##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
  þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 for the Quarterly Period Ended March 31, 2006
 or
 o
    
    transition report
pursuant to section 13 or
15(d) of the securities
exchange act of 1934for the transition
period from  to
 Commission file number 000-24389
 VASCO Data Security International, Inc.
  DELAWARE
    
    36-4169320(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 1901 South Meyers Road, Suite 210
Oakbrook Terrace, Illinois 60181
 (630) 932-8844
 þ o
 o þ o
 o þ




---



##### 



VASCO Data Security International, Inc.
Form 10-Q
For The Three Months Ended March 31, 2006
 Table of Contents
 PART I. FINANCIAL INFORMATION
    
    Page No.Item 1.
    
    Consolidated Financial Statements:Consolidated Balance Sheets as of
March 31, 2006 (Unaudited) and December 31, 2005
    
    
    3Consolidated Statements of Operations (Unaudited)
for the three months ended March 31, 2006 and 2005
    
    
    4Consolidated Statements of Comprehensive Income (Unaudited)
for the three months ended March 31, 2006 and 2005
    
    
    5Consolidated Statements of Cash Flows (Unaudited)
for the three months ended March 31, 2006 and 2005
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    23Item 4.
    
    Controls and Procedures
    
    
    23PART II. OTHER INFORMATIONItem 6.Exhibits
    
    
    24SIGNATURES
    
    
    25CERTIFICATIONS
    
    
    26CertificationCertificationCertificationCertification
  
 This report may contain the following trademarks of the
Company, some of which are registered: VASCO, AccessKey, VACMan Server and
VACMan/CryptaPak, AuthentiCard and Digipass. -2-




---



##### Table of Contents



VASCO Data Security International, Inc.
 
 Consolidated Balance Sheets
 (In thousands except share data)
 March 31,
    
    
    December 31,2006
    
    
    2005(Unaudited)ASSETSCurrent assets:Cash and equivalents
    
    $
    15,068
    
    
    $
    16,962Restricted cash
    
    
    185
    
    
    
    181Accounts receivable, net of allowance for doubtful accounts
    
    
    11,533
    
    
    
    12,083Inventories
    
    
    2,295
    
    
    
    1,570Prepaid expenses
    
    
    636
    
    
    
    726Deferred income taxes
    
    
    447
    
    
    
    117Foreign sales tax receivable
    
    
    611
    
    
    
    89Other current assets
    
    
    407
    
    
    
    451Total current assets
    
    
    31,182
    
    
    
    32,179Property and equipment:Furniture and fixtures
    
    
    1,873
    
    
    
    1,893Office equipment
    
    
    1,801
    
    
    
    2,1553,674
    
    
    
    4,048Accumulated depreciation
    
    
    (2,610
    )
    
    
    (3,066
    )Property and equipment, net
    
    
    1,064
    
    
    
    982Intangible assets, net of accumulated amortization
    
    
    982
    
    
    
    1,054Goodwill
    
    
    6,665
    
    
    
    6,665Investment in Secured Services, Inc.
    
    
    
    
    
    
    600Other assets
    
    
    25
    
    
    
    25Total assets
    
    $
    39,918
    
    
    $
    41,505LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Bank borrowing
    
    $
    776
    
    
    $
    $3,173Accounts payable
    
    
    3,805
    
    
    
    4,753Deferred revenue
    
    
    1,089
    
    
    
    1,765Accrued wages and payroll taxes
    
    
    1,971
    
    
    
    2,329Income taxes payable
    
    
    2,631
    
    
    
    1,547Other accrued expenses
    
    
    2,214
    
    
    
    2,287Total current liabilities
    
    
    12,486
    
    
    
    15,854Deferred warranty revenues
    
    
    248
    
    
    
    256Stockholders equity:Common
stock, $.001 par value  75,000,000 shares authorized;
36,329,549 shares issued and outstanding at March 31, 2006
and 36,180,425 issued and outstanding at December 31, 2005
    
    
    36
    
    
    
    36Additional paid-in capital
    
    
    59,575
    
    
    
    59,625Deferred compensation
    
    
    
    
    
    
    (403
    )Accumulated deficit
    
    
    (31,814
    )
    
    
    (32,985
    )Accumulated
other comprehensive loss Cumulative translation adjustment
    
    
    (613
    )
    
    
    (878
    )Total stockholders equity
    
    
    27,184
    
    
    
    25,395Total liabilities and stockholders equity
    
    $
    39,918
    
    
    $
    41,505
  -3-




---



##### Table of Contents



VASCO Data Security International, Inc.
 
 Consolidated Statements of Operations
 (Unaudited)
 (In thousands, except per share data)
 Three months endedMarch 31,2006
    
    
    2005Net revenues
    
    $
    13,690
    
    
    $
    11,444Cost of goods sold
    
    
    4,239
    
    
    
    4,223Gross profit
    
    
    9,451
    
    
    
    7,221Operating costs:Sales and marketing
    
    
    3,977
    
    
    
    3,337Research and development
    
    
    942
    
    
    
    809General and administrative
    
    
    1,534
    
    
    
    974Amortization of intangible assets
    
    
    98
    
    
    
    177Total operating costs
    
    
    6,551
    
    
    
    5,297Operating income
    
    
    2,900
    
    
    
    1,924Impairment
of investment in Secured Services, Inc.
    
    
    (789
    )
    
    
    Interest income, net
    
    
    60
    
    
    
    25Other income (expense)
    
    
    (27
    )
    
    
    216Income before income taxes
    
    
    2,144
    
    
    
    2,165Provision for income taxes
    
    
    974
    
    
    
    758Net income
    
    
    1,170
    
    
    
    1,407Preferred stock dividends
    
    
    
    
    
    
    (14
    )Net income available to common shareholders
    
    $
    1,170
    
    
    $
    1,393Basic net income per common share
    
    $
    0.03
    
    
    $
    0.04Fully diluted net income per common share
    
    $
    0.03
    
    
    $
    0.04Weighted average common shares outstanding:Basic
    
    
    36,114
    
    
    
    34,423Fully diluted
    
    
    37,712
    
    
    
    36,326
  -4-




---



##### Table of Contents



VASCO Data Security International, Inc.
 
 Consolidated Statements of Comprehensive Income
 (Unaudited)
 (In thousands)
 Three Months EndedMarch 31,2006
    
    
    2005Net income
    
    $
    1,170
    
    
    $
    1,407Other
comprehensive income (loss) Cumulative translation adjustment
    
    
    265
    
    
    
    (402
    )Comprehensive income
    
    $
    1,435
    
    
    $
    1,005
  -5-




---



##### Table of Contents



VASCO Data Security International, Inc.
 
 Consolidated Statements of Cash Flows
 (Unaudited)
 (In thousands)
 Three Months Ended March 31,2006
    
    
    2005Cash flows from operating activities:Net income from continuing operations
    
    
    
    
    
    $
    1,170
    
    
    $
    1,407Adjustments to reconcile net income from continuing operations
to net cash provided by (used in) operating activities:Impairment
of investments in Secured Services, Inc.
    
    
    
    
    
    
    789
    
    
    
    Depreciation and amortization
    
    
    
    
    
    
    197
    
    
    
    245Non-cash compensation expense
    
    
    
    
    
    
    282
    
    
    
    36Changes in assets and liabilities, net of effect of acquisition:Accounts receivable, net
    
    
    
    
    
    
    733
    
    
    
    (1,129
    )Inventories
    
    
    
    
    
    
    (688
    )
    
    
    6Prepaid expenses
    
    
    
    
    
    
    94
    
    
    
    87Foreign sales tax receivable
    
    
    
    
    
    
    (510
    )
    
    
    (34
    )Other current assets
    
    
    
    
    
    
    (172
    )
    
    
    75Other assets
    
    
    
    
    
    
    (330
    )
    
    
    Accounts payable
    
    
    
    
    
    
    (1,019
    )
    
    
    16Deferred revenue
    
    
    
    
    
    
    (689
    )
    
    
    (137
    )Accrued wages and payroll taxes
    
    
    
    
    
    
    (388
    )
    
    
    173Income taxes payable
    
    
    
    
    
    
    1,043
    
    
    
    739Accrued expenses
    
    
    
    
    
    
    (100
    )
    
    
    (56
    )Deferred warranty revenues
    
    
    
    
    
    
    (8
    )
    
    
    49Net cash provided by operating activities
    
    
    
    
    
    
    404
    
    
    
    1,477Cash flows from investing activities:Additions to property and equipment, net
    
    
    
    
    
    
    (165
    )
    
    
    (29
    )Acquisition of AOS-Hagenuk less cash acquired
    
    
    
    
    
    
    
    
    
    
    (4,039
    )Additions to intangibles
    
    
    
    
    
    
    (26
    )
    
    
    Decrease in restricted cash
    
    
    
    
    
    
    
    
    
    
    4Payments received on SSI note receivable
    
    
    
    
    
    
    30
    
    
    
    82Net cash used in investing activities
    
    
    
    
    
    
    (161
    )
    
    
    (3,982
    )Cash flows from financing activities:Repayment of borrowings
    
    
    
    
    
    
    (2,397
    )
    
    
    Proceeds from exercise of stock options
    
    
    
    
    
    
    62
    
    
    
    508Proceeds from exercise of preferred stock warrants
    
    
    
    
    
    
    11
    
    
    
    572Dividends paid on preferred stock
    
    
    `
    
    
    
    
    
    
    
    (14
    )Net cash provided by (used in) financing activities
    
    
    
    
    
    
    (2,324
    )
    
    
    1,066Effect of exchange rate changes on cash
    
    
    
    
    
    
    187
    
    
    
    (221
    )Net decrease in cash
    
    
    
    
    
    
    (1,894
    )
    
    
    (1,660
    )Cash, beginning of period
    
    
    
    
    
    
    16,962
    
    
    
    8,138Cash, end of period
    
    
    
    
    
    $
    15,068
    
    
    $
    6,478
  -6-




---



##### Table of Contents



VASCO Data Security International, Inc.
 
 Notes to Consolidated Financial Statements
 (All amounts are in thousands, except per share data)
 Note 1
 Summary of Significant Accounting Policies
 Nature of Operations
  Basis of Presentation
   Use of Estimates
  Revenue Recognition
  Hardware Revenue and License Fees:
 Support Agreements:
 -7-




---



##### Table of Contents



Consulting and Education Services:
 Multiple-Element Arrangements:
   Valuation of Investment in Secured Services, Inc.
  Whether an
Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock
  The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
 Interim
Financial Reporting
 -8-




---



##### Table of Contents



Cash and Equivalents
   Stock-Based Compensation
 Stock-Based Compensation Accounting for Stock Issued to Employees
   Weighted
    
    
    WeightedAverage
    
    
    Average
    
    
    AggregateExercise
    
    
    Remaining
    
    
    IntrinsicShares
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding at January 1, 2006
    
    
    2,218
    
    
    $
    3.27
    
    
    
    5.98
    
    
    $
    14,773Exercised
    
    
    (30
    )
    
    
    2.06
    
    
    
    5.34
    
    
    
    189Forfeited or expired
    
    
    (23
    )
    
    
    3.86
    
    
    
    6.69
    
    
    
    133Outstanding at March 31, 2006
    
    
    2,165
    
    
    
    3.28
    
    
    
    5.73
    
    
    
    10,981At March 31, 2006:Fully vested, exercisable options
    
    
    1,827
    
    
    $
    3.02
    
    
    
    5.59
    
    
    $
    9,793Options expected to vest
    
    
    282
    
    
    
    4.67
    
    
    
    6.53
    
    
    
    989Expected forfeitures
    
    
    56
    
    
    
    4.65
    
    
    
    6.45
    
    
    
    199Total
    
    
    2,165
    
    
    
    3.28
    
    
    
    5.73
    
    
    $
    10,981
 -9-




---



##### Table of Contents



Weighted
    
    
    Weighted
    
    
    UnrecognizedAverage
    
    
    Average
    
    
    Compen-Grant Date
    
    
    Remaining
    
    
    sationShares
    
    
    Fair Value
    
    
    Term
    
    
    CostNon-vested shares at January 1, 2006
    
    
    510
    
    
    $
    3.43
    
    
    
    6.80
    
    
    $
    1,085Vested
    
    
    (149
    )
    
    
    3.07
    
    
    
    6.63Forfeited
    
    
    (23
    )
    
    
    3.85
    
    
    
    6.69Non-vested shares at March 31, 2006
    
    
    338
    
    
    
    3.56
    
    
    
    6.52
    
    
    
    954
 Accounting for
Stock-Based Compensation
 Three Months Ended March 31,2006
    
    
    2005Compensation expense included in income:Stock options
    
    $
    157
    
    
    $
    Restricted stock
    
    
    125
    
    
    
    34Total
    
    
    282
    
    
    
    34Income tax benefit
    
    
    
    
    
    
    Effect on net income
    
    $
    282
    
    
    $
    34Proforma stock compensation disclosures
previously required by FASB Statement 123:Net income available to common shareholders:As reported
    
    
    
    
    
    $
    1,393Compensation expense, net of tax
    
    
    
    
    
    
    173Proforma
    
    
    
    
    
    $
    1,220Basic net income per share:As reported
    
    
    
    
    
    $
    0.04Proforma
    
    
    
    
    
    
    0.04Fully diluted net income per share:As reported
    
    
    
    
    
    $
    0.04Proforma
    
    
    
    
    
    
    0.03Weighted average fair value of options granted
    
    None granted
    
    

    $
    4.32Assumptions used to value options granted:Expected volatility
    
    
    
    
    
    
    69
    %Expected life
    
    
    
    
    
    6 - 7 yearsRisk free interest rate
    
    
    
    
    
    
    4.23
    %Expected dividends
    
    
    
    
    
    
    Intrinsic value of options exercised
    
    $
    189
    
    
    $
    1,153Fair value of shares vested
    
    
    458
    
    
    
    1,190
  -10-




---



##### Table of Contents



Earnings per Common Share
  Three Months Ended March 31,2006
    
    
    2005Weighted average common shares outstandingBasic
    
    
    36,114
    
    
    
    34,423Incremental shares with dilutive effect:Stock options
    
    
    1,356
    
    
    
    1,580Warrants
    
    
    153
    
    
    
    217Restricted stock awards
    
    
    89
    
    
    
    37Identikey acquisition shares
    
    
    
    
    
    
    69Dilutive
    
    
    37,712
    
    
    
    36,326
 Note 2
 Accounts Receivable and Allowance for Doubtful Accounts
  March 31,
    
    
    December 31,2006
    
    
    2005Accounts receivable
    
    $
    11,691
    
    
    $
    12,239Allowance for doubtful accounts
    
    
    (158
    )
    
    
    (156
    )Accounts receivable, net
    
    $
    11,533
    
    
    $
    12,083
 Note 3  Inventories
   March 31,
    
    
    December 31,2006
    
    
    2005Component parts
    
    $
    905
    
    
    $
    601Work-in-process and finished goods
    
    
    1,390
    
    
    
    969Total
    
    $
    2,295
    
    
    $
    1,570
 -11-




---



##### Table of Contents



Note 4
 Goodwill and Other Intangibles
  TotalCapitalized
    
    
    Patents &
    
    
    IntangibleTechnology
    
    
    Trademarks
    
    
    Assets
    
    
    GoodwillNet balance at December 31, 2005
    
    $
    957
    
    
    $
    97
    
    
    $
    1,054
    
    
    $
    6,665Additions
    
    
    
    
    
    
    26
    
    
    
    26
    
    
    
    Amortization Expense
    
    
    (96
    )
    
    
    (2
    )
    
    
    (98
    )
    
    
    Net balance at March 31, 2006
    
    $
    861
    
    
    $
    121
    
    
    $
    982
    
    
    $
    6,665Estimated amortization expense for the years ended:December 31, 2006
    
    $
    393December 31, 2007
    
    
    394December 31, 2008
    
    
    121December 31, 2009
    
    
    42December 31, 2010 and thereafter
    
    
    130
  Note 5
 Bank Borrowing
  Note 6  Deferred Warranty
   Year
    
    Amount2006
    
    $
    682007
    
    
    1212008
    
    
    1042009
    
    
    412010
    
    
    12$
    346
 -12-




---



##### Table of Contents



Note 7
 Stockholders Equity
  Common Stock IssuedNumber of
    
    Value ofShares
    
    SharesExercise of options
    
    
    30
    
    
    $
    62Exercise of warrants
    
    
    3
    
    
    
    11Restricted stock awards, net
    
    
    116
    
    
    
    1,107
  Note
8  Supplemental Disclosures of Cash Flow Information
 Three months ended March 31,2006
    
    2005Supplemental disclosure of cash flow information:Interest paid
    
    $
    21
    
    
    $
    Income taxes paid
    
    
    246
    
    
    $
    Supplemental disclosure of non-cash investing activities:Common stock issued for acquisition (263 shares)
    
    $
    
    
    
    $
    2,128Supplemental disclosure of non-cash financing activities:Common stock issued to redeem Series D preferred
stock upon conversion (1,040 shares)
    
    $
    
    
    
    $
    1,504Common stock issued to Series D preferred stock
shareholders as a dividend payment (5 shares)
    
    $
    
    
    
    $
    27
 Note 9  Business Combination
 Business Combinations.
  -13-




---



##### Table of Contents



February 4,2005Cash
    
    $
    529Accounts receivable, net
    
    
    466Inventory
    
    
    11Prepaid expenses
    
    
    47Other current assets
    
    
    608Property and equipment, net
    
    
    122Total assets acquired
    
    
    1,783Accounts payable
    
    
    47Deferred revenue
    
    
    1,071Deferred income taxes
    
    
    28Accrued expenses
    
    
    156Total liabiltites assumed
    
    
    1,302Net assets acquired
    
    $
    481The purchase price has been allocated as follows:Net assets acquired
    
    $
    481Capitalized purchase orders
    
    
    367Goodwill
    
    
    6,415$
    7,263
 -14-




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 (In thousands, except headcount, Digipass unit volume and unit price data)
    Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities
Litigation Reform Act of 1995
  -15-




---



##### Table of Contents



Comparison of Results for the Three Months Ended March 31, 2006 and 2005.
 Industry Growth:
 Economic Conditions:
 Currency Fluctuations:
   Accounting
for Derivative Instruments and Hedging Activities
 -16-




---



##### Table of Contents



Revenue
 Revenue by Geographic Regions:
 Europe,Middle East,
    
    
    
    
    
    
    
    
    
    OtherAfrica
    
    United States
    
    Asia
    
    Countries
    
    TotalThree months ended
March 31:Total Revenue:2006
    
    $
    9,534
    
    
    $
    848
    
    
    $
    1,222
    
    
    $
    2,086
    
    
    $
    13,6902005
    
    
    10,001
    
    
    
    740
    
    
    
    132
    
    
    
    571
    
    
    
    11,444Percent of Total:2006
    
    
    70
    %
    
    
    6
    %
    
    
    9
    %
    
    
    15
    %
    
    
    100
    %2005
    
    
    88
    %
    
    
    6
    %
    
    
    1
    %
    
    
    5
    %
    
    
    100
    %
     -17-




---



##### Table of Contents



Revenue by Target Market:
 Banking
    
    CNA
    
    TotalThree months ended
March 31:Total Revenue:2006
    
    $
    11,192
    
    
    $
    2,498
    
    
    $
    13,6902005
    
    
    9,736
    
    
    
    1,708
    
    
    
    11,444Percent of Total:2006
    
    
    82
    %
    
    
    18
    %
    
    
    100
    %2005
    
    
    85
    %
    
    
    15
    %
    
    
    100
    %
   -18-




---



##### Table of Contents



Gross Profit and Operating Expenses
  Three Months EndedMarch 31,2006
    
    
    2005Revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    31.0
    
    
    
    36.9Gross profit
    
    
    69.0
    
    
    
    63.1Operating costs:Sales and marketing
    
    
    29.0
    
    
    
    29.2Research and development
    
    
    6.9
    
    
    
    7.1General and administrative
    
    
    11.2
    
    
    
    8.5Amortization of intangible assets
    
    
    0.7
    
    
    
    1.5Total operating costs
    
    
    47.8
    
    
    
    46.3Operating income
    
    
    21.2
    
    
    
    16.8Interest income, net
    
    
    0.4
    
    
    
    0.2Other income (expense), net
    
    
    (0.2
    )
    
    
    1.9Impairment
of investments in SSI
    
    
    (5.8
    )
    
    
    Income before income taxes
    
    
    15.6
    
    
    
    18.9Provision for income taxes
    
    
    7.1
    
    
    
    6.6Net income
    
    
    8.5
    
    
    
    12.3
 Gross Profit
    -19-




---



##### Table of Contents



Operating Expenses
  Sales and Marketing Expenses
  Research and Development Expenses
  General and Administrative Expenses
  Amortization of Intangible Assets
  -20-




---



##### Table of Contents



Impairment of Investment in Secured Services, Inc.
  Interest Income (Expense), net
  Other Income (Expense), Net
  Income Taxes
    Liquidity and Capital Resources
  -21-




---



##### Table of Contents



Three Months Ended March 31,2006
    
    
    2005(unaudited)EBITDA
    
    $
    2,281
    
    
    $
    2,385Interest income
    
    
    60
    
    
    
    25Provision for income taxes
    
    
    (974
    )
    
    
    (758
    )Depreciaton and amortization
    
    
    (197
    )
    
    
    (245
    )Net income
    
    $
    1,170
    
    
    $
    1,407
     -22-




---



##### Table of Contents



Recently Issued Accounting Pronouncements
 Stock-Based Compensation Accounting for Stock Issued to
Employees
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
   -23-




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 6. Exhibits
     -24-




---



##### Table of Contents



SIGNATURES
  VASCO Data Security International, Inc./s/ T. Kendall HuntT. Kendall HuntChief Executive Officer and
Chairman of the Board of Directors (Principal Executive Officer)/s/ Clifford K. BownClifford K. BownExecutive Vice President and Chief Financial Officer(Principal Financial Officer and Principal Accounting Officer)
 -25-