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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk" contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933 concerning, among other things, the prospects of, and developments and business strategies for, VASCO and our operations, including the development and marketing of certain new products and the anticipated future growth in certain markets in which we currently market and sell our products or anticipate selling and marketing our products in the future. These forward-looking statements (1) are identified by use of terms and phrases such as "expect," "believe," "will," "anticipate," "emerging," "intend," "plan," "could," "may," "estimate," "should," "objective" and "goal" and similar words and expressions, but such words and phrases are not the exclusive means of identifying them, and (2) are subject to risks and uncertainties and represent our present expectations or beliefs concerning future events. VASCO cautions that the forward-looking statements are qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These risks, uncertainties and other factors have been described in greater detail in VASCO's Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission, and include, but are not limited to, (a) risks of general market conditions, including currency fluctuations and the unprecedented uncertainties resulting from the current turmoil in world economic and financial markets,
(b) risks inherent to the computer and network security industry, including rapidly changing technology, evolving industry standards, increasing numbers of patent infringement claims, changes in customer requirements, price competitive bidding, changing government regulations and (c) risks specific to VASCO, including, demand for our products and services, competition from more established firms and others, pressures on price levels and our historical dependence on relatively few products, certain suppliers and certain key customers. Thus, the results that we actually achieve may differ materially from any anticipated results included in, or implied by these statements.

General

The following discussion is based upon our consolidated results of operations for the three months ended March 31, 2009 and 2008 (percentages in the discussion may be rounded to the closest full percentage point) and should be read in conjunction with our consolidated financial statements included elsewhere in this Form 10-Q and our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission.

We design, develop market and support open standards-based hardware and software security systems that manage and secure access to information assets. We also design, develop, market and support patented Strong User Authentication products and services for e-business and e-commerce. Our products enable secure financial transactions to be made over private enterprise networks and public networks, such as the Internet. Our Strong User Authentication is delivered via our hardware and software DIGIPASS security products (collectively DIGIPASSES), most of which incorporate an electronic signature capability, which further protects the integrity of electronic transactions and data transmissions. Some of our DIGIPASSES are compliant with the Europay MasterCard Visa (EMV) standard and are compatible with MasterCard's and VISA's Chip Authentication Program (CAP). Some of our DIGIPASS units comply with the Initiative for Open Authentication (OATH). As evidenced by our current customer base, our products are purchased by companies and, depending

on the business application, are distributed to either their employees or their customers. Those customers may be other businesses or, as an example in the case of Internet banking, our customer banks' corporate and retail customers.

Our target market is any business process that uses some form of electronic interface, particularly the Internet, where the owner of that process is at risk if unauthorized users can gain access to its process and either obtain proprietary information or execute transactions that are not authorized. Our products can not only increase the security associated with accessing the business process, thereby reducing the losses from unauthorized access, but also, in many cases, can reduce the cost of the process itself by automating activities that were previously performed manually.

Comparison of Results for the Three Months Ended March 31, 2009 and 2008

Industry Growth: We do not believe that there are any accurate measurements of the total industry's size or the industry's growth rate. Also, given the current turmoil in world economic and financial markets and the worldwide recession, we expect that the industry may not grow in 2009 and may, in fact, decline if the economic conditions do not improve. We do believe, however, that over the longer term, the industry will grow at a significant rate. We expect that growth will be driven by new government regulations, growing awareness of the impact of identity theft, and the growth in commerce that is transacted electronically. The issues driving the growth are global issues and the rate of adoption in each country is a function of that country's culture, the competitive position of businesses operating in those countries, the country's overall economic conditions and the degree to which businesses and consumers within the country use technology.

Economic Conditions: Our revenue may vary significantly with changes in the economic conditions in the countries in which we sell products. With our current concentration of revenue in Europe and specifically in the banking/finance vertical market, significant changes in the economic outlook for the European banking market may have a significant effect on our revenue. As is currently the case, during difficult economic periods, our customers may delay the rollout of existing applications and defer purchase decisions related to the implementation of our product in new applications. We have responded to the current economic conditions by focusing our sales efforts on markets that we believe have the most near-term opportunity and implementing a cost containment initiative, which includes but is not limited to a hiring freeze. We believe that these actions will allow us to remain profitable while not diminishing the value of key investments we have made over the last two years to build a strong infrastructure that will support our long-term growth.

Currency Fluctuations: In the first quarter of 2009 and 2008, approximately 95% and 92%, respectively, of our revenue was generated outside the United States. In addition, approximately 88% and 73%, respectively, of our operating expenses were incurred outside the United States. Excluding the benefit derived in the first quarter of 2009 from the reversal of accruals for performance-based equity incentive awards of $2,002, 75% of our operating expenses were incurred outside of the United States. Changes in currency exchange rates, especially from the Euro to U.S. Dollar, can have a significant impact on revenue and expenses.

In general, to minimize the net impact of currency fluctuations, we attempt to denominate our billings in a currency such that it would provide a hedge against the operating expenses being incurred in that currency. We expect that changes in currency rates may also impact our future results if we are unable to match amounts of revenue with our operating expenses in the same currency. In periods in which the U.S. Dollar is weakening, we expect that our operating earnings will increase as a result of the change in currency exchange rates. Conversely, in periods in which the U.S. Dollar is strengthening, we expect that our operating earnings will decrease as a result of the change in currency exchange rates.

The U.S. Dollar strengthened by approximately 13% against the Euro and 37% against the Australian Dollar for the quarter ended March 31, 2009, as compared to the same period in 2008. We

estimate that the strengthening of the U.S. Dollar versus these two currencies in 2009 compared to 2008 resulted in a decrease in revenue of approximately $1,869 for the quarter ended March 31, 2009, compared to the same period in 2008 and a decrease in operating expenses of approximately $1,438 for the quarter ended March 31, 2009, compared to the same period in 2008.

The financial position and results of operations of most of our foreign subsidiaries, with the exception of our subsidiaries in Switzerland and Singapore (in which the functional currency is the U.S. Dollar), are generally measured using the local currency as the functional currency. Accordingly, assets and liabilities are translated into U.S. Dollars using current exchange rates as of the balance sheet date. Translation adjustments arising from differences in exchange rates are included as a separate component of stockholders' equity. Revenue and expenses are translated at average exchange rates prevailing during the period. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations in other non-operating income (expense). Foreign exchange transaction losses aggregating $521 in the first quarter of 2009 compare to gains of $341 in the first quarter of 2008.

Revenue

Revenue by Geographic Regions: We classify our sales by customers' location in four geographic regions: 1) EMEA, which includes Europe, the Middle East and Africa; 2) the United States, which for our purposes includes sales in Canada;
3) Asia Pacific; and 4) Other Countries, including Australia, Latin America and Central Asia. The breakdown of revenue for the three months ended March 31, 2009 and 2008 in each of our major geographic regions follows:

                                 EMEA      United States    Asia Pacific     Other Countries     Total
Three months ended March 31:

              Total Revenue:
                        2009   $ 16,510   $         1,139   $       2,853   $           2,673   $ 23,175
                        2008     19,460             2,396           3,151               3,921     28,928

           Percent of Total:
                        2009        71%                5%             12%                 12%       100%
                        2008        67%                8%             11%                 14%       100%

Total revenue in the first quarter of 2009 decreased $5,753, or 20%, over first quarter 2008. The decrease was primarily attributable to a decrease in the number of units shipped, a decrease in non-hardware revenue and the strengthening of the U.S. Dollar as compared to the Euro, as previously noted. In the first quarter of 2009, we saw a change in our banking customers' buying patterns. Our existing banking customers are depleting their DIGIPASS inventories and placing more frequent, smaller orders as compared to one or two large orders a year, as was the case in the past.

Non-hardware revenue, which includes software, maintenance, support, customization, warranty and other services, was 20% of revenue in both the first quarter of 2009 and first quarter 2008.

Revenue generated in EMEA during the first quarter 2009 was $2,950, or 15%, lower than the first quarter of 2008. The decrease was primarily attributable to factors noted above related to the quarter as a whole and reflected decreased revenue in both the banking and enterprise security markets.

Revenue generated in the United States during the first quarter was $1,257, or 52%, lower than the first quarter of 2008. Revenue in the United States declined in both the banking and enterprise security markets and is due, in part we believe, to broad economic conditions that have been widely publicized. The U.S. banking market continues to defer the decision to implement strong

authentication for users of its retail Internet banking services, but we believe that we are well positioned to meet the needs of the U.S. market when banks decide to deploy strong user authentication to their retail banking customers.

Revenue generated in the Asia Pacific region during the first quarter was $298, or 9%, lower than the first quarter of 2008. The decrease was attributable to the banking market partially offset by an increase in the enterprise security market.

Revenue generated from other countries during the first quarter was $1,248, or 32%, lower than the first quarter of 2008. The decrease in other countries was primarily due to declines in South American markets where the initial deployments with large banking customers were completed in 2008. VASCO continues to invest in new markets, as evidenced by the opening of a new sales office in Bahrain in the first quarter 2009 and one in India in July 2008, to help penetrate the developing markets for strong user authentication.

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

                                                       Enterprise
                                           Banking      Security      Total
            Three months ended March 31:

                          Total Revenue:
                                    2009   $ 17,289   $      5,886   $ 23,175
                                    2008     23,081          5,847     28,928

                       Percent of Total:
                                    2009        75%            25%       100%
                                    2008        80%            20%       100%

Revenue in the first quarter of 2009 from the Banking market decreased $5,792, or 25%, over the first quarter of 2008 and revenue from the Enterprise Security market increased $39, or less that 1%, in the same period. The decrease in revenue in the Banking market is attributable to a decrease in the number of units shipped as customers deplete their inventories as mentioned above, a decrease in non-hardware revenue and the strengthening of the U.S. Dollar as compared to the Euro, as previously noted. The increase in the Enterprise Security market was attributable to an increase in the number of units shipped partially offset by a decrease in non-hardware revenues and the strengthening of the U.S. Dollar as compared to the Euro.

Gross Profit and Operating Expenses

The following table sets forth, for the periods indicated, certain consolidated
financial data as a percentage of revenue for the three months ended March 31,
2009 and 2008:



                                                        Three months ended
                                                            March 31,
                                                        2009         2008
        Net revenues                                     100.0%       100.0%

        Cost of goods sold                                27.9%        30.7%


        Gross profit                                      72.1%        69.3%

        Operating costs:
        Sales and marketing                               30.5%        26.6%
        Research and development                          10.5%         9.3%
        General and administrative                        10.2%        12.2%
        Amortization of purchased intangible assets        0.5%         1.0%

        Total operating costs                             51.7%        49.1%

        Operating income                                  20.4%        20.2%

        Interest income                                    0.6%         0.9%
        Other income (expense)                            -1.1%         0.9%


        Income before income taxes                        19.9%        22.0%
        Provision for income taxes                         5.0%         5.1%


        Net income                                        14.9%        16.9%

Gross Profit

Consolidated gross profit for the quarter ended March 31, 2009 was $16,698, a decrease of $3,341, or 17%, from the quarter ended March 31, 2008. Gross profit as a percentage of revenue (gross profit margin) was 72% for the quarter ended March 31, 2009, as compared to 69% for the quarter ended March 31, 2008. The increase in gross profit as a percentage of revenue for the first quarter of 2009 compared to 2008 primarily reflects:

• a higher percentage of our revenue from the Enterprise Security market, which generally has margins that are 20-25% points higher than the banking market, and

• lower non-product related costs, both partially offset by,

• the negative impact of changes in foreign currency rates.

The majority of our inventory purchases are denominated in U.S. Dollars. Also, as previously noted, our sales are denominated in various currencies including the Euro and Australian Dollar. As the U.S. Dollar has strengthened, when compared to the Euro and Australian Dollar in the same periods in the prior year, revenue from sales made in Euros and Australian Dollars decreased, as measured in U.S. Dollars, without the corresponding decrease in cost of goods sold. The impact from changes in currency rates as noted above are estimated to have decreased revenue by approximately $1,869 for the quarter ended March 31, 2009. Had the currency rates in 2009 been equal to the rates in 2008, the gross profit rate would have been approximately 2.1 percentage points higher for the three months ended March 31, 2009.

Operating Expenses

Our operating expenses are generally based on anticipated revenue levels and the majority of such expenses are fixed over short periods of time. As a result, small variations in the amount of revenue recognized in any given quarter could cause significant variations in the quarter-to-quarter comparisons of either the absolute amounts of operating income or operating income as a percentage of revenue. As mentioned earlier we have implemented a cost containment initiative, which includes but is not limited to a hiring freeze. We believe that these actions will allow us to remain profitable while not diminishing the value of key investments we have made over the last two years to build a strong infrastructure that will support our long-term growth.

Sales and Marketing Expenses

Consolidated sales and marketing expenses for the quarter ended March 31, 2009 were $7,059, a decrease of $641, or 8%, from the first quarter of 2008. This decrease in sales and marketing expenses is primarily related to:

• the reversal of long-term, performance-based, incentive awards accrued through December 31, 2008, that are not likely to be achieved, of $684 and

• the impact of a stronger U.S. Dollar compared to the Euro, both partially offset by,

• increased compensation expenses related to an increase in headcount (the average sales, marketing and operations employee headcount increased 23% to 170 in the first quarter of 2009 from 138 in the first quarter of 2008), and

• increased expenses related to our recently opened sales offices primarily in Brazil, Japan and India. Expenses related to new sales offices were $312, or 155%, higher in the first quarter 2009 when compared to the first quarter 2008.

Research and Development Expenses

Consolidated research and development expenses for the quarter ended March 31, 2009, were $2,444, a decrease of $247, or 9%, from the first quarter of 2008. This decrease was primarily due to:

• the reversal of long-term, performance-based, incentive awards accrued through December 31, 2008, that are not likely to be achieved of $371, and

• a stronger U.S. Dollar compared to the Euro and Australian Dollar, both partially offset by,

• increased compensation expense related to an increase in headcount (the average research and development employee headcount increased 26% to 93 in the first quarter of 2009 from 74 in the first quarter of 2008).

General and Administrative Expenses

Consolidated general and administrative expenses for the quarter ended March 31, 2008, were $2,366, a decrease of $1,169, or 33%, from the first quarter of 2008. This decrease is primarily due to:

• the reversal of long-term, performance-based, incentive awards, accrued through December 31, 2008, that are not likely to be achieved of $947,

• lower recruiting, purchased services expenses and professional fees,

• lower bad debt expense due to the recovery of amounts reserved previously, and

• the stronger U.S. Dollar, all partially offset by,

• increased compensation expenses related to an increase in headcount (the average general and administrative employee headcount increased 47% to 47 in the first quarter of 2009 from 32 in the first quarter of 2008).

Amortization of Intangible Assets

Amortization of intangible assets for the first quarter of 2009 decreased $165 over the comparable periods in 2008. The decrease in amortization expense reflects the fact that the intangible assets related to our acquisition of Identikey Ltd. in March 2001 were fully amortized in the first quarter of 2008.

Interest Income

Consolidated net interest income was $143 in the first quarter of 2009 as compared to income of $257 in the first quarter of 2008. The decline in interest income reflects the lower interest rates paid on invested cash balances partially offset by higher average cash balances. Our average cash balance in the first quarter of 2009 of $57,522 was $14,198, or 33%, higher than in the first quarter of 2008.

Other Income (Expense), Net

Other income (expense) primarily includes exchange gains (losses) on transactions that are denominated in currencies other than our subsidiaries' functional currencies, subsidies received from foreign governments in support of our export business in those countries and other miscellaneous non-operational, non-recurring expenses. Other expense for the first quarter of 2009 was $248 and compares to other income of $261 for the first quarter of 2008. The decrease in other income (expense) primarily reflects exchange losses of $521 in the first quarter of 2009 compared to exchange gains of $341 in the first quarter of 2008 partially offset by an increase in $352 in other income mostly related to government subsidies.

Income Taxes

Income tax expense for the first quarter of 2009 was $1,154, a decrease of $309 from the first quarter of 2008. The decrease in tax expense is attributable to a decline in pretax income partially offset by a higher effective tax rate. The effective tax rate was 25% for the first quarter of 2009 and compares to 23% for the first quarter of 2008. The effective tax rate for both periods reflects our estimate of our full-year tax rate at the end of each respective period. The increase in the tax rate is primarily attributable to a reduction in pretax profits in tax jurisdictions that either have a lower statutory tax rate or have tax loss carryforwards that have been reserved. During this period of economic uncertainty, we believe that our effective tax rate may vary significantly quarter to quarter as actual earnings or losses are realized in countries with lower tax rates or with loss carryforwards that have been reserved.

At December 31, 2008, we had U.S. net operating loss carryforwards of $22,422. A valuation allowance has been provided to offset the future tax benefits because we have not determined that their realization is more likely than not. Of this amount, $16,064 may reduce future tax expense if the valuation reserve is released. The remainder represents tax deductions for employee stock option gains which would be credited to paid-in capital. The U.S. loss carryforwards expire in varying amounts beginning in 2018 and continuing through 2027. 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.

At December 31, 2008, we also had foreign loss carryforwards of $5,895. The foreign loss carryforwards have no expiration dates.

Liquidity and Capital Resources

Our net cash balance was $57,329 at March 31, 2009, a decrease of $385, or less than 1%, from $57,714 at December 31, 2008. The decrease in cash from December 31, 2008 primarily reflected the pay down of current liabilities and the impact of the strengthening of the U.S. dollar partially offset by positive earnings before interest, taxes, depreciation and amortization (EBITDA).

At March 31, 2008, we had working capital of $75,252, a $678 decrease, or less than 1%, from $75,930 reported at December 31, 2008. The decrease in working capital was primarily related to the impact of the strengthening of the U.S. dollar.

Days sales outstanding (DSO) in net accounts receivable increased to 84 days at March 31, 2008, from 79 days at December 31, 2008 The increase in DSO reflects the lower level of average daily sales in the first quarter of 2009 compared to the first quarter of 2008.

EBITDA from continuing operations for the three months ended March 31, 2009, and 2008 was $5,302 and $7,021, a decrease of $1,719, or 24%, from the same period of the prior year. A reconciliation of EBITDA to net income for the three months ended March 31, 2009, and 2008 follows:

                                                    Three months
                                                   ended March 31,
                                              2009                2008
                                              (in thousands, unaudited)

          EBITDA                          $       5,302       $       7,021

          Interest income, net                      143                 257
          Provision for income taxes             (1,154 )            (1,463 )
          Depreciation and amortization            (828 )              (919 )
. . .