- -----------------------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE AT
PERCENT OF ASSUMED ANNUAL RATES OF STOCK PRICE
TOTAL APPRECIATION FOR OPTION TERM (2)
NUMBER OF OPTIONS/ ------------------------------------
SECURITIES SARS
UNDERLYING GRANTED TO
OPTIONS/ EMPLOYEES EXERCISE OF
SARS GRANTED IN FISCAL BASE PRICE EXPIRATION
NAME (1) YEAR ($/SH) DATE 5% ($) 10% ($)
- -----------------------------------------------------------------------------------------------------------------------
T. Kendall Hunt 125,000 25.6 % 2.53 1/08/14 515,000 820,000
- -----------------------------------------------------------------------------------------------------------------------
Jan Valcke 100,000 20.5% 2.53 1/08/14 412,000 656,000
- -----------------------------------------------------------------------------------------------------------------------
Clifford K. Bown 50,000 10.3% 2.53 1/08/14 206,000 328,000
- -----------------------------------------------------------------------------------------------------------------------
(1) Vesting schedule is based on a time period of 36 months, with 6/36th of the
options vesting at the end of the first six months and 1/36th of the options
vesting each month thereafter on the last day of each month.
(2) The potential realizable value amounts shown illustrate the values that
might be realized upon exercise immediately prior to the expiration of their
term using five percent and ten percent appreciation rates as required to be
used in this table by the Securities and Exchange Commission, compounded
annually, and are not intended to forecast future appreciation, if any, of our
stock price. Additionally, these values do not take into consideration the
provisions of the options providing for nontransferability or termination of the
options following termination of employment. Therefore, the actual values
realized may be greater or less than the potential realizable values set forth
in the table.
AGGREGATED OPTION /SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION/SAR VALUES
The following table sets forth the aggregate value as of December 31,
2004 of unexercised stock options held by the Named Executive Officers. The
Named Executive Officers did not exercise any stock options during 2004 and the
relevant columns have, therefore, been omitted.
- -----------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES UNDERLYING
UNEXERCISED OPTIONS/SARS AT FISCAL VALUE OF UNEXERCISED IN-THE-MONEY
NAME YEAR-END OPTIONS/SARS AT FISCAL YEAR-END ($) (1)
- -----------------------------------------------------------------------------------------------------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -----------------------------------------------------------------------------------------------------------------------
T. Kendall Hunt 509,721 135,279 2,050,539 635,861
- -----------------------------------------------------------------------------------------------------------------------
Jan Valcke 326,805 106,945 1,432,297 503,128
- -----------------------------------------------------------------------------------------------------------------------
Clifford K. Bown 121,528 78,472 659,285 390,965
- -----------------------------------------------------------------------------------------------------------------------
(1) Market value of underlying securities is based on the closing price of the
Common Stock as reported on the Nasdaq National market on December 31, 2004
($6.62) minus the exercise price.
38
COMPENSATION OF DIRECTORS
The Compensation Committee of our Board of Directors reviews and sets
the salaries and incentive compensation for our executive officers. The
Compensation Committee reviews information relevant to Director compensation and
presents its recommendation for such compensation to the full Board for its
approval. The Compensation Committee also administers our stock option plan. In
its capacity as administrator of the stock option plan, the Compensation
Committee has authority to grant stock options to all employees and determine
the terms thereof. The Compensation Committee also makes recommendations to the
Board for its approval relative to options to be granted to non-employee Board
members. The members of the Compensation Committee for 2004 were: Michael A.
Mulshine, Michael P. Cullinane and John R. Walter.
Each of our directors received a quarterly cash payment of $5,000 in
connection with his service on the Board of Directors in 2004. The directors
also receive cash compensation for participation on Committees of the Board as
follows: Audit Committee Chair $10,000 annually, paid quarterly; other Committee
Chairs $5,000 annually, paid quarterly; Audit Committee members $5,000 annually,
paid quarterly; and other Committee members $2,500 annually, paid quarterly. Our
directors are also reimbursed for expenses incurred in connection with their
attendance at periodic Board meetings. In addition, non-employee directors are
eligible to receive stock option grants from time to time. In 2004, options to
purchase 20,000 shares of our Common Stock were issued to each of Messrs.
Cullinane, Mulshine, and Walter. Options to directors were at a per share
exercise price of $2.55.
EMPLOYMENT AGREEMENTS
Mr. Hunt's salary and bonus are determined pursuant to his employment
agreement dated November 20, 2002. Mr. Hunt's annual salary, any discretionary
bonus and stock options will be determined by the Compensation Committee for
each fiscal year of the Company during the employment period. In 2004, Mr. Hunt
received a base salary of $225,000, 125,000 stock options and earned a $90,000
bonus to be paid in 2005. In the event Mr. Hunt is terminated Without Cause, he
quits for Good Reason, or he is terminated or quits for Good Reason after a
Change in Control (as the foregoing terms are defined in his employment
agreement), Mr. Hunt will continue to receive his base pay and any applicable
Incentive Compensation over a 24-month period. In the event of such termination,
Mr. Hunt has agreed to abide by several non-compete restrictions. Mr. Hunt's
current 2005 annual base salary is $260,000 with a target bonus, if specific
objectives are met, of $75,000.
Mr. Valcke's salary and bonus are determined pursuant to an Independent
Contractor Employment Agreement (the "Agreement") dated November 20, 2002. Mr.
Valcke's annual salary, his bonus and stock options will be determined by the
Compensation Committee for each fiscal year of the Company during the employment
period. In 2004, Mr. Valcke received 260,000 Euros, $321,256 using the average
exchange rate for 2004, in base compensation, 100,000 stock options and earned a
bonus of 48,000 Euros to be paid in 2005. Either Mr. Valcke or the Company have
the option to terminate Mr. Valcke's employment with or without cause, for any
reason whatsoever, without any breach of the Agreement by giving six (6) month's
written notice. In the event of such termination, Mr. Valcke has agreed to abide
by various non-compete and non-solicitation restrictions for up to 12 months
following termination of the Agreement. Mr. Valcke's 2005 base compensation is
260,000 Euros with a target bonus, if specific objectives are met of 75,000
Euros.
Mr. Bown's salary and bonus are determined pursuant to his employment
agreement dated January 1, 2003. Mr. Bown's annual salary, any discretionary
bonus and stock options will be determined by the Compensation Committee for
each fiscal year of the Company during the employment period. In 2004, Mr. Bown
received a base salary of $175,000, 50,000 stock options and earned a $60,000
bonus to be paid in 2005. In the event Mr. Bown is terminated Without Cause, he
quits for Good Reason, or he is terminated or quits for Good Reason after a
Change in Control (as the foregoing terms are defined in his employment
agreement), Mr. Bown will continue to receive his base pay and any applicable
Incentive Compensation over a 12-month period. In the event of such termination,
Mr. Bown has agreed to abide by various non-compete restrictions. Mr. Bown's
2005 annual base salary is $200,000 with a target bonus, if specific objectives
are met of $50,000.
39
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
For 2004, our Compensation Committee was comprised of Messrs. Mulshine,
Cullinane and Walter. There were no Committee interlocks or insider
participation in 2004.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth shares of our Common Stock that are
authorized to be issued under the Company's 1997 Stock Compensation Plan, as
amended and restated in 1999:
- ------------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION
BE ISSUED UPON EXERCISE OF EXERCISE PRICE OF PLANS (EXCLUDING
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED IN
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS COLUMN (A)
- ------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by 2,626,438 $2.75 4,089,900
security holders
- ------------------------------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by
security holders none not applicable not applicable
- ------------------------------------------------------------------------------------------------------------------------
The following table sets forth certain information with respect to the
beneficial ownership of our Common Stock as of March 24, 2005 for each person or
entity who is known to us to beneficially own five percent or more of the Common
Stock. For purposes of the table, a person or group of persons is deemed to have
beneficial ownership of any shares as of a given date that such person has the
right to acquire within 60 days after such date.
------------------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT AND NATURE OF
BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
T. Kendall Hunt
1901 S. Meyers Road 10,447,253(1) 29.962%
Ste. 210
Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------
(1) Includes 200,000 shares held in the T. Kendall Hunt Charitable Remainder
Trust and 1,111,300 shares held by the estate of Barbara J. Hunt, with Mr. Hunt
as executor of the estate, as to which shares Mr. Hunt disclaims beneficial
ownership.
40
The table below sets forth certain information with respect to the
beneficial ownership of our Common Stock as of March 31, 2005 for (i) each of
our directors, (ii) each of our named executive officers, and (iii) all
directors and executive officers as a group. The persons named in the table have
sole voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them unless otherwise indicated. For purposes of
the table, a person or group of persons is deemed to have beneficial ownership
of any shares as of a given date that such person has the right to acquire
within 60 days after such date.
------------------------------------------------------------------------------------------------------------
NAME AND ADDRESS OF BENEFICIAL AMOUNT AND NATURE OF
OWNER BENEFICIAL OWNERSHIP (1) PERCENT OF CLASS
------------------------------------------------------------------------------------------------------------
T. Kendall Hunt 10,447,253 (2) 29.962%
1901 S. Meyers Road
Ste. 210 Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------------------------------
Jan Valcke 359,972 1.032%
Koningin Astridlaan 164
B-1780 Wemmel, Belgium
------------------------------------------------------------------------------------------------------------
Michael P. Cullinane
1901 S. Meyers Road
Ste. 210 95,333 0.273%
Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------------------------------
Michael A. Mulshine
1901 S. Meyers Road
Ste. 210 95,333 0.273%
Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------------------------------
John R. Walter
1901 S. Meyers Road
Ste. 210 93,333 0.268%
Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------------------------------
Cliff Bown
1901 S. Meyers Road
Ste. 210 164,306 0.471%
Oakbrook Terrace, IL 60181
------------------------------------------------------------------------------------------------------------
All Executive Officers and Directors
as a Group 11,284,930 32.279%
(6 persons)
------------------------------------------------------------------------------------------------------------
(1) The number of shares beneficially owned by each director and executive
officer is determined under rules promulgated by the Securities and Exchange
Commission, and the information is not necessarily indicative of beneficial
ownership for any other purpose. Under such rules, beneficial ownership includes
any shares as to which the individual has sole or shared voting power or
investment power and also any shares that the individual has the right to
acquire within 60 days after March 31, 2005 through the exercise of any stock
option or other right. The inclusion herein of such shares, however, does not
constitute an admission that the named stockholder is a direct or indirect
beneficial owner of such shares. Unless otherwise indicated, each person or
entity named in the table has sole voting power and investment power (or shares
such power with his or her spouse) with respect to all shares of capital stock
listed as owned by such person or entity.
(2) Includes 200,000 shares held in the T. Kendall Hunt Charitable Remainder
Trust and 1,111,300 shares held by the estate of Barbara J. Hunt, with Mr. Hunt
as executor of the estate, as to which shares Mr. Hunt disclaims beneficial
ownership.
41
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In July 2003, the Company sold its VACMAN Enterprise business unit
("VACMAN") to SecureD Services, Inc. ("SSI"), a then newly organized company in
which T. Kendall Hunt had a 19% equity ownership interest and is one of three
directors on its board. The transaction was approved by all of the independent
directors of the Company. The Company received a $1.1 million senior secured
promissory note and $2.0 million of convertible preferred stock from SSI in
exchange for the VACMAN assets. The note is payable in 36 monthly installments
and bears interest at 6% per annum. The preferred stock pays a 6% cumulative
stock dividend quarterly, and may be converted into SSI common stock on a
share-for-share basis in phases commencing July 1, 2005. An independent
valuation firm valued the transaction at approximately $1.6 million. SSI has
since merged with a public company and its common stock is traded on the OTC
Bulletin Board.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following sets forth the amount of fees paid to our registered
public accounting firm, KPMG LLP, for services rendered in 2004 and 2003:
AUDIT FEES: The aggregate fees billed by KPMG LLP for professional
services rendered for the audit of the Company's annual financial statements,
the reviews of the financial statements included in the Company's quarterly
reports on Form 10-Q, and services normally provided by the independent auditor
in connection with statutory and regulatory filings were $250,959 for the fiscal
year ended December 31, 2004, and $221,050 for the fiscal year ended December
31, 2003.
AUDIT-RELATED FEES: There were no audit-related fees paid in 2004. The
aggregate fees billed by KPMG LLP for assurance and related services related to
the performance or review of the Company's financial statements and not
described above under "Audit Fees" were approximately $39,450 for the 2003
fiscal year. In 2003, the audit-related services included audits of the
carve-out financial statements for the VACMAN Enterprise business as required
under the agreement to sell the business unit.
TAX FEES: The aggregate fees billed by KPMG LLP for tax compliance and
tax advice were approximately $39,375 for the 2004 fiscal year and approximately
$83,220 for the 2003 fiscal year. The fees for 2004 and 2003 primarily related
to the filing of the Company's tax returns.
ALL OTHER FEES: There were no such fees in 2004 or 2003.
It is currently the policy of the Audit Committee of the Board of
Directors to pre-approve all services rendered by KPMG LLP. The Audit Committee
pre-approved all of the above fees for both 2004 and 2003.
PART IV
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements and notes
thereto, and the related independent auditors' report, are included on pages F-1
through F-23 of this Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the Years Ended December
31, 2004, 2003 and 2002
42
Consolidated Statements of Comprehensive Income (Loss) for the Years
Ended December 31, 2004, 2003 and 2002
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the Years Ended December
31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(2) The following consolidated financial statement schedule of the
Company is included in this Form 10-K:
o Schedule II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because such
schedules are not required or the information required has been
presented in the aforementioned consolidated financial statements.
(3) The following exhibits are filed with this Form 10-K or
incorporated by reference as set forth at the end of the list of
exhibits:
EXHIBIT
NUMBER DESCRIPTION
+3.1 Certificate of Incorporation of Registrant, as amended.
++3.2 Bylaws of Registrant, as amended and restated.
4.1 Intentionally Omitted.
+4.2 Specimen of Registrant's Common Stock Certificate.
4.3 Intentionally Omitted.
+4.4 Form of Letter of Transmittal and Release.
+4.5 Form of Registrant's Warrant Agreement.
+4.6 Form of Registrant's Option Agreement.
+4.7 Form of Registrant's Convertible Note Agreement.
+10.1 Netscape Communications Corporation OEM Software Order Form
dated March 18, 1997 between VASCO Data Security, Inc. and
Netscape Communications Corporation.**
+10.2 License Agreement between VASCO Data Security, Inc. and SHIVA
Corporation effective June 5, 1997.**
+10.3 Heads of Agreement between VASCO Data Security International,
Inc., VASCO Data Security Europe S.A., Digiline International
Luxembourg, Digiline S.A., Digipass S.A., Dominique Colard and
Tops S.A. dated May 13, 1996.
43
EXHIBIT
NUMBER DESCRIPTION
+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.
+10.10 Lease Agreement by and between TOPS S.A. and Digipass S.A.
effective July 1, 1996.
+10.11 Lease Agreement by and between Perkins Commercial Management
Company, Inc. and VASCO Data Security, Inc. dated November 21,
1995.
+10.12 Asset Purchase Agreement by and between VASCO Data Security
International, Inc. and Wizdom Systems, Inc. dated August 20,
1996.
+10.13 1997 VASCO Data Security International, Inc. Stock Option Plan,
as amended.
+10.14 Distributor Agreement between VASCO Data Security, Inc. and
Hucom, Inc. dated June 3, 1997.**
+10.15 Non-Exclusive Distributor Agreement by and between VASCO Data
Security, Inc. and Concord-Eracom Nederland BV dated May 1,
1994.**
+10.16 Banque Paribas Belgique S. A. Convertible Loan Agreement for
$3.4 million.
+10.17 Pledge Agreement dated July 15, 1997 by and between T. Kendall
Hunt and Banque Paribas Belgique S.A.
+10.18 Engagement Letter between Banque Paribas S.A. and VASCO Data
Security International, Inc. dated June 20, 1997, as amended.
+10.19 Financing Agreement between Generale Bank and VASCO Data
Security International, Inc. dated as of June 27, 1997.
+10.20 Letter Agreement between Generale Bank and VASCO Data Security
International, Inc. dated June 26, 1997.
+10.21 Form of Warrant dated June 16, 1997 (with Schedule).
+10.22 Form of Warrant dated October 31, 1995 (with Schedule).
+10.23 Form of Warrant dated March 7, 1997 (with Schedule).
+10.24 Form of Warrant dated August 13, 1996 (with Schedule).
+10.25 Form of Warrant dated June 27, 1996 (with Schedule).
+10.26 Form of Warrant dated June 27, 1996 (with Schedule).
44
EXHIBIT
NUMBER DESCRIPTION
+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.
45
EXHIBIT
NUMBER DESCRIPTION
10.48 Acquisition of Identikey, Ltd. (Incorporated by reference -
Form 8-K filed March 29, 2001.)
10.49 Agreement with Artesia Bank to revise the terms of the $3.4
million convertible loan. (Incorporated by reference - Form 8-K
filed August 9, 2001.)
##10.50 Employment agreement with T. Kendall Hunt.
##10.51 Independent Contractor Employment agreement with Jan
Valcke.
##10.52 Employment agreement with Clifford Bown.
##10.53 Indemnification Agreement with T. Kendall Hunt.
*10.54 Code of Ethics.
21 Subsidiaries of Registrant. (Incorporated by reference - Form
10-K filed April 2, 2001.)
23 Consent of KPMG LLP.
31.1 Statement Under Oath of Principal Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated March 29,
2005.
31.2 Statement Under Oath of Principal Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated March 29,
2005.
32.1 Statement Under Oath of Principal Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, dated March 29,
2005.
32.2 Statement Under Oath of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, dated March 29,
2005.
- --------------------------
+ Incorporated by reference to the Registrant's Registration Statement on
Form S-4, as amended (Registration No. 333-35563), originally filed with
the Securities and Exchange Commission on September 12, 1997.
++ Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on May 5,
1998.
# Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on April 14,
1999.
## Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on March 31,
2003.
* Incorporated by reference to the Registrant's Annual Report on Form 10-K,
originally filed with the Securities and Exchange Commission on March 30,
2004.
** Confidential treatment has been granted for the omitted portions of this
document.
46
(b) 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.
(c) Reports on Form 8-K
(1) On October 22, 2004, the Company filed a Form 8-K covering items 2
and 9 that included:
o A copy of the press release dated October 22, 2004 providing a
financial update of the Company for the third quarter and
nine-months ended September 30, 2004, and
o The text of the script for the earnings conference call held on
October 22, 2004.
(2) On December 20, 2004, the Company filed a Form 8-K covering items 2
and 9 that included:
o A copy of the press release dated December 16, 2004 providing a
financial update of the Company for the fourth quarter and
full-year ended December 31, 2004 and full-year 2005, and
o The text of the script for the call held on December 16, 2004.
(3) On February 8, 2005, the Company filed a Form 8-K covering items 2
and 9 that included:
o Share Sale and Purchase Agreement by and among VASCO Data
Security International, Inc., A.O.S. Holding B.V., Filipan
Beheer B.V., Mr. Mladen Filipan, and Pijnenburg Beheer N.V.,
dated February 4, 2005.
o A copy of the press release dated February 8, 2005 announcing
the acquisition of AOS Hagenuk, B.V.
o Registration Rights Agreement by and among A.O.S. Holding B.V.,
Filipan Beheer B.V., Mr. Mladen Filipan, and Pijnenburg Beheer
N.V., and VASCO Data Security International, Inc. dated
February 4, 2005.
(4) On February 16, 2005, the Company filed a Form 8-K covering items 2
and 9 that included:
o A copy of the press release dated February 15, 2005 providing a
financial update of the Company for the fourth quarter and
full-year ended December 31, 2004, and
o The text of the script for the earnings conference call held on
February 15, 2005.
47
VASCO DATA SECURITY INTERNATIONAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets as of December 31, 2004 and 2003 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2004, 2003 and 2002 F-4
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
December 31, 2004, 2003 and 2002 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2004, 2003 and 2002 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004, 2003 and 2002 F-7
Notes to Consolidated Financial Statements F-8
FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule is included herein:
Schedule II - Valuation and Qualifying Accounts F-24
All other financial statement schedules are omitted because they are not
applicable or the required information is shown in the consolidated financial
statements or notes thereto.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
VASCO Data Security International, Inc.:
We have audited the accompanying consolidated balance sheets of VASCO
Data Security International, Inc. and subsidiaries (the "Company") as of
December 31, 2004 and 2003 and the related consolidated statements of
operations, comprehensive income (loss), stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2004. In
connection with our audits of the consolidated financial statements, we have
also audited the accompanying consolidated financial statement Schedule II -
Valuation and Qualifying Accounts. These consolidated financial statements and
the consolidated financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and the consolidated financial statement
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Accounting Oversight Board. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of VASCO Data
Security International, Inc. and subsidiaries as of December 31, 2004 and 2003,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related
consolidated financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
/s/ KPMG LLP
Chicago, Illinois
March 23, 2005
F-2
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
December 31, December 31,
2004 2003
---------------- ---------------
ASSETS
Current assets:
Cash $ 8,138 $ 4,817
Restricted cash 82 -
Accounts receivable, net of allowance for doubtful accounts
of $160 and $471 in 2004 and 2003, repectively 5,965 2,523
Inventories, net 1,346 1,075
Prepaid expenses 791 476
Deferred income taxes 23 70
Foreign sales tax receivable 313 362
Other current assets 464 335
-------- --------
Total current assets 17,122 9,658
Property and equipment
Furniture and fixtures 1,683 1,941
Office equipment 2,008 2,221
-------- --------
3,691 4,162
Accumulated depreciation (2,853) (3,280)
-------- --------
Net property and equipment 838 882
Intangible asset, net of accumulated amortization of $4,479
and $4,085 in 2004 and 2003, repectively 1,134 1,378
Goodwill, net of accumulated amortization of $973 in 2004 and 2003 250 250
Note receivable and investment in SSI 760 1,132
Other assets 146 83
-------- --------
TOTAL ASSETS $ 20,250 $ 13,383
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,065 $ 1,698
Deferred revenue 620 386
Accrued wages and payroll taxes 1,602 1,515
Income taxes payable (receivable) 435 (197)
Other accrued expenses 1,345 1,038
-------- --------
Total current liabilities 7,067 4,440
Deferred warranty revenues 152 -
Stockholders' equity :
Series D Convertible Preferred Stock, $10,000 par value - 500,000 shares
authorized; 208 shares issued and outstanding in 2004, 800 shares 1,504 5,786
issued and outstanding in 2003
Common stock, $.001 par value - 75,000,000 shares authorized; 33,581,689
shares issued and outstanding in 2004
30,425,284 shares issued and outstanding in 2003 34 30
Additional paid-in capital 51,825 47,167
Accumulated deficit (40,672) (43,693)
Accumulated other comprehensive income (loss) -
cumulative translation adjustment 340 (347)
-------- --------
Total stockholders' equity 13,031 8,943
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 20,250 $ 13,383
======== ========
See accompanying notes to consolidated financial statements.
F-3
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
For the Years Ended December 31,
---------------------------------------------------------
2004 2003 2002
---------------- ----------------- -----------------
Net revenues $ 29,893 $ 22,866 $ 17,370
Cost of goods sold 9,184 9,010 7,160
-------- -------- --------
Gross profit 20,709 13,856 10,210
-------- -------- --------
Operating costs:
Sales and marketing 9,160 6,987 7,956
Research and development 2,835 2,281 2,341
General and administrative 3,194 3,424 4,542
Non-cash compensation (recovery) - 41 (50)
Restructuring expenses (32) - 319
-------- -------- --------
Total operating costs 15,157 12,733 15,108
-------- -------- --------
Operating income (loss) from continuing operations 5,552 1,123 (4,898)
Interest income (expense), net 120 (80) (270)
Other income (expense), net (539) 115 15
-------- -------- --------
Income (loss) before income taxes 5,133 1,158 (5,153)
Provision for income taxes 1,880 397 140
-------- -------- --------
Net income (loss) from continuing operations 3,253 761 (5,293)
Discontinued operations:
Income from discontinued operations, net of tax - 638 754
Gain on sale of discontinued operations, net of tax - 1,357 -
-------- -------- --------
Net income (loss) 3,253 2,756 (4,539)
Preferred stock beneficial conversion option - (3,720) -
Preferred stock accretion and dividends (232) (751) (1,164)
-------- -------- --------
Net income (loss) available to common stockholders $ 3,021 $ (1,715) $ (5,703)
======== ======== ========
Basic and diluted net income (loss) per common share:
Income (loss) from continuing operations $ 0.09 $ (0.13) $ (0.22)
Income from discontinued operations - 0.07 0.02
-------- -------- --------
Net income (loss) $ 0.09 $ (0.06) $ (0.20)
======== ======== ========
Weighted average common shares outstanding:
Basic 32,216 29,270 28,348
======== ======== ========
Diluted 33,128 29,270 28,348
======== ======== ========
See accompanying notes to consolidated financial statements.
F-4
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
For the Years Ended December 31,
-----------------------------------------------------------------
2004 2003 2002
------------------- ------------------- --------------------
Net income (loss) $ 3,253 $ 2,756 $(4,539)
Other comprehensive income (loss) -
cumulative translation adjustment 687 133 (31)
------- ------- -------
Comprehensive income (loss) $ 3,940 $ 2,889 $(4,570)
======= ======= =======
See accompanying notes to consolidated financial statements.
F-5
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS EXCEPT SHARE DATA)
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred Stock Common Stock Additional
---------------- ------------- Paid-In
Description Shares Amount Shares Amount Capital
-----------
===========================================================================
BALANCE AT DECEMBER 31, 2001 ............................ 150,000 $ 7,944 28,263,058 $ 28 $ 37,693
===========================================================================
Net loss ................................................ - - - - -
Foreign currency translation adjustment ................. - - - - -
Stock issued for acquisition ............................ - - 126,426 - 284
Preferred stock accretion ............................... - 1,164 - - (1,164)
Non-cash compensation ................................... - - - - (50)
---------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 ............................ 150,000 $ 9,108 28,389,484 $ 28 $ 36,763
===========================================================================
Net income .............................................. - - - - -
Foreign currency translation adjustment ................. - - - - -
Exercise of stock options ............................... - - 35,800 - 63
Preferred stock accretion ............................... - 629 - - (629)
Purchase and redemption of series C preferred stock
and warrants .......................................... (150,000) (9,737) 2,000,000 2 5,735
Issuance of series D preferred stock .................... 800 5,786 - - 5,194
Dividend payable ........................................ - - - - -
Non-cash compensation ................................... - - - - 41
---------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2003 ............................ 800 $ 5,786 30,425,284 $ 30 $ 47,167
===========================================================================
Net income .............................................. - - - - -
Foreign currency translation adjustment ................. - - - - -
Exercise of stock options ............................... - - 118,062 1 188
Conversion of series D preferred stock .................. (592) (4,282) 2,960,000 3 4,279
Cash dividend to series D preferred stock shareholders .. - - - - -
Dividend paid in common stock on series D
preferred stock ....................................... - - 64,843 - 144
Dividend payable ........................................ - - - - -
Conversion of series D warrants ......................... - - 13,500 - 47
---------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2004 ............................ 208 $ 1,504 33,581,689 34 $ 51,825
===========================================================================
- --------------------------------------------------------------------------------------------------------------------
Accumulated Other Total
Accumulated Comprehensive Stockholders'
Description Deficit Income (Loss) Equity
-----------
===========================================================
BALANCE AT DECEMBER 31, 2001 ............................ $ (38,069) $ (449) $ 7,147
===========================================================
Net loss ................................................ (4,539) - (4,539)
Foreign currency translation adjustment ................. - (31) (31)
Stock issued for acquisition ............................ - - 284
Preferred stock accretion ............................... - - -
Non-cash compensation ................................... - - (50)
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 ............................ $ (42,608) $ (480) $ 2,811
===========================================================
Net income .............................................. 2,756 - 2,756
Foreign currency translation adjustment ................. - 133 133
Exercise of stock options ............................... - - 63
Preferred stock accretion ............................... - - -
Purchase and redemption of series C preferred stock
and warrants .......................................... - - (4,000)
Issuance of series D preferred stock .................... (3,720) - 7,260
Dividend payable ........................................ (121) - (121)
Non-cash compensation ................................... - - 41
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 2003 ............................ $ (43,693) $ (347) $ 8,943
===========================================================
Net income .............................................. 3,253 - 3,253
Foreign currency translation adjustment ................. - 687 687
Exercise of stock options ............................... - - 189
Conversion of series D preferred stock .................. - - -
Cash dividend to series D preferred stock shareholders .. (182) - (182)
Dividend paid in common stock on series D
preferred stock ....................................... (23) - 121
Dividend payable ........................................ (27) - (27)
Conversion of series D warrants ......................... - - 47
-----------------------------------------------------------
BALANCE AT DECEMBER 31, 2004 ............................ $ (40,672) $ 340 $ 13,031
===========================================================
F-6
VASCO DATA SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
For the Years Ended December 31,
-----------------------------------------------------
2004 2003 2002
--------------- -------------- -----------------
Cash flows from operating activities:
Net income (loss) from continuing operations $ 3,253 $ 761 $(5,293)
Adjustments to reconcile net income (loss) from
continuing operations
to net cash provided by (used in) operating activities:
Depreciation and amortization 734 1,061 1,188
Deferred tax expense (benefit) 46 (70) 83
Loss on disposal of fixed assets 16 - -
Non-cash compensation expense - 41 (50)
Changes in assets and liabilities, net of effects of acquisitions
and dispositions:
Accounts receivable, net (3,002) 697 1,284
Inventories, net (168) 670 666
Foreign sales tax receivable 74 (243) 293
Prepaid expenses (278) (22) 28
Other current assets (56) 58 268
Accounts payable 1,138 (370) (1,700)
Deferred revenue 203 (296) 28
Accrued wages and payroll taxes (35) 21 326
Income taxes payable 598 (86) (132)
Accrued expenses 202 (141) (590)
Deferred warranty 152 - -
Net cash provided by discontinued operations - 328 691
------- ------- -------
Net cash provided by (used in) operations 2,877 2,409 (2,910)
------- ------- -------
Cash flows from investing activities:
Acquisition of Identikey, Ltd. - (7) (23)
Other assets (64) 3 (51)
Additions to property and equipment (252) (124) (16)
Proceeds from the sale of property and equipment, net - 140 -
Increase in restricted cash (82) - -
Payments received on note receivable 304 116 -
------- ------- -------
Net cash provided by (used in) investing activities (94) 128 (90)
------- ------- -------
Cash flows from financing activities:
Repayment of debt - (3,590) (237)
Purchase and retirement of Series C preferred stock - (4,000) -
Net proceeds from issuance of Series D preferred stock - 7,260 -
Proceeds from exercise of stock options and warrants 236 63 -
Dividends paid on preferred stock (182) - -
------- ------- -------
Net cash provided by (used in) financing activities 54 (267) (237)
Effect of exchange rate changes on cash 484 (69) (489)
Net increase (decrease) in cash 3,321 2,201 (3,726)
Cash, beginning of year 4,817 2,616 6,342
------- ------- -------
Cash, end of year $ 8,138 $ 4,817 $ 2,616
======= ======= =======
See accompanying notes to consolidated financial statements.
F-7
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
VASCO Data Security International, Inc. and its wholly owned
subsidiaries (the Company) designs, develops, markets and supports security
products and services which manage and protect against unauthorized access to
computer systems of corporate and government customers. VASCO has operations in
Belgium, Australia, Singapore, Shanghai and the United States (U.S.).
Principles of Consolidation
The consolidated financial statements include the accounts of VASCO
Data Security International, Inc. and its wholly owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Foreign Currency Translation and Transactions
The financial position and results of operations of the Company's
foreign subsidiaries are measured using the local currency as the functional
currency. Accordingly, assets and liabilities are translated into U.S. dollars
using current exchange rates as of the balance sheet date. Revenues and expenses
are translated at average exchange rates prevailing during the year. Translation
adjustments arising from differences in exchange rates are included as a
separate component of stockholders' equity. Gains and losses resulting from
foreign currency transactions are included in the consolidated statements of
operations. Foreign exchange transaction gains (losses) aggregating $(538), $146
and $77 are included in other income (expense) for 2004, 2003 and 2002,
respectively.
Revenue Recognition
License Fees. Revenues from the sale of computer security hardware and
software are recorded upon shipment or, if an acceptance period is allowed, at
the later of shipment or customer acceptance. No significant obligations exist
with regard to delivery or customer acceptance at the time of recognizing
revenue.
Support Agreements. Support agreements generally call for the Company
to provide technical support and software updates to customers. Revenue on
technical support and software update rights is recognized ratably over the term
of the support agreement.
Consulting and Education Services. The Company provides consulting and
education services to its customers. Revenue from such services is generally
recognized during the period in which the services are performed.
Restricted Cash
Restricted cash of $82 at December 31, 2004 supports a bank guarantee
issued in favor of a customer relating to a contract prepayment. Under the terms
of the contract, the Company will have unrestricted use of this cash when it has
fulfilled its commitment to deliver the products. The customer has the right to
put a claim on the guarantee if the Company does not perform. The guarantee
automatically ceases on January 31, 2012, but can be cancelled earlier upon
mutual agreement of both parties or when all of the products have been
delivered. The Company has materially fulfilled the contract during 2004 and it
is the Company's intention to fulfill remaining deliveries during the first
quarter of 2005.
Allowance for Doubtful Accounts
An allowance for doubtful accounts is maintained based upon estimated
losses resulting from the inability of customers to make payments for good and
services.
F-8
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
Inventories
Inventories, consisting principally of hardware and component parts,
are stated at the lower of cost or market. Cost is determined using the
first-in-first-out (FIFO) method. Reserves are recorded for inventory when the
carrying cost of the inventory may not be recovered through subsequent sale of
the inventory.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the related
assets ranging from three to seven years. Additions and improvements are
capitalized, while expenditures for maintenance and repairs are charged to
operations as incurred. Gains or losses resulting from sales or retirements are
recorded as incurred, at which time related costs and accumulated depreciation
are removed from the accounts.
Research and Development Costs
Costs for research and development, principally the design and
development of hardware and software prior to the determination of technological
feasibility, are expensed as incurred on a project-by-project basis. The
Company's research and development costs were $2,835, $2,281 and $2,341 for
2004, 2003 and 2002, respectively.
Software Costs
The Company capitalizes software development costs in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed". Research
and development costs, prior to the establishment of technological feasibility,
determined based upon the creation of a working model, are expensed as incurred.
The Company's policy is to amortize capitalized costs by the greater of (a) the
ratio that current gross revenues for a product bear to the total of current and
anticipated future gross revenues for that product or (b) the straight-line
method over the remaining estimated economic life of the product, generally two
to five years, including the period being reported on. The Company did not
capitalize any software costs during the years ended December 31, 2004, 2003 and
2002.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Fair Value of Financial Instruments
At December 31, 2004 and 2003 the Company's financial instruments were
accounts receivable, notes receivable, accounts payable and accrued liabilities.
The estimated fair value of the Company's financial instruments has been
determined by using available market information and appropriate valuation
methodologies. The fair values of the Company's financial instruments were not
materially different from their carrying amounts at December 31, 2004 and 2003.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
F-9
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company assesses the recoverability of long-lived assets and
certain intangibles by comparing the carrying amount of the asset to a projected
discounted cash flow expected to result and eventual disposition of the asset.
If an asset is considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying value of the asset exceeds the fair
value of the asset.
Valuation of Investment in Secured Services, Inc.
The Company received from Secured Services, Inc. ("SSI") preferred
stock and a note receivable as consideration for assets of the VACMAN Enterprise
business unit. An independent valuation firm established the initial value of
the consideration received from SSI. On an ongoing basis, the Company reviews
information made available by SSI through its public filings and evaluates that
information within the context of the assumptions made by the independent
valuation firm to determine if a reduction in the value of the investment in SSI
is required. At December 31, 2004, there was no reduction in the carrying value
of the Company's investment in SSI.
Goodwill and Other Intangibles
The Company accounts for goodwill and other intangible assets in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets". This
statement replaced the requirements to amortize intangible assets with
indefinite lives and goodwill with a requirement for an impairment test. SFAS
142 also established requirements for identifiable intangible assets, which
included customer lists and proprietary technology.
The Company assesses the impairment of intangible assets, and goodwill
each year-end or whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. The Company completed its last review
during December 2004. Factors considered important which could trigger an
impairment review include significant underperformance relative to expected
historical or projected future operating results, significant changes in the
manner of our use of the acquired assets or the strategy for our overall
business, and significant negative industry or economic trends. The Company
assesses the recoverability of its software development costs against estimated
future revenue for the individual products over the estimated remaining economic
life of the software.
When the Company determines that the carrying value of intangibles and
goodwill may not be recoverable based upon the existence of one or more of the
above indicators of impairment, any impairment is measured based on a projected
discounted cash flow method using a discount rate determined by management to be
commensurate with the risk inherent in the current business model. Given the
highly competitive environment and technological changes, it is reasonably
possible that estimates of anticipated future revenue, the remaining economic
life of the Company's software products, or both may be reduced significantly.
Stock-Based Compensation
At December 31, 2004, the Company had a stock-based employee
compensation plan, which is described more fully in Note 10. The Company
accounts for the plan under the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying Common Stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of FASB Statement
No. 123, "Accounting for Stock-Based Compensation", to stock-based employee
compensation:
F-10
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
For the Years Ended December 31,
-------------------------------------------------
2004 2003 2002
------------- ------------- -------------
Net income (loss) available to common shareholders as reported $ 3,021 $ (1,715) $ (5,703)
Add: Total stock-based employee compensation determined
under fair-value-based methods for all awards, net of tax ........ (1,065) (1,016) (1,005)
------------- ------------- -------------
Pro forma net income (loss)..................................... $ 1,956 $ (2,731) $ (6,708)
============= ============= =============
Net income (loss) per common share - basic and diluted:
As reported ...................................................... $ 0.09 $ (0.06) $ (0.20)
Pro forma ........................................................ $ 0.06 $ (0.09) $ (0.24)
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 2004, 2003 and 2002: dividend yield of 0%;
expected volatility of 104%, 120%, 118%, respectively; risk free interest rates
ranging from 4.08% to 4.27%, 4.07% to 4.19% and 4.29% to 5.10%, respectively;
and expected lives ranging from 1 to 4 years.
Deferred Warranty
The Company's standard practice is to provide a warranty on its
authenticators for one year after the date of purchase. Customers may purchase
extended warranties covering periods from one to three years after the standard
warranty period. The Company defers the revenue associated with the extended
warranty and recognizes it into income on a straight-line basis over the
extended warranty period.
Earnings (Loss) Per Common Share
Basic earnings per share are based on the weighted average number of
shares outstanding and exclude the dilutive effect of unexercised common stock
equivalents. Diluted earnings per share is based on the weighted average number
of shares outstanding and includes the dilutive effect of unexercised common
stock equivalents to the extent they are not anti-dilutive.
Shares issuable from securities that could potentially effect diluted
earnings per share in the future that were not included in the computation of
diluted earnings per share because their effect was anti-dilutive were as
follows:
2004 2003 2002
-------------- -------------- --------------
Stock options 300,500 2,926,375 4,609,000
Warrants - 600,000 1,239,747
Convertible term loan - - 453,333
Convertible preferred stock 2,330,260 4,000,000 1,052,632
--------- --------- ---------
Total 2,630,760 7,526,375 7,354,712
========= ========= =========
The amounts included above for the convertible preferred stock for 2002
reflect the number of shares that would be issued if converted prior to the
mandatory conversion date. See Note 18 for information related to the mandatory
conversion.
The net income available to common stockholders for the year ended
December 31, 2004 would have been increased $232 by adding back dividends
related to the convertible preferred stock. Additionally, the net loss
applicable to common stockholders for the years ended December 31, 2003 and 2002
would have been decreased by adding back interest expense related to the
convertible term loan of approximately $153 and $204, respectively, and the net
loss would have been further decreased by adding back the beneficial conversion
option, accretion and accrued dividends related to the convertible preferred
stock of $4,471 in 2003, and $1,164 in 2002.
F-11
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
Reclassifications
Certain prior year amounts in the consolidated financial statements
have been reclassified to conform to the 2004 presentation.
NOTE 2 - GOODWILL AND OTHER INTANGIBLES
Intangible asset data as of December 31, 2004 is as follows:
Gross Carrying Accumulated
Amount Amortization
------------------ ----------------
Amortized intangible assets -
Capitalized Technolgy and Customer Lists $5,613 $4,479
Unamortized intangible assets - Goodwill $1,223 $ 973
Aggregate amortization expense $ 394
Estimated amortization expense for the years ended:
December 31, 2005 $ 352
December 31, 2006 352
December 31, 2007 352
December 31, 2008 78
At December 31, 2004 and 2003, ending balances of goodwill and other
intangibles, net of accumulated amortization are as follows:
Capitalized Customer Lists
Technology and Other Goodwill Total
------------- ----------------- ----------- ----------
Net ending balance at December 31, 2002 $1,875 $ 35 $ 250 $2,160
Additions to capitalized technology 7 - - 7
Amortization expense 504 35 - 539
------ ------ ------ ------
Net ending balance at December 31, 2003 1,378 - 250 1,628
Additions to capitalized technology 150 - - 150
Amortization expense 394 - - 394
------ ------ ------ ------
Net ending balance at December 31, 2004 $1,134 $ - $ 250 $1,384
====== ====== ====== ======
NOTE 3 - ACQUISITIONS
On March 29, 2001, the Company acquired Identikey Ltd. ("Identikey"), a
privately held international security software company headquartered in
Brisbane, Australia, with operations in the United States, Europe and Australia.
Under the terms of the purchase agreement, more than 90 percent of the
outstanding capital stock of Identikey was exchanged for 366,913 shares of
Company Common Stock, with potential additional earn-out payments made in the
form of additional shares which were based on defined performance incentives as
specified in the purchase agreement.
The acquisition of Identikey was accounted for under the purchase
method of accounting, and accordingly, the acquired assets have been recorded at
their estimated fair values at the date of acquisition. Intangible assets
consisting of technology licenses related to this transaction were $1,897 and
are being amortized over a period of 7 years.
F-12
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The remaining 10% of Identikey has been acquired at various times with
the final purchase completed in January 2003. During 2002, in exchange for the
shares not obtained in the initial transaction, the Company issued 126,426
shares of
Common Stock and paid $23 in cash. Intangible assets related to the purchase of
the Identikey shares in 2002 were valued at $275 and are being amortized over
the same period as the intangible assets identified in the initial transaction.
NOTE 4 - INVENTORIES
Inventories, net of valuation allowance of $198 and $252 at December
31, 2004 and 2003, respectively, are comprised of the following:
December 31,
-----------------------------------
2004 2003
--------------- ---------------
Component parts $ 601 $ 277
Work-in-process and finished goods 745 798
------ ------
Total $1,346 $1,075
====== ======
NOTE 5 - OTHER ACCRUED EXPENSES
Accrued expenses are comprised of the following:
December 31,
-----------------------------------
2004 2003
--------------- ---------------
Restructuring accrual $ 18 $ 134
Other accrued expenses 1,327 904
------ ------
$1,345 $1,038
====== ======
NOTE 6 - INCOME TAXES
At December 31, 2004, the Company has United States net operating loss
carryforwards approximating $26,555 and foreign net operating loss carryforwards
approximating $5,295. Such losses are available to offset future taxable income
in the respective jurisdictions and expire in varying amounts beginning in 2005
and continuing through 2024. In addition, if certain substantial changes in the
Company's ownership were deemed to have occurred, there would be an annual
limitation on the amount of the U.S. carryforwards that could be utilized.
Income (loss) before income taxes was generated in the following
jurisdictions:
For the Years Ended December 31,
-------------------------------------------
2004 2003 2002
------------- ----------- -----------
Domestic:
Continuing operations $ 1,128 $(1,989) $(4,261)
Discontinued operations - 1,995 754
------- ------- -------
Total domestic 1,128 6 (3,507)
Foreign 4,005 3,147 (892)
------- ------- -------
Total $ 5,133 $ 3,153 $(4,399)
======= ======= =======
F-13
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The provision (benefit) for income taxes consists of the
following:
For the Years Ended December 31,
-------------------------------------------
2004 2003 2002
------------- ----------- -----------
Current:
Federal $ 25 $ - $ -
State - - -
Foreign 1,809 467 57
Deferred:
Federal $ - $ - $ 83
State - - -
Foreign 46 (70) -
------ ------ ------
Total $1,880 $ 397 $ 140
====== ====== ======
The differences between income tax provision (benefit) computed using
the statutory federal income tax rate of 35% and the provision (benefit) for
income taxes reported in the consolidated statements of operations are as
follows:
For the Years Ended December 31,
-------------------------------------------
2004 2003 2002
------------ ----------- ------------
Expected tax provision (benefit) at statutory rate $ 1,797 $ 1,103 $(1,496)
Increase (decrease) in income taxes resulting from:
Foreign taxes at rates other than the federal stautory rate - - 76
Settlement of foreign taxes - 144 -
Change in foreign tax rates - (129) -
State income taxes, net of federal benefit - - (175)
Permanent adjustments 95 52 -
Change in valuation allowance primarily related to the generation
(utilization) of net operating loss carryforwards (22) (739) 1,732
Other, net 10 (34) 3
------- ------- -------
Total $ 1,880 $ 397 $ 140
======= ======= =======
Included in the net change in the valuation allowance are differences
between estimates used for book purposes and the actual tax return as filed for
fiscal year 2003 and 2002.
F-14
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The deferred income tax balances are comprised of the following:
As of
December 31,
---------------------------
2004 2003
------------ -----------
Deferred tax assets:
U.S. net operating loss carryforwards $ 10,356 $ 10,783
Foreign net operating loss carryforwards 1,800 1,383
Accounts receivable 6 7
Inventory 23 36
Capitalized technology - 34
Fixed assets 11 -
Accrued expenses 53 39
Deferred revenue 26 25
-------- --------
Total gross deferred tax assets $ 12,275 $ 12,307
Less valuation allowance (12,252) (12,230)
-------- --------
23 77
Deferred tax liabilities:
Fixed assets - (7)
-------- --------
Net deferred income taxes $ 23 $ 70
======== ========
The net change in the total valuation allowance for the years ended
December 31, 2004, 2003 and 2002 was an increase (decrease) of $22, $(215) and
$2,205, respectively. In assessing the realizability of deferred tax assets, the
Company considers whether it is more likely than not that some portion or all of
the deferred tax assets will be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
period in which these temporary differences become deductible. This valuation
allowance will be reviewed on a regular basis and adjustments made as
appropriate. In 2004, the Company utilized $1,094 of its United States net
operating loss carryforwards. The Company has provided a reserve at December 31,
2004 for all of the gross deferred tax assets except for inventory associated
with its Belgian operations. The Company anticipates realizing this deferred tax
asset in the future as the Company expects to generate taxable income in Belgium
in 2005.
In October of 2003, the Company paid 185 Euros to settle outstanding
tax assessments from the Belgian tax authorities for fiscal years 2000 and 1999.
As a result, certain inter-company research and development costs previously
expensed were required to be capitalized and amortized over a three-year period.
At December 31, 2004, these development costs were fully amortized, reducing the
tax liability of the Company.
F-15
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
NOTE 7 - DEFERRED WARRANTY
The deferred warranty revenue as of December 31, 2004 will be
recognized as income as follows:
Year Amount
-------------- ------------
2005 ............ $ 18
2006 ............ 51
2007 ............ 51
2008 ............ 32
------
$ 152
======
NOTE 8 - DEBT
In August 1997, the Company renegotiated the guarantee with Artesia
Bank N.V., formerly Banque Paribas Belgique S.A. and is now doing business as
Dexia Bank ("Dexia") related to the final payment for the 1996 acquisition of
Digipass into a term loan in the amount of $3,400 with a maturity date of
September 30, 2002 and an interest rate of 3.25%. In August 2001, the Company
agreed to revise the terms of the loan. Under the new terms, the loan was
convertible into shares of VASCO Common Stock at the fixed conversion rate of
$7.50 per share rather than a floating rate based on the market price of the
VASCO Common Stock. Also, the maturity date of this convertible loan was reset
to September 30, 2003 with a revised interest rate of 6%. On September 11, 2003,
the Company sold $8,000 of its Series D Preferred Stock and Warrants to purchase
Common Stock. A portion of the proceeds was used to repay the debt to Dexia
including accrued interest.
The Company maintains an overdraft agreement with Fortis Banque/Bank of
Belgium. Under terms of the agreement, the Company can borrow an amount equal to
80% of its Belgium subsidiary's defined accounts receivable up to a maximum of
2,000 Euros. Borrowings under the overdraft agreement accrue interest at an
annual rate of 5.7% and the Company is obligated to pay a quarterly commitment
fee of 0.125%. As of December 31, 2004, approximately 2,000 Euros were available
under the overdraft agreement and there were no borrowings outstanding under the
agreement. The agreement is secured by the assets of the Belgian subsidiary,
excluding inventory, and while it has no specific termination date, it can be
terminated with thirty (30) days notice. The agreement is governed by the
General Lending Conditions for Corporate Customers, registered in Brussels,
Belgium on December 20, 2001.
Interest expense related to debt was $0, $157 and $221 for the
years ended December 31, 2004, 2003 and 2002, respectively.
NOTE 9 - STOCKHOLDERS' EQUITY
Preferred Stock
On September 11, 2003, the Company sold 800 shares of Series D 5%
Cumulative Convertible Voting Preferred Stock (the "Series D Preferred Stock")
and 600,000 detachable warrants to purchase Common Stock. The Series D Preferred
Stock carries a 5% dividend, is convertible into 4,000,000 shares of Common
Stock at a fixed price of $2.00 per share and will vote with the Common Stock as
a class on matters presented to the stockholders. The implied value of the
Series D Preferred Stock was $5,714 calculated based upon the annual dividend
rate divided by a required rate of return. The warrants are exercisable, over a
five-year period, at $3.47 per share and were valued at $1,455 using the
Black-Scholes pricing model. Of the net proceeds from the sale, $5,786 was
allocated to the Series D Preferred Stock and $1,474 was allocated to the
warrants based upon their relative fair values. In addition, a beneficial
conversion value was calculated for the Series D Preferred Stock as the
difference between the price of the Company's Common Stock at the transaction
date and the conversion price of the Series D Preferred Stock. The amount of the
beneficial conversion, $3,720, is analogous to a preferred dividend and was
recorded to accumulated deficit. In 2004, 592 shares of the Series D Preferred
Stock were converted resulting in the issuance of 2,960,000 shares of the
Company's Common Stock. See Common Stock.
F-16
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
In July 2000, the Company issued 150,000 shares of Series C Preferred
Stock for cash of $15,000. The preferred stock was convertible into 1,052,632
shares of Common Stock at any time through July 2004. In conjunction with this
financing, the Company issued Common Stock Purchase Warrants to purchase 789,474
common shares at $15 per share with an estimated fair value, using the
Black-Scholes pricing model, of approximately $4,100 and warrants to
purchase 480,000 shares at $4.25 per share with an estimated fair value, using
the Black-Scholes pricing model, of approximately $4,700. The warrants issued at
$15 per share were immediately exercisable. The warrants issued at $4.25 were
exercisable over 48 months and the related fair value was being accreted over
their lives reducing earnings available to holders of Common Stock. The value of
the warrants, which reduces the carrying value of the preferred stock, was being
accreted and reduced earnings available to common shareholders. The preferred
stock and warrants were purchased and redeemed by the Company on July 15, 2003.
See Common Stock.
Common Stock
On July 15, 2003, the Company reached an agreement with Ubizen N.V.
("Ubizen") whereby VASCO purchased and redeemed all 150,000 shares of the Series
C Convertible Preferred Stock (the "Series C Preferred Stock") and 1,239,474
Common Stock Purchase Warrants owned by Ubizen. Under the terms of the Purchase
Agreement, the Company paid $4,000 to Ubizen and issued 2,000,000 shares of the
Company's Common Stock on July 25, 2003 at a fair value of $4,000. The Common
Stock issued by the Company was subject to a lock-up period wherein the lock-up
expired in increments of 500,000 shares each on October 15, 2003, January 15,
2004, April 15, 2004 and July 15, 2004. The shares were subject to volume
trading restrictions through January 1, 2005.
In 2002, the Company issued 126,426 shares of Common Stock to acquire
the majority of the remaining outstanding capital stock of Identikey Ltd. The
Company recorded additional intangible assets, in the form of capitalized
technology of $275 related to the issuance of this stock.
F-17
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
Warrants
Warrant activity for the years ended December 31, 2004, 2003 and 2002
is summarized below:
Weighted
Number of Average Exercise
Shares Price Exercise Price
--------------- -------------------- --------------------
Outstanding at December 31, 2001 ..... 1,377,251 $ 10.44 $ 4.254- 15.00
Granted ..................... - - -
Exercised ................... - - -
Cancelled ................... (137,777) 4.50 4.50
--------------- -------------------- --------------------
Outstanding at December 31, 2002 ..... 1,239,474 11.10 4.25 - 15.00
Granted ..................... 600,000 3.47 3.47
Exercised ................... - - -
Cancelled ................... (1,239,474) 11.10 4.25 - 15.00
--------------- -------------------- --------------------
Outstanding at December 31, 2003 ..... 600,000 3.47 3.47
Granted ..................... - - -
Exercised ................... (13,500) 3.47 3.47
Cancelled ................... - - -
--------------- -------------------- --------------------
Outstanding at December 31, 2004 ..... 586,500 $ 3.47 3.47$ 3.47
=============== ==================== ====================
NOTE 10 - STOCK COMPENSATION PLAN
The Company's 1997 Stock Compensation Plan, as amended and restated in
1999, ("Compensation Plan") is designed and intended as a performance incentive.
The Compensation Plan is administered by the Compensation Committee as appointed
by the Board of Directors of the Company ("Compensation Committee").
The Compensation Plan permits the grant of options to employees of the
Company to purchase shares of Common Stock and is intended to be a nonqualified
plan. All options granted to employees are for a period of ten years, are
granted at a price equal to the fair market value of the Common Stock on the
date of the grant and are typically vested 25% on the first anniversary of the
grant, with an additional 25% vesting on each subsequent anniversary of the
grant. Alternative vesting schedules may include either date or event-based
vesting.
The Compensation Plan further permits the grant of options to
directors, consultants and other key persons (non-employees) to purchase shares
of Common Stock. All options granted to non-employees are granted at a price
equal to the fair market value of the Common Stock on the date of the grant, and
may contain vesting requirements and/or restrictions as determined by the
Compensation Committee at the time of grant. Non-cash compensation expense
(recovery) of $0, $41 and $(50) was recognized in 2004, 2003 and 2002,
respectively, in accordance with FASB Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation", an interpretation of
Accounting Principles Board Opinion No. 25. This expense (recovery) was
attributed to stock options issued to officers of the Company who are located
outside the U.S. and whose services are rendered under consulting agreements.
As of December 31, 2004, the Compensation Plan was authorized to issue
options representing up to 6,716,338 shares of the Company's Common Stock. The
authorized shares under the Compensation Plan represent 20% of the issued and
outstanding shares of the Company.
F-18
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The following is a summary of activity under the Compensation Plan:
Options Outstanding Options Exercisable
------------------------------- -------------------------------
Weighted - Weighted - Weighted-Average
Number of Average Number of Average Fair Value of
Shares Price Shares Price Options Granted
--------------- ------------ -------------- ------------- --------------------
Outstanding at December 31, 2001 3,280,837 $ 3.76 1,235,545 $ 4.49
Granted ........................ 1,642,750 2.22 $1.75
Exercised ...................... - -
Forfeited ...................... (314,587) 5.11
----------
Outstanding at December 31, 2002 4,609,000 3.12 1,917,056 3.63
Granted ........................ 591,000 0.75 0.50
Exercised ...................... (35,800) 1.77
Forfeited ...................... (2,237,825) 3.31
----------
Outstanding at December 31, 2003 2,926,375 2.55 1,651,534 3.11
Granted ........................ 441,500 2.53 $1.59
Exercised ...................... (118,062) 1.59
Forfeited and refused........... (623,375) 1.90
----------
Outstanding at December 31, 2004 2,626,438 $ 2.75 1,947,612 $ 3.10
==========
In 2004, the Company has included 577,000 stock options that were not
accepted by employees in the Forfeited and Refused line item. These options
related to the years 2001 and 2002.
The following table summarizes information about stock options
outstanding at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------- -------------------------------
Weigted - Weigted - Weigted -
Average Average Average
Number of Remaining Exercise Number of Exercise
Range of Exercise Prices Shares Contractual Life Price Shares Price
- ------------------------------- -------------- ---------------------- ------------- -------------- -------------
$ 0.0000 - 2.3000 ........... 1,399,688 7.3 years $ 1.37 992,836 $ 1.43
$ 2.3001 - 4.6000 ........... 974,250 5.8 years $ 3.07 702,276 $ 3.28
$ 4.6001 - 6.9000 ........... 61,500 3.1 years $ 5.53 61,500 $ 5.53
$ 6.9001 - 9.2000 ........... 72,000 4.5 years $ 8.88 72,000 $ 8.88
$ 9.2001 - 11.5000 .......... 94,000 5.7 years $ 10.25 94,000 $ 10.25
$11.5001 - 13.8000 .......... 10,000 5.8 years $ 12.44 10,000 $ 12.44
$13.8001 - 16.1000 .......... 15,000 5.1 years $ 15.88 15,000 $ 15.88
--------- ---------
2,626,438 $ 2.75 1,947,612 $ 3.10
========= =========
F-19
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
In 2002, the Company loaned Belgian employees who received stock
options in 1999 and 2000, 142 Euros to pay taxes assessed on those options by
the Belgian Government. Even though stock options granted to all employees were
granted at prices equal to the fair market value of the Common Stock on the date
of the grant, Belgian employees who were recipients of stock options were
assessed taxes based on the value determined under Belgian tax legislation dated
March 26, 1999. The total amounts advanced in 2002 were based on each
recipient's specific tax assessment. Due to the uncertainty of collecting the
amounts loaned to the employees, the notes have been fully reserved for as of
December 31, 2004 and 2003.
NOTE 11 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
For the Years Ended December 31,
----------------------------------------------------
2004 2003 2002
----------------- --------------- -------------
Supplemental disclosure of cash flow information:
Interest paid $ 17 $ 157 $ 342
Income taxes paid $ 1,294 $ 749 $ -
Supplemental disclosure of non-cash investing activities:
Common stock issued in connection with acquisition $ - $ - $ 284
Note receivable and preferred stock received
from sale of business unit $ - $ 1,553 $ -
Additional consideration to be issued in connection
with acquisition $ 150 $ - $ -
Supplemental disclosure of non-cash financing activities:
Common stock issued to redeem Series C preferred stock
and warrants (in shares) - 2,000,000 -
Increase in additional paid-in capital related to beneficial
conversion of Series D preferred stock $ - $ 3,720 $ -
Deemed dividend on preferred stock $ - $ (3,720) $ -
Dividends accrued on preferred stock $ (27) $ (121) $ -
Common stock issued as dividends to Series D
preferred stock shareholders (64,843 shares) $ 144 $ - $ -
NOTE 12 - DISCONTINUED OPERATIONS
On July 8, 2003, effective as of July 1, 2003, VASCO sold its VACMAN
Enterprise ("VME") business, originally known as Intellisoft and/or Snareworks,
to SecureD Services, Inc. (SSI). Mr. Hunt, VASCO's CEO and Chairman of the
Board, has a 19% equity ownership interest in SSI and is one of three directors
on its board. Under the terms of the agreement, VASCO received a senior secured
promissory note with a face value of approximately $1,100, valued at $1,000 by
an independent valuation firm, and $2,000 of Convertible Preferred Stock from
SSI, valued at $600 by an independent valuation firm, in exchange for the VACMAN
Enterprise assets. The promissory note bears a 6% interest rate and is payable
in 36 equal and consecutive monthly payments. The Preferred Stock includes a 6%
cumulative stock dividend, payable quarterly, and can be converted into SSI's
common stock at defined intervals beginning July 1, 2005. In accordance with
Statement of Financial Accounting Standard (SFAS) No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", the assets and liabilities of this
business unit have been disaggregated from the operational assets and
liabilities of the Company. The assets of and liabilities related to
discontinued operations were $0 as of December 31, 2004 and 2003. The results of
the operations of VME for the twelve months ended December 31, 2003 have been
reported as results of discontinued operations. Prior periods have been restated
to conform to this presentation. The Company recorded a gain on the sale of
$1,400 comprised of the proceeds of $1,600 less net basis in the assets sold and
related fees of the sale. Prior to the sale, during 2003, discontinued
operations had revenue of $1,033, cost of sales of $82 and operating expenses of
$313.
F-20
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
NOTE 13 - EMPLOYEE BENEFIT PLAN
The Company maintains a contributory profit sharing plan established
pursuant to the provisions of Section 401(k) of the Internal Revenue Code, which
provides benefits for eligible employees of the Company. In January 2001, the
Company amended its benefit plan to allow Company-matching. For the years ended
December 31, 2004, 2003 and 2002, the Company contributed $21, $23 and $19,
respectively, to this plan.
NOTE 14 - GEOGRAPHIC AND CUSTOMER INFORMATION
The Company allocates revenue based on the location of the country that
initiates the sale. Information regarding geographic areas for the years ended
December 31, 2004, 2003 and 2002 is as follows and has been restated to reflect
discontinued operations:
United States Europe Other Total
---------------- ------------ ----------- -----------
2004
- ----
Revenue from continuing operations..................... $ 3,105 $ 24,245 $ 2,543 $ 29,893
Gross profit from continuing operations ................. 2,816 15,891 2,002 20,709
Long-lived assets related to continuing operations 2,076 913 139 3,128
2003
- ----
Revenue from continuing operations..................... $ 1,498 $ 19,201 $ 2,167 $ 22,866
Gross profit from continuing operations .. ............... 1,299 11,173 1,384 13,856
Income from discontinued operations .................. 638 - - 638
Gain on sale of discontinued operations ............... 1,357 - - 1,357
Long-lived assets related to continuing operations. 2,610 973 143 3,726
Long-lived assets related to discontinued operations - - - -
2002
- ----
Revenue from continuing operations...................... $ 1,423 $ 14,658 $ 1,289 $ 17,370
Gross profit from continuing operations ................. 1,161 8,658 391 10,210
Income from discontinued operations ............ 754 - - 754
Long-lived assets related to continuing operations 1,849 1,449 100 3,398
Long-lived assets related to discontinued operations 132 - - 132
For the years 2004, 2003 and 2002, the Company's top 10 customers
contributed 60%, 71% and 67%, respectively, of total worldwide revenues. In
2004, three customers accounted for 12.6%, 12.0% and 11.8% of the Company's
revenues. In 2003, two customers accounted for 24.7% and 14.1% of the Company's
revenues. In 2002, one customer accounted for 24.4% of the Company's revenues.
F-21
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
NOTE 15 - COMMITMENTS AND CONTINGENCIES
The Company leases office space and automobiles under operating lease
agreements expiring at various times through 2012.
Future minimum rental payments required under non-cancelable leases are
as follows:
Year Amount
---------- ------------
2005 ....................... $ 1,223
2006 ....................... 1,153
2007 ....................... 1,023
2008 ....................... 969
2009 ....................... 827
Thereafter 1,105
-------
Total ................. $ 6,300
=======
Rent expense under operating leases aggregated approximately $851, $685
and $799 for the years ended December 31, 2004, 2003 and 2002, respectively.
From time to time, the Company has been involved in litigation
incidental to the conduct of its business. Currently, the Company is not a party
to any lawsuit or proceeding that, in management's opinion, is likely to have a
material adverse effect on its business, financial condition or results of
operations.
NOTE 16 - RESTRUCTURING
During the fourth quarter of 2002, the Company recorded restructuring
charges of $319 related to operations in France and excess space in its U.S.
headquarters. Of the $319 recorded, $18 remained unpaid at December 31, 2004 and
is included in other accrued expenses. In 2004, $32 was reversed from
restructuring accruals as a result of the renegotiation of the Corporate
Headquarters' office lease.
NOTE 17 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The quarterly results of operations are as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------------- --------------- --------------- -------------
2004
-------
Net sales $ 6,021 $ 7,174 $ 7,400 $ 9,298
Gross profit from continuing operations 4,446 5,075 5,156 6,032
Operating expenses 3,547 3,596 3,475 4,539
Operating income from continuing operations 899 1,479 1,681 1,493
Net income 583 953 1,201 516
Basic and diluted net income per share $ 0.02 $ 0.03 $ 0.03 $ 0.02
======= ======= ======= =======
2003
-------
Net sales $ 5,118 $ 5,953 $ 5,599 $ 6,196
Gross profit from continuing operations 2,959 3,531 3,453 3,913
Operating expenses 2,942 2,847 3,395 3,549
Operating loss from continuing operations 17 684 58 364
Discontinued operations 314 170 1,481 30
Net income 481 721 1,288 266
Basic and diluted net income (loss) per share $ 0.01 $ 0.01 $ (0.08) $ -
======= ======= ======= =======
Due to rounding in earnings per share, the sum of the quarters may not
be equal to the full year.
F-22
VASCO DATA SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
NOTE 18 - SUBSEQUENT EVENTS
On February 4, 2005, the Company acquired all of the share capital of
A.O.S. Hagenuk B.V. ("A.O.S.") a private limited liability company organized and
existing under the laws of the Netherlands. The base purchase price was EUR
5,000, of which EUR 3,750 was paid in cash and the remainder was paid in the
Company's common stock. The common stock will be held in escrow for the benefit
of the seller for a period of twelve (12) months. Six (6) months after closing,
the seller shall have the right to pay EUR 1,250 into the escrow account against
release of the common stock. In addition to the base purchase price, a variable
amount related to the gross profits collected on the sales of certain equipment
will be paid to the seller over a period of two (2) years following the closing.
AOS will be a wholly owned subsidiary of the Company, accounted for using the
purchase method in accordance with SFAS No. 141," Business Combinations."
On February 17, 2005, the Company, in accordance with the Designation
of Rights and Preferences of the Series D 5% Cumulative Convertible Voting
Preferred Stock (the "Series D Preferred Stock"), issued a call for the
mandatory conversion of all outstanding shares of the Series D Preferred Stock.
All accrued dividends through the conversion date have been paid.
F-23
SCHEDULE II
VASCO DATA SECURITY INTERNATIONAL, INC.
VALUATION AND QUALIFYING ACCOUNTS
Beginning Expense Accounts Ending
Allowance for Doubtful Accounts Balance (Recovery) Written Off Balance
--------------- ------------------- ---------------- --------------
For Trade Accounts Receivable
- --------------------------------------------
Year ended December 31, 2004 $ 471 $(109) $(202) $ 160
Year ended December 31, 2003 461 92 (82) 471
Year ended December 31, 2002 207 321 (67) 461
Obsolescence
Beginning Expense Inventory Ending
Balance (Recovery) Written Off Balance
--------------- ------------------- ---------------- --------------
Reserve for Obsolete Inventories
- --------------------------------------------
Year ended December 31, 2004 $ 252 $ (3) $ (51) $ 198
Year ended December 31, 2003 112 141 - 252
Year ended December 31, 2002 92 20 - 112
F-24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 29, 2005.
VASCO Data Security International, Inc.
/s/ T. Kendall Hunt
---------------------------
T. Kendall Hunt
Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT
IN THE CAPACITIES INDICATED ON MARCH 29, 2005.
POWER OF ATTORNEY
Each of the undersigned, in his capacity as an officer or director, or
both, as the case may be, of VASCO Data Security International, Inc. does hereby
appoint T. Kendall Hunt, and each of them severally, his true and lawful
attorneys or attorney to execute in his name, place and stead, in his capacity
as director or officer, or both, as the case may be, this Annual Report on Form
10-K for the fiscal year ended December 31, 2004 and any and all amendments
thereto and to file the same with all exhibits thereto and other documents in
connection therewith with the Securities and Exchange Commission. Each of said
attorneys shall have power to act hereunder with or without the other attorney
and shall have full power and authority to do and perform in the name and on
behalf of each of said directors or officers, or both, as the case may be, every
act whatsoever requisite or necessary to be done in the premises, as fully and
to all intents and purposes as to which each of said officers or directors, or
both, as the case may be, might or could do in person, hereby ratifying and
confirming all that said attorneys or attorney may lawfully do or cause to be
done by virtue hereof.
SIGNATURE TITLE
/s/ T. Kendall Hunt Chief Executive Officer and Chairman
- ----------------------------------------- (Principal Executive Officer)
T. Kendall Hunt
/s/ Jan Valcke
- ----------------------------------------- President and Chief Operating Officer
Jan Valcke (Principal Operating Officer)
/s/ Clifford K. Bown Chief Financial Officer and
- ----------------------------------------- (Principal Financial Officer and
Secretary Principal Accounting Officer)
Clifford K. Bown
/s/ Michael P. Cullinane Director
- -----------------------------------------
Michael P. Cullinane
/s/ Michael A. Mulshine Director
- -----------------------------------------
Michael A. Mulshine
/s/ John R. Walter Director
- -----------------------------------------
John R. Walter