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 and nine months ended September 30, 2009 and 2008 (percentages in the discussion may be rounded to the closest full percentage point) and should be read in conjunction with our condensed 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 and Nine Months Ended September 30, 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 expect to relax the hiring freeze as it relates to sales and related support staff in areas where we believe there is a near term opportunity to strengthen our position in specific markets. With the exception of the addition of sales-related staff, we plan to continue our cost containment programs. We believe that they will allow us to remain profitable for the full-year 2009 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 third quarter of 2009 and 2008, approximately 91% and 95%, respectively, of our revenue was generated outside the United States. For both the nine months ended September 30, 2009 and 2008, approximately 94% of our revenue was generated outside of the United States.

In addition, in the third quarter of 2009 and 2008, approximately 76% and 74%, respectively, of our operating expenses were incurred outside the United States. For the nine months ended September 30, 2009 and 2008, approximately 80% and 74%, respectively, of our operating expenses were incurred outside of 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, approximately 77% of our operating expenses were incurred outside of the United States for the nine months ended September 30, 2009.

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 8% and 12% against the Euro for the quarter and nine months ended September 30, 2009, respectively, as compared to the same periods in 2008. The U.S. Dollar strengthened 12% and 26% against the Australian Dollar for the quarter and nine months ended September 30, 2009, respectively, as compared to the same periods 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 $592 and $4,292 for the quarter and nine months ended September 30, 2009, respectively, compared to the same periods in 2008 and a decrease in operating expenses of approximately $934 and $4,318 for the quarter and nine months ended September 30, 2009, respectively, compared to the same periods 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 condensed consolidated statements of operations in other non-operating income (expense). Foreign exchange transaction gains aggregating $308 and $643 in the third quarter and first nine months of 2009, respectively, compare to losses aggregating $836 and $751 in the third quarter of 2008 and first nine months of 2008, respectively.

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 and nine months ended September 30, 2009 and 2008 in each of our major geographic regions follows:

                                     EMEA         United States       Asia Pacific        Other countries         Total
Three months ended September 30:

                  Total Revenue:
                            2009   $ 17,002      $         1,921      $       1,354      $           1,849      $  22,126
                            2008     25,652                2,066              2,730                  9,257         39,705

               Percent of Total:
                            2009         77 %                  9 %                6 %                    8 %          100 %
                            2008         65 %                  5 %                7 %                   23 %          100 %

 Nine months ended September 30:

                  Total Revenue:
                            2009   $ 50,598      $         4,488      $       6,451      $           8,222      $  69,759
                            2008     69,508                6,423              8,278                 19,833        104,042

               Percent of Total:
                            2009         73 %                  6 %                9 %                   12 %          100 %
                            2008         67 %                  6 %                8 %                   19 %          100 %

Total revenue in the third quarter of 2009 decreased $17,579, or 44% from third quarter 2008. The decrease was primarily attributable to a significant decline in products sold to the banking and enterprise and application security markets and the strengthening of the U.S. Dollar as compared to the Euro as previously noted. Please see the discussion below under "Revenue by Target Market" for additional information regarding the changes in revenue from the banking market and the enterprise and application security market.

Revenue generated in EMEA during the third quarter 2009 was $8,650 or 34% lower than during the third quarter of 2008. The decrease was primarily attributable to factors noted above related to the quarter as a whole. Revenues were approximately 37% and 17% lower in the banking and enterprise and application security markets, respectively, than in the third quarter of 2008.

Revenue generated in the United States during the third quarter was $145 or 7% lower than the third quarter of 2008. The decrease was primarily attributable to a decline in revenue from the enterprise and application security market.

Revenue generated in the Asia Pacific region during the third quarter was $1,376 or 50% lower than the third quarter of 2008. The decrease was primarily attributable to factors noted above related to the quarter as a whole. Revenues in the Asia Pacific region were approximately 44% and 75% lower in the banking and enterprise and application security markets, respectively, than in the third quarter of 2008. The decline in revenue from the enterprise and application security market reflects the fact that the overall volume of that business is relatively small and changes in the timing of shipment of order can have an impact on the period over period comparisons.

Revenue generated from other countries during the third quarter was $7,408 or 80% lower than the third quarter of 2008. The decrease in other countries was primarily due to declines in South American banking markets where the initial deployments with large banking customers were completed in 2008. We expect that revenue from other countries will be more volatile than our other regions given the earlier stage of development of the authentication market in those countries. VASCO, however, plans to continue to invest in new markets based on our estimates of the market's demand for strong user authentication.

Total revenue for the nine months ended September 30, 2009 decreased $34,283 or 33%, from the nine months ended September 30 of 2008. The decrease was primarily attributable to a significant decline in products sold to the banking market and the strengthening of the U.S. Dollar as compared to the Euro as previously noted.

Revenue for the nine months ended September 30, 2009 generated in the European region was $18,910 or 27% lower than the same period in 2008 reflecting a 35% decline in the banking market partially offset by a 6% increase in the enterprise and application security market.

Revenue for the nine months ended September 30, 2009 generated in the United States was $1,935 or 30% lower than the same period in 2008, reflecting a 42% decline in the banking market and an 18% decline in the enterprise and application security market.

Revenue for the nine months ended September 30, 2009 generated in the Asia Pacific region was $1,827 or 22% lower than the same period in 2008 reflecting a 32% decline in the banking market partially offset by a 24% increase in the enterprise and application security market.

Revenue for the nine months ended September 30, 2009 generated from other countries was $11,611 or 59% lower than the same period in 2008. The majority of the decrease in this region was from the banking market and reflected the same factors as those noted for the third quarter.

Revenue by Target Market: Revenue is generated currently from two primary markets, banking/finance (banking) and enterprise and application security, through the use of both direct and indirect sales channels. The enterprise and application security market includes products used by employees of corporations to secure their internal networks (the enterprise security market) and business-to-business, business-to-consumer, e-commerce, e-government, e-gaming and other vertical applications (the application security market) that are not related to banking or finance. Management currently views the enterprise and application security market as one market because the same products are sold, through the same channels to both customer groups. Sales to the enterprise and application security market are generally for smaller quantities and higher prices than sales made to the banking market. The breakdown of revenue between the two primary markets was as follows:

                                                       Enterprise &
                                                       application
                                           Banking       security        Total
        Three months ended September 30:

                          Total Revenue:
                                    2009   $ 16,630   $        5,496   $  22,126
                                    2008     32,864            6,841      39,705

                       Percent of Total:
                                    2009        75%              25%        100%
                                    2008        83%              17%        100%

         Nine months ended September 30:

                          Total Revenue:
                                    2009   $ 50,643   $       19,116   $  69,759
                                    2008     85,317           18,725     104,042

                       Percent of Total:
                                    2009        73%              27%        100%
                                    2008        82%              18%        100%

Revenue in the third quarter of 2009 from the banking market decreased $16,234 or 49% from the third quarter of 2008 and revenue from the enterprise and application security market decreased $1,345 or 20% in the same period.

The decline in the banking market reflects a decline in products sold, both hardware and non-hardware, and the strengthening of the U.S. Dollar as compared to the Euro, as previously noted. We believe that banks in many, but not all, of our markets have been affected by the financial crisis. As a result, we believe that bank management teams have increased their focus on short-term objectives while their internal structures are being realigned based on new ownership

or new government rules. Also, given the worldwide recession, we believe that many banks are postponing marketing campaigns and related large-scale deployments of our products until a time when such marketing campaigns are expected to yield a higher return. For several consecutive quarters the banks have been placing smaller orders, which we believe was done to primarily meet their short-term needs. Looking forward, we believe that the financial, economic and regulatory environments that have had a large negative effect on our banking customers is improving and we expect to see an increase in orders from the banking market in the fourth quarter of 2009.

The increase in the enterprise and application security market was primarily attributable to an increase in the number of products shipped partially offset by the strengthening of the U.S. Dollar as compared to the Euro.

Revenue for the first nine months of 2009 from the banking market decreased $34,674 or 41%, compared to the first nine months of 2008 and revenue from the enterprise and application security market increased $391 or 2% in the same period. Changes in the revenue in both markets for the first nine months of 2009 compared to the same period in 2008 were attributable to the same factors noted above in the comparison of revenue for the third quarter of 2009 to the revenue for the third quarter of 2008.

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 and nine months
ended September 30, 2009 and 2008:



                                                   Three months ended              Nine months ended
                                                     September 30,                   September 30,
                                                  2009            2008            2009            2008
Net revenue                                        100.0 %         100.0 %         100.0 %         100.0 %

Cost of goods sold                                  30.4            29.9            30.0            29.6


Gross profit                                        69.6            70.1            70.0            70.4

Operating costs:
Sales and marketing                                 30.6            22.4            31.3            24.6
Research and development                            12.7             7.7            11.9             8.4
General and administrative                          16.9            10.9            14.8            11.6
Amortization of purchased intangible assets          0.5             0.3             0.5             0.5

Total operating costs                               60.7            41.3            58.4            45.1

Operating income                                     8.8            28.8            11.5            25.3

Interest income                                      0.3             0.6             0.5             0.7
Other income (expense)                               2.4            (2.0 )           2.1            (0.5 )


Income before income taxes                          11.6            27.4            14.2            25.5
Provision for income taxes                           4.7             4.4             4.1             4.8


Net income                                           6.9 %          23.0 %          10.1 %          20.7 %

Gross Profit

Consolidated gross profit for the quarter ended September 30, 2009 was $15,390 a decrease of $12,449 or 45% from the quarter ended September 30, 2008. Gross profit as a percentage of revenue (gross profit margin) was 69.6% for the quarter ended September 30, 2009, as compared to 70.1% for the quarter ended September 30, 2008. The most significant items affecting the comparison of the gross profit margins, whose impacts largely offset each other are described below.

Consolidated gross profit for the nine months ended September 30, 2009 was $48,800 a decrease of $24,481 or 33% from the comparable period in 2008. Gross profit as a percentage of revenue was 70.0% for the first nine months of 2009, as compared to 70.4% for the comparable period in 2008.

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 a corresponding decrease in cost of goods sold. The impact from changes in currency rates as noted above is estimated to have decreased revenue by approximately $592 for the quarter and $4,292 for the nine months ended September 30, 2009, respectively. Had the currency rates in 2009 been equal to the rates in 2008, the gross profit rate would have been approximately 0.7 higher for the quarter and 1.7 percentage points higher for the nine months ended September 30, 2009.

Non-hardware revenue, which can have a gross profit margin that is approximately 20 to 30 percentage points higher than hardware-related revenue, depending on the model and quantity of the hardware units sold, was 24% and 23% of revenue for the third quarter and first nine months of 2009, respectively. Non-hardware revenue was approximately 23% of total revenue for both the third quarter and first nine months of 2008, respectively. We plan to continue to focus on sales of our non-hardware revenue items and expect that they will increase as a percentage of our total revenue in future periods.

Card readers, which can have a gross profit margin that is approximately 25 to 35 percentage points lower than other hardware-related margins, due to competitive pricing pressures, were 19% and 18% of our revenue for the third quarter and first nine months of 2009, respectively, compared to 13% and 16% for the same periods in 2008. We expect that there will be continued pressure on the pricing of card readers as there are a number of competitors in the EMV market that produce products with fewer features than our products and at lower costs.

As noted above, revenue from our enterprise and application security markets was 25% and 27% of total revenue for the third quarter and first nine months of 2009, respectively, compared to 17% and 18% for the same periods in 2008. The gross profit margin from our enterprise and application security business is approximately 20 to 25 percentage points higher than in the banking market because sales in the enterprise and application security market are generally for lower quantities and higher prices than in the banking market. We plan to continue to invest in both the banking market and the enterprise and application security market and the overall mix between the two markets will vary in the future based on the growth rates in each of the markets.

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. The most significant factor driving our operating expenses is our headcount. Direct compensation and benefit plan expenses generally represent between 55% and 60% of our operating expenses. In addition, a number of other expense categories are directly related to headcount. As mentioned earlier, we have implemented a cost containment initiative, which includes, but is not limited to, a hiring freeze in all areas with the

. . .