<PAGE>

                                  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, 2005

                                       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)

<TABLE>
<S>                                                          <C>
            DELAWARE                                              36-4169320
(State or Other Jurisdiction of                                 (IRS Employer
 Incorporation or Organization)                              Identification No.)
</TABLE>

                        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 if the registrant is a well-known seasoned issuer,
as defined by Rule 405 of the Securities Act. Yes       No   X
                                                  -----    -----

     Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the act. Yes       No   X
                                                -----    -----

     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. [X]

     Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or a non-accelerated filer (See definition of "accelerated
filer" in Rule 12b-2 of the Exchange Act).

Large accelerated filer [ ]   Accelerated filer [X]   Non-accelerated filer [ ]

     As of June 30, 2005, 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, 2005) held by non-affiliates of the registrant was
$250,640,000 at $9.70 per share.


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<PAGE>

     As of March 8, 2006, there were 36,214,092 shares of Common Stock
outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     None.

                                TABLE OF CONTENTS

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                                                                            PAGE
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PART I
Item 1.    Business                                                            3
Item 1A.   Risk Factors                                                       13
Item 1B.   Unresolved Staff Comments                                          19
Item 2.    Properties                                                         19
Item 3.    Legal Proceedings                                                  20
Item 4.    Submission of Matters to a Vote of Security Holders                20

PART II
Item 5.    Market for Registrant's Common Equity, Related Stockholder
              Matters and  Issuer Purchases of Equity Securities              20
Item 6.    Selected Financial Data                                            22
Item 7.    Management's Discussion and Analysis of Financial Condition
           and Results of Operations                                          23
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk         36
Item 8.    Financial Statements and Supplementary Data                        36
Item 9.    Changes in and Disagreements with Accountants on Accounting
              and Financial Disclosures                                       36
Item 9A.   Controls and Procedures                                            36
Item 9B.   Other Information                                                  38

PART III
Item 10.   Directors and Executive Officers of the Registrant                 39
Item 11.   Executive Compensation                                             40
Item 12.   Security Ownership of Certain Beneficial Owners and Management
              and Related Stockholder Matters                                 43
Item 13.   Certain Relationships and Related Transactions                     45
Item 14.   Principal Accountants Fees and Services                            46

PART IV
Item 15.   Exhibits and Financial Statement Schedules                         46

CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE                               F-1
</TABLE>

     This report contains the following trademarks of the Company, some of which
are registered: VASCO, VACMAN, Digipass, and Digipass Pack.


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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 we currently market
and sell our products or anticipate selling and marketing our 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 our present expectations or beliefs concerning
future events. We caution 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 our products and services, competition and
price levels and our 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 - BUSINESS

     VASCO Data Security International, Inc. was incorporated in the state of
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 on
Form 10-K 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

     We, through our operating subsidiaries, design, develop, market and support
open standards-based hardware and software security systems that manage and
secure access to information assets. We design, develop, market and support
patented "Strong User 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. Our Strong User
Authentication is delivered via our hardware and software Digipass security
products, Our Digipass devices, most of which incorporate an electronic
signature capability, guarantee the integrity of electronic transactions and
data transmissions. Some of our Digipass units are compliant with the Europay
MasterCard Visa ("EMV") standard and are compatible with MasterCard's and VISA's
new smart cards.

     The backbone of our product range is VACMAN Controller. VACMAN Controller
is being extended to support all authentication technologies, including
passwords, dynamic password technology (Digipass), certificates and biometrics,
on one unique platform. Our strategy is to become the full option, all-terrain
authentication company.

     For user access control, our VACMAN Middleware 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.

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     Our target markets are the applications and their several hundred million
users that utilize fixed passwords as security. Our 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.

     As of December 31, 2005, we had shipped approximately 20 million Digipass
units since our 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 2,300 customers in more than 100
countries. Representative customers of our products include HSBC, Rabobank
Nederland, ING Bank, Fortis Bank, Wachovia, Daimler Chrysler, Volvo and CoStar
Group. In 2004, we sold to 543 new accounts of which 70 were banks and 473 were
corporate network access customers. For full year 2005, we sold 821 new accounts
including 89 new banks and 732 new Corporate Network Access accounts.

OUR 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 five 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, we received a senior secured
promissory note with a face value of approximately $1.1 million, valued at $1.0
million, and Convertible Preferred Stock from SSI, valued at $0.6 million, 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 our
operational assets and liabilities and have been reported as results of
discontinued operations. Prior periods have been restated to conform to this
presentation.

     On February 4, 2005, pursuant to a share sale and purchase agreement by and
among us, A.O.S. Holding B.V., Filipan Beheer B.V., Mr. Mladen Filipan and
Pijnenburg Beheer N.V., we completed our acquisition of 100% of the total issued
share capital of A.O.S. Hagenuk B.V., a private limited liability company
organized and existing under the laws of the Netherlands. The base purchase
price was EUR 5 million of which EUR 3.75 million was paid in cash and the
remainder was paid in shares of our Common Stock.

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


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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. Many banks in European countries began to issue smart cards (credit
cards with a micro-chip) that are compliant with the EMV standard in 2005.

     Worldwide, more governments are issuing guidance for online banking
security. For example, the Hong Kong Monetary Authority (HKMA), the Hong Kong
Association of Banks (HKAB) and the Hong Kong Police Force (HKPF) jointly issued
the following statement regarding the use of two-factor authentication for
Internet banking:

     "In view of the increasing acceptance of Internet banking services and the
growing sophistication of Internet banking frauds, the banking industry in Hong
Kong reached a general consensus in June 2004 to implement two-factor
authentication for high-risk retail Internet banking transactions. Banks
offering high-risk retail Internet banking transactions will have two-factor
authentication ready for their customers by June 2005. Customers will need to
adopt two-factor authentication if they wish to conduct those transactions."

     In October 2005, in the U. S., the Federal Financial Institutions
Examination Council (FFIEC) issued guidance for Strong Authentication/Two Factor
Authentication in the Internet banking environment. Financial institutions are
expected to achieve compliance by year-end 2006.

     Components of Security. Data and financial asset security, and secured
access to and participation in on-line commerce, generally consist of the
following components:

     -    Encryption: Maintains data privacy by converting information into an
          unreadable pattern and allowing only authorized parties to decrypt the
          data. Encryption can also maintain data integrity by creating digital
          signatures for transmitted data, enabling the recipient to check
          whether the data has been changed since or during transmission.

     -    Identification and Authentication: Serves as the foundation for other
          security mechanisms by verifying that a user is who he or she claims
          to be. Identification and authentication mechanisms are often employed
          with encryption tools to authenticate users, to determine the proper
          encryption key for encrypting/decrypting data, or to enable users to
          digitally "sign" or verify the integrity of transmitted data.

     -    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.


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<PAGE>

     -    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. Many companies, however, only implement a patchwork of these
components, which could result in their security systems being compromised.

OUR SOLUTION

     We have 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:

     -    Speed and ease of implementation, use and administration;

     -    Reliability;

     -    Interoperability with diverse enterprise environments, existing
          customer applications and the security infrastructure;

     -    Scalability; and

     -    Overall cost of ownership.

     Accordingly, we have adopted the following approach to data security:

     -    In designing our products, we have sought to incorporate
          industry-accepted, open and non-proprietary protocols . This permits
          interoperability between our products and the multiple platforms,
          products and applications widely in use.

     -    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.

     -    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 the
leading provider of strong software and hardware authentication security
solutions for all types of on-line, risk-based transactions.

OUR STRATEGY

     We believe we have one of the most complete lines of security products and
services for Strong User Authentication available in the market today and we
also believe that we are the 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:


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     -    Make VASCO the full option, all-terrain authentication company by
          offering our customers a solution with VACMAN Controller as the core
          and the backbone, encompassing all four authentication technologies
          (passwords, dynamic password technologies, certificates and
          biometrics);

     -    Market new services and products to our existing customers by
          providing testimonial evidence of user experiences from other
          customers;

     -    Maintain a marketing campaign in Europe, the Middle East, North
          America and Asia 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;

     -    Form additional strategic relationships with resellers and vendors of
          complementary, innovative security products and systems; and

     -    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:

     -    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);

     -    Acquiring complementary technologies or businesses; and

     -    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.

OUR 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:

     -    What the user has (the Digipass device itself);

     -    What the user knows (the PIN code to activate the Digipass); and

     -    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:

     -    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

     -    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


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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).

     Digipass technology combines the benefits of traditional password tokens
(authentication and digital signatures) with smart card readers. Together, they
bring portability to smart cards and allow secure time-based algorithms.

     A VASCO-secured system has the features needed to secure both today's and
tomorrow's IT resources.


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DIGIPASS AT WORK

                                    (IMAGE 1)
                                    (IMAGE 2)
                                    (IMAGE 3)
                                    (IMAGE 4)
                                    (IMAGE 5)

     The above illustration shows the various steps in the Digipass
authentication 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 disks 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 the Digipass units 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 along with a user manual.
The protected PIN-code is sent to the end user in a separate shipment on a
secure PIN-mailer.

     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.


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     Currently, the Digipass is used in a wide variety of applications, the
largest of which is banking. Banking applications include:

     -    Corporate banking through direct dial-up, as well as over the
          Internet, and

     -    Retail banking to secure transactions made through the use of a
          dial-up connection with a personal computer, the traditional phone
          system, the Internet, 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).

                                    (IMAGE 6)

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.

VACMAN Controller

VACMAN Controller is the backbone of VASCO's product strategy towards the
banking and e-commerce markets.

VACMAN Controller is natively embedded in or compatible with the solutions of
over 100 VASCO solution partners.

     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


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<PAGE>

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 authorized to have a Digipass.

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 U. S. and
in certain European countries, which cover multiple aspects of our technology.
The majority of our patents cover our Digipass family. These patents expire
between 2006 and 2022, with one patent expiring in 2006. In addition to the
issued patents, we also have several patents pending in the U. S. and other
countries. 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 a team of full-time engineers
and, from time to time, also engage independent engineering firms to conduct
non-strategic research and development efforts on our behalf.

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 a limited number of 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 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


                                       11

<PAGE>
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 microprocessors 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 three 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.

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. Our main competitor is RSA Security.
Additional competitors are ActivIdentity, Xiring, Todos Data Systems and Kobil
Systems. There are many other companies such as Secure Computing, SafeNet,
Entrust, and Aladdin Knowledge Systems 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.

     Some 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. It is possible that new competitors or alliances may
emerge and rapidly acquire significant market share. Accordingly, VASCO has, and
will continue to forge its own partnerships to offer a broader range of products
and capabilities to the market.

     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 31
coordinates our sales activity through both our sales channels and our 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


                                       12

<PAGE>

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:

<TABLE>
<CAPTION>
BANKING/FINANCIAL SERVICES            OTHER
--------------------------   -----------------------
<S>                          <C>
    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
      Sovereign Bank
       Wachovia, USA
     Zagrebacka Banka
</TABLE>

     For the years 2005, 2004 and 2003, our top 10 customers contributed 64%,
60% and 71%, respectively, of total worldwide revenues. Sales to Rabobank
Nederland and HSBC each exceeded 10% of our revenue in 2005. Rabobank Nederland,
Ementor and Fortis Bank each exceeded 10% of our revenue in 2004. Rabobank
Nederland and Fortis Bank each exceeded 10% of our revenue in 2003.

     A significant portion of our sales is denominated in foreign currencies and
changes in exchange rates could impact results of operations. To minimize
exposure to risks associated with fluctuations in currency exchange rates, we
attempt to denominate an amount of billings in a currency such that it would
provide a hedge against operating expenses being incurred in that currency. For
additional information regarding how currency fluctuations can affect our
business, please refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Quantitative and Qualitative
Disclosures About Market Risk".

     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 13 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 December 31, 2005, we had 128 full time employees. Of these, 19 were
located in North America, 85 were located in Europe, 17 were located in
Australia and 7 located in Asia/Pacific. Of the total, 50 were involved in
sales, marketing and customer support, 30 in operations, 31 in research and
development and 17 in administration.

ITEM 1A - RISK FACTORS

     You should carefully consider the risk factors described below and all
other information contained or incorporated by reference in this Annual Report
on Form 10-K before you make an investment decision. If any of the following
risk factors, as well as other risks or uncertainties that are not currently
known to us or that we currently believe are not material, actually occur, our
business, financial condition and results of operations could


                                       13

<PAGE>

be materially and adversely affected. In that case, the trading price of our
Common Stock could decline and you may lose part or all of your investment.

     WE HAD A HISTORY OF OPERATING LOSSES AND HAVE A LARGE ACCUMULATED DEFICIT.

     Although we have reported net income of $7,701, $3,253 and $2,756 for the
years ended December 31, 2005, 2004 and 2003, respectively, we have incurred
significant net losses in prior years and as of December 31, 2005, our
accumulated deficit is $32,985.

     OUR REVENUE AND CASH RECEIPTS MAY NOT BE SUFFICIENT TO MEET THE OPERATING
NEEDS OF OUR BUSINESS.

     Our revenue and cash receipts may not be sufficient to meet the operating
needs of the business. If this is the case, we may 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.

     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, ActivIdentity, Xiring, Todos Data
Systems and Kobil Systems Many of our competitors have significantly greater
financial, marketing, technical and other competitive resources than we do. As a
result, our competitors 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:

          -    The time required for a prospective customer to recognize the
               need for our products;

          -    The significant expense of many data security products and
               network systems;

          -    Customers' internal budgeting processes; and

          -    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.


                                       14

<PAGE>

     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 U. S. 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:

          -    Inconsistent regulations and unexpected changes in regulatory
               requirements;

          -    Difficulties and costs of staffing and managing international
               operations;

          -    Potentially adverse tax consequences;

          -    Wage and price controls;

          -    Uncertain protection for intellectual property rights;

          -    Imposition of trade barriers;

          -    Differing technology standards;

          -    Uncertain demand for electronic commerce;

          -    Linguistic and cultural differences;

          -    Political instability; and

          -    Social unrest.


                                       15
<PAGE>

     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 U. S., 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 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 four independent vendors, one headquartered in
Europe and the other three 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 U. S.
that are adverse to trade, including enactment of protectionist legislation.

     WE CANNOT BE CERTAIN THAT OUR RESEARCH AND DEVELOPMENT ACTIVITIES WILL BE
SUCCESSFUL.

     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.

     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 U. S. and in some European countries, which
cover multiple aspects of our technology. The majority of our patents cover the
Digipass product line. These patents expire between 2006 and 2022, with one
patent expiring in 2006. In addition to the issued patents, we also have several
patents pending in the U. S. and other countries. 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. Although certain of our security
token technologies are patented, there are other organizations that offer


                                       16

<PAGE>

token-type password generators incorporating challenge-response or response-only
approaches that employ different technological solutions and compete with us for
market share.

     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:

     -    Any significant advance in techniques for attacking cryptographic
          systems, including the development of an easy factoring method or
          faster, more powerful computers;

     -    Publicity of the successful decoding of cryptographic messages or the
          misappropriation of keys; and

     -    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:

     -    Difficulty in assimilating the operations, technology and personnel of
          acquired companies;

     -    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;

     -    Difficulty in retaining key technical and managerial personnel from
          acquired companies;

     -    Dilution of our stockholders, if we issue equity to fund these
          transactions;

     -    Assumption of operating losses, increased expenses and liabilities;
          and

     -    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.

     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:


                                       17

<PAGE>

     -    The level of competition;

     -    The size, timing, cancellation or rescheduling of significant orders;

     -    New product announcements or introductions by current competitors;

     -    Technological changes in the market for data security products
          including the adoption of new technologies and standards;

     -    Changes in pricing by current competitors;

     -    Our ability to develop, introduce and market new products and product
          enhancements on a timely basis, if at all;

     -    Component costs and availability;

     -    Our success in expanding our sales and marketing programs;

     -    Market acceptance of new products and product enhancements;

     -    Changes in foreign currency exchange rates; and

     -    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 31%, with Mr. T. Kendall Hunt
controlling approximately 29%, of the outstanding shares of our common stock. 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:

     -    Actual or anticipated fluctuations in our operating results;

     -    Changes in market valuations of other technology companies;

     -    Announcements by us or our competitors of significant technical
          innovations, contracts, acquisitions, strategic partnerships, joint
          ventures or capital commitments;

     -    Additions or departures of key personnel;

     -    Future sales of common stock;

     -    Any deviations in net revenues or in losses from levels expected by
          the investment community; and

     -    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.

     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.


                                       18

<PAGE>

     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 U.S..

     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:

     -    That the judgment is not contrary to the principles of public policy
          in Belgium or rules of Belgian public law;

     -    That the judgment did not violate the rights of the defendant;

     -    That the judgment is final under applicable law;

     -    That the court did not accept its jurisdiction solely on the basis of
          the nationality of the plaintiff; and

     -    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 1B - UNRESOLVED STAFF COMMENTS

     None.

ITEM 2 - PROPERTIES

     Our corporate office is located in the U. S. 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 U. S. 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 29,600 square feet of office space that are
occupied under a lease expiring on September 30, 2011. Our Netherlands sales and
R&D facility, approximately 6,100 square feet, is occupied under a lease
expiring on December 31, 2010.

     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.


                                       19

<PAGE>

     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, 2007. The second sales office
is located in Shanghai, China consisting of approximately 1,200 square feet
under a lease expiring on November 30, 2006.

     We believe that these facilities are adequate for our present growth plans.

ITEM 3 - LEGAL PROCEEDINGS

     We are from time to time involved in litigation incidental to the conduct
of our business. We are not currently a party to any lawsuit or proceeding
which, in the opinion of management, is likely to have a material adverse effect
on our 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 2005, through solicitation of proxies or otherwise.

                                     PART II

ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

     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 U. S.
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 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 was 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. There were 136,250 warrants outstanding at February 28, 2006.

     The following table sets forth the high and low closing bid quotations for
the Common Stock for the periods indicated.


                                       20

<PAGE>

<TABLE>
<CAPTION>
                                             HIGH     LOW
                                            ------   -----
<S>                                         <C>      <C>
2006
First Quarter (through February 28, 2006)   $11.44   $9.20

2005
Fourth Quarter                              $12.48   $7.72
Third Quarter                                12.05    8.59
Second Quarter                               11.45    6.00
First Quarter                                 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
</TABLE>

Holders and Dividends

     On February 28, 2006, the closing sale price for the Common Stock on the
Nasdaq was $9.99 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, 2006, there were approximately 2,400
holders of record of the Common Stock.

     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.

Recent Sales of Unregistered Securities

     None

Issuer Purchases of Equity Securities

     None.


                                       21

<PAGE>

ITEM 6 - SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,
                                                     ----------------------------------------------------------
                                                       2005                                 2002         2001
                                                       (7)         2004        2003         (1)           (1)
                                                     -------     -------     -------      -------      --------
<S>                                                  <C>         <C>         <C>          <C>          <C>
Statements of Operations Data:
Net revenues                                         $54,579     $29,893     $22,866      $17,370      $ 22,690
Operating income (loss) from continuing operations    10,953(2)    5,552(2)    1,123       (4,898)(2)   (10,788)(2)
Net income (loss) from continuing operations           7,701       3,253         761       (5,293)       (9,717)
Net income (loss) from discontinued operations            --          --       1,995(6)       754        (2,317)
Net income (loss)                                      7,701       3,253       2,756       (4,539)      (12,034)
Net income (loss) available to common stockholders     7,687(3)    3,021(3)   (1,715)(4)   (5,703)(5)   (13,198)(5)
Diluted income (loss) per common share  from
   continuing operations                             $  0.21(3)  $  0.09(3)  $ (0.13)(4)  $ (0.22)(5)  $  (0.39)(5)
Shares used in computing per share amounts            37,244      33,128      29,270       28,348        28,169
Balance Sheet Data:
Cash and equivalents                                 $16,962     $ 8,138     $ 4,817      $ 2,616      $  6,342
Working capital (deficiency)                          16,325       9,995       5,218         (587)        6,672
Total assets                                          41,505      20,250      13,383       11,133        17,451
Long-term obligations, less current portion               --          --          --           --         3,668
Stockholders' equity                                  25,395      13,031       8,943        2,811         7,147
</TABLE>

----------
(1)  Years prior to 2003 have been restated to reclassify 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 $(172) in 2005, $(32) in
     2004, $320 in 2002 and $3,970 in 2001.

(3)  Includes the impact of preferred stock dividends of $14 in 2005 and $232 in
     2004.

(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 in 2002 and in
     2001.

(6)  Includes $638 from discontinued operations and $1,357 from gain on sale of
     discontinued operations.

(7)  Includes the results of AOS-Hagenuk B.V., which was acquired on February 4,
     2005.


                                       22
<PAGE>

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

       (IN THOUSANDS, EXCEPT SHARE COUNT, HEAD COUNT AND UNIT PRICE DATA)

OVERVIEW

     The following discussion is based upon our consolidated results of
operations for the years ended December 31, 2005, 2004 and 2003 (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 Annual Report on 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 their 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.

     Economic Conditions: Our revenues may vary significantly with changes in
the economic conditions in the countries in which we sell products currently.
With our 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 our revenues.
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 2005, approximately 93% of our revenue and
approximately 74% of our operating expenses were generated/incurred outside of
the U. S.. In 2004, approximately 90% of our revenue and approximately 79% of
our operating expenses were generated/incurred outside of the U. S.. 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 on operating earnings, we attempt to denominate an amount of billings
in a currency such that it would provide a hedge against the operating expenses
being incurred in that currency. In addition, we also attempt to minimize
transaction gains and losses by hedging our net U.S. dollar asset exposure by
borrowing U.S. dollars in foreign countries such that assets denominated in U.S.
dollars are approximately equal to liabilities denominated in U.S. dollars.

     In 2005, the annual average exchange rate for the Euro strengthened
approximately 1% and the Australian Dollar strengthened approximately 4% against
the U.S. Dollar. The Euro strengthened approximately 10% and the Australian
Dollar strengthened approximately 15% against the U.S. Dollar in 2004. We
estimate that the strengthening of the two currencies in 2005 compared to 2004
resulted in a decrease in revenues of approximately $301 and an increase in
operating expenses of approximately $112. While we expect that a strengthening
of the Euro compared to the U. S. dollar would result in an increase in revenue,
that was not the case in 2005. The decline in revenue in 2005, due to currency,
reflects the timing of when revenue was realized and the corresponding changes
in currency rates in those periods. In the fourth quarter of 2005, we realized a
significant portion of our revenues


                                       23

<PAGE>

when the Euro was weaker than the same period in 2004. We estimate that the
strengthening of the two currencies in 2004 compared to 2003 resulted in an
increase in revenues of approximately $1,089 and an increase in operating
expenses of approximately $1,106.

     Gains and losses resulting from foreign currency transactions are included
in the consolidated statements of operations. Foreign exchange transaction gains
aggregating $330 are included in other non-operating income (expense) for 2005.
Foreign exchange transaction losses aggregating $538 are included in other
non-operating income (expense) for 2004 and gains of $146 are included in other
non-operating income (expense) for 2003.

     The financial position and the results of operations of our 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 deficit of
$1,218 in 2005 and a surplus and $687 in 2004 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 U. S. and other countries,
primarily Australia and Asia/Pacific. The breakdown of revenue in each of our
major geographic areas was as follows:

<TABLE>
<CAPTION>
       YEAR          EUROPE   UNITED STATES   OTHER COUNTRIES    TOTAL
       ----         -------   -------------   ---------------   -------
<S>                 <C>       <C>             <C>               <C>
Total Revenue:
   2005             $39,219      $3,687           $11,673       $54,579
   2004              24,245       3,105             2,543        29,893
   2003              19,201       1,498             2,167        22,866

Percent of Total:
   2005                  72%          7%               21%          100%
   2004                  81%         10%                9%          100%
   2003                  84%          7%                9%          100%
</TABLE>

     2005 Compared to 2004 - Overview and Geographic Breakdown

     Total revenues in 2005 increased $24,686 or 83% over 2004. The increase was
primarily attributable to an increase in the number of Digipass units sold and
the acquisition of AOS-Hagenuk ("AOS"), partially offset by a decline in the
average sales price per unit. Revenues from AOS were $4,542 in 2005, net of
purchase price amortization costs of $421. Excluding revenue from AOS,
consolidated revenue increased $20,144 or 67% from 2004.

     In 2005, we sold approximately 7,340 Digipass products, an increase of
approximately 4,505 units, or 159%, over the 2,835 Digipass products sold in
2004. We believe that the increase in Digipass volume is attributable to the
growth in our distribution channel, increased investment in sales staff and
marketing programs, increased awareness of the need for strong authentication to
combat identity theft and our ability to deploy large volumes of high-quality
products at an affordable price. Our strategy of being the high-volume,
high-quality, low-cost producer allows us to compete effectively in both of our
primary target markets, banking/finance ("Banking") and corporate network access
("CNA"). In 2005, we believe that our unit volume increased in large part due to
our Banking customers' desire and need to provide two-factor authentication to
its internet banking customers. We expect to see continued worldwide expansion
in authentication for consumer-related applications and believe that we are well
positioned to compete for that business as the market expands.

     The average price per unit in 2005 was $7.44 and was 29% lower than the
$10.54 average price per unit in 2004. The decline in average price per unit
reflects our strategy of providing volume-purchase discounts to


                                       24

<PAGE>

customers that place firm purchase orders for large-volume deployments and a
change in mix of our business. We believe that the lower average prices are a
critical element in our customers' decision to deploy our technology to their
consumer-level customers. In 2005, while each of our markets grew, the growth in
large-volume deployments exceeded our growth in our lower-volume, higher priced
markets, such as Corporate Banking and CNA.

     As noted in the table above, revenues from each of our geographic regions
increased. Both the absolute amount of revenue from each region and the growth
over the prior year reflect, in general, the regulatory environment of the
region and the customers' attitudes towards and acceptance of two-factor
authentication. The growth in Europe, $14,974 or 62% over 2004, was attributable
to several factors including, but not limited to, the acquisition of AOS, the
maturity of our sales and distribution channels, increased investment in sales
staff and marketing programs and the rollout of the new smart card standard by
Europay, Mastercard, Visa ("EMV"). The growth in the U. S., $582 or 19%, was a
result of increased investment in our sales staff and marketing programs. The
growth in other countries, $9,130 or 359%, reflects the growth in the Asia and
Central/South American markets. The growth in other countries was not only
attributable to increased investment in our sales staff and marketing programs,
but also to changes in regulations. In 2005, new regulations were enacted in
Hong Kong. Under the new regulation, each bank that offered internet banking
services was required to provide some form of two-factor authentication to its
customers.

     2004 Compared to 2003 - Overview and Geographic Breakdown

     Total revenues in 2004 increased $7,027 or 31% over 2003. The increase was
attributable to an increase in both the number of Digipass units sold and an
increase in the average sales price per unit. In 2004, we sold approximately
2,835 Digipass products, an increase of approximately 441 units, or 18%, over
the 2,394 Digipass products sold in 2003. The average price per unit in 2004 was
$10.54, which was 11% higher than the $9.53 average price per unit in 2003. The
increase in units is primarily attributable to our investment in sales and
marketing activities in 2004. The average sales price increased primarily as a
result of broadening our customer base. As a result of adding approximately
1,100 new customers in 2003 and 2004 combined, the average sales price increased
as our dependence on a few major customers decreased. The new customers added in
2004 were ordering smaller quantities at higher average prices as compared to
the existing major customers.


                                       25

<PAGE>

     REVENUES BY TARGET MARKET: Revenues are generated currently from two
primary markets, Banking and CNA through the use of both direct and indirect
sales channels. The breakdown of revenue between the two primary markets is as
follows:

<TABLE>
<CAPTION>
       YEAR         BANKING     CNA     TOTAL
       ----         -------   ------   -------
<S>                 <C>       <C>      <C>
Total Revenue:
   2005             $46,784   $7,795   $54,579
   2004              23,977    5,916    29,893
   2003              17,725    5,141    22,866

Percent of Total:
   2005                  86%      14%      100%
   2004                  80%      20%      100%
   2003                  78%      22%      100%
</TABLE>

     Revenues from the Banking market increased $22,807 or 95% in 2005 over 2004
and revenues from the CNA market increased $1,879 or 32% 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 45 at
the end of 2005 from 39 at the end of 2004. 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 generated by AOS in 2005
are included in the Banking market.

     Revenues from the Banking market increased $6,252 or 35% in 2004 over 2003
and revenues from the CNA market increased $775 or 15% 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.

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, 2005, 2004 and 2003.


                                       26

<PAGE>

<TABLE>
<CAPTION>
                                                   PERCENTAGE OF REVENUE
                                                  YEAR ENDED DECEMBER 31,
                                                 ------------------------
                                                  2005    2004   2003 (a)
                                                 -----   -----   --------
<S>                                              <C>     <C>     <C>
Revenues                                         100.0%  100.0%   100.0%
Cost of goods sold                                36.9    30.7     39.4
                                                 -----   -----    -----
Gross profit                                      63.1    69.3     60.6
Operating costs:
   Sales and marketing                            27.1    30.6     30.7
   Research and development                        6.6     8.2      8.5
   General and administrative                      8.3    10.7     14.1
   Restructuring expenses (recoveries)            (0.3)   (0.1)      --
   Amortization of purchased intangible assets     1.3     1.3      2.4
                                                 -----   -----    -----
                                                  43.0    50.7     55.7
                                                 -----   -----    -----
Operating income from continuing operations       20.1    18.6      4.9
Interest income (expense)                          0.1     0.4     (0.3)
Other income (expense), net                        0.9    (1.8)     0.5
                                                 -----   -----    -----
Income before income taxes                        21.1    17.2      5.1
Provision for income taxes                         7.0     6.3      1.8
                                                 -----   -----    -----
Net income from continuing operations             14.1    10.9      3.3
                                                 =====   =====    =====
</TABLE>

(a)  Excludes results of discontinued operations. See footnote 11 to the
     consolidated financial statements for more detailed information regarding
     discontinued operations.

GROSS PROFIT

     2005 Compared to 2004

     Consolidated gross profit for 2005 was $34,438, an increase of $13,729, or
66%, from the $20,709 reported for 2004. Gross profit as a percentage of revenue
was 63% in 2005, as compared to 69% in 2004. The decrease in the gross profit as
a percentage of revenue reflects the decline in average sales price per unit
related to the increase in the average size of orders received partially offset
by a decline in the average manufacturing cost of our product.

     The significant increase in the Digipass products sold in 2005 over 2004
reflected larger customer deployments in the Banking market, the results of
which were reflected in an increase in the average quantity ordered and a
decrease in the average sales price per unit. In 2005, the average quarterly
order size for the Banking market increased 98%, from approximately 11 units to
22 units per shipment, and the average selling price per unit decreased 25%,
from approximately $8.95 per unit to $6.70 per unit. We expect the Banking
market to continue large deployments to its consumer Internet banking customers
and, as a result, we expect that we will see additional pressure on the average
selling price in 2006. During 2005, we also saw an increase in the average order
size and a corresponding decrease in average selling price for customers in our
CNA segment. The average selling price per Digipass product declined
approximately 26% to $26.75 per unit in 2005 as compared to 2004.

     The average manufacturing cost per Digipass unit sold declined from
approximately $3.24 to $2.74, or 15%, in 2005 as compared to 2004. The decline
in the average cost per unit reflected a reduction in the manufacturing cost of
almost all units as well as a change in mix of specific products sold.

     Our purchases of inventory are denominated in U.S. dollars. Also, as
previously noted, the Company denominates a portion of its sales in Euros in an
effort to offset the effects of currency fluctuations on operating expenses. The
decrease in revenue resulting from changes in currency rates of $301, as noted
above, along with our cost of goods sold being denominated in U.S. dollars
resulted in a decrease in the gross profit rate of approximately 0.2 percentage
points.

     2004 Compared to 2003


                                       27

<PAGE>

     Consolidated gross profit for the year ended December 31, 2004 was $20,709,
an increase of $6,853, or 49%, from $13,856 reported 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 units to 11 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.

     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.

     Our purchases of inventory are denominated in U.S. dollars. Also, as
previously noted, we also 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 and represents an
improvement in the gross profit rate of approximately 1.2 percentage points.

SALES AND MARKETING EXPENSES

     2005 Compared to 2004

     Consolidated sales and marketing expenses for the year ended December 31,
2005 were $14,784, an increase of $5,624, or 61%, from the $9,160 reported for
2004. Expenses in 2005 included approximately $841 of expense related to AOS.
Excluding AOS, sales and marketing expenses increased approximately $4,783 or
52% from 2004.

     The increase was primarily due to an increase in average headcount and
related compensation expenses, an increase in marketing programs and materials,
an increase in travel, an increase in commissions paid to third-party agents and
redundancy costs associated with the termination of a small group of employees.
The average full-time sales, marketing and operations employee headcount
increased 42% to 71 in 2005 from 50 in 2004. At year-end 2005, the Company
employed 80 full-time sales, marketing and operations employees, reflecting its
increased investment in an effort to accelerate its sales growth.

     The change in currency rates in 2005 did not have a significant impact on
the comparison of sales and marketing expenses in 2005 to 2004.

     2004 Compared to 2003

     Consolidated sales and marketing expenses for the year ended December 31,
2004 were $9,160, an increase of $2,132, or 30%, from the 7,028 reported for
2003. The stronger Euro increased sales and marketing expense approximately $729
in 2004. Excluding the impact of changes in exchange rates, sales and marketing
expenses increased approximately $1,403 or 20% 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 we employed 61 full-time sales and marketing employees,
reflecting its increased investment in an effort to accelerate its sales growth.

RESEARCH AND DEVELOPMENT EXPENSES


                                       28

<PAGE>

     2005 Compared to 2004

     Consolidated research and development costs for the year ended December 31,
2005 were $3,579, an increase of $1,138, or 47%, from the $2,441 reported for
2004. Expenses in 2005 included approximately $802 of expense related to AOS.
Excluding AOS, research and development expenses increased approximately $336 or
14% from 2004.

     The increase primarily reflects higher compensation-related expense.
Average full-time research and development employee headcount in 2005 was 27
compared to 18 in 2004. The change in currency rates in 2005 did not have a
significant impact on the comparison of research and development expenses in
2005 to 2004.

     2004 Compared to 2003

     Consolidated research and development costs for the year ended December 31,
2004 were $2,441, an increase of $486, or 25%, from the $1,955 reported for
2003. The stronger Euro and Australia Dollar increased research and development
expenses approximately $255 in 2004. Excluding the impact of changes in exchange
rates, research and development expenses increased approximately $231 or 12%
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.

GENERAL AND ADMINISTRATIVE EXPENSES

     2005 Compared to 2004

     Consolidated general and administrative expenses for the year ended
December 31, 2005 were $4,556, an increase of $1,365 or 43%, from the $3,191
reported for 2004. Expenses in 2005 included approximately $269 of expense
related to AOS. Excluding AOS, general and administrative expenses increased
approximately $1,096 or 34% from 2004.

     The increase was primarily due to increased cost of professional services,
an increase in average headcount and related compensation expenses and an
increase in the provision for uncollectible accounts. The increase in
professional services was primarily related to the cost of performing
management's assessment of internal controls over financial reporting, the
increased cost of the integrated audit and legal services related to tax
planning initiatives. The average full-time general and administrative employee
headcount increased 27% to 14 in 2005 from 11 in 2004.

     The change in currency rates in 2005 did not have a significant impact on
the comparison of general and administrative expenses in 2005 to 2004.

     2004 Compared to 2003

     Consolidated general and administrative expenses for the year ended
December 31, 2004 were $3,191, a decrease of $20, or 1%, from the $3,211
reported for 2003. The stronger Euro increased general and administrative
expense approximately $123 in 2004. Excluding the impact of changes in exchange
rates, general and administrative expenses decreased approximately $143 or 4%
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
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.

RESTRUCTURING EXPENSES

     2005 Compared to 2004


                                       29

<PAGE>

     During the fourth quarter of 2002, we recorded restructuring charges of
$319 related to operations in France and excess space in our U.S. headquarters.
In 2005, we resolved all issues associated with the closure of the French
operation and reversed reserves that were no longer needed, some of which had
been recorded prior to the decision to close the operation, resulting in a gain
of $172.

     2004 Compared to 2003

     In 2004, we reversed $32 of the restructuring reserve that had been
established in prior years. The adjustment was a result of renegotiating the U.
S. headquarters lease in 2004.

AMORTIZATION EXPENSE

     2005 Compared to 2004

     Amortization expense for 2005 was $738, an increase of $341 or 86% over the
2004 amount. The increase was due to the amortization of a $367 intangible asset
for purchase orders acquired as part of the AOS-Hagenuk acquisition in February,
2005.

     2004 Compared to 2003

     Amortization expense for 2004 was $397, a decrease of $142 or 26% from the
2003 amount. This reduction reflects lower amortization of capitalized
technology, partly offset by the effect of exchange rates.

INTEREST INCOME (EXPENSE), NET

     2005 Compared to 2004

     Consolidated net interest income (expense) was income of $69 in 2005
compared to income of $120 in 2004. The reduction in income reflected the cost
of borrowings related to our foreign currency hedging program, lower interest
earned on the installment note it received as a result of its sale of the VACMAN
Enterprise business in 2003, partially offset by interest earned on an increase
in average net cash balances that resulted from our strong operating cash flow
throughout 2005. Average net cash balances were $9,200 in 2005, an increase of
$2,700 or 42% from $6,500 in 2004. Our bank borrowings are solely related to our
foreign currency hedging program. We invested its cash balances in short-term
money market instruments at nominal rates of interest.

     2004 Compared to 2003

     Consolidated net interest income (expense) was income of $120 in 2004
compared to expense of $80 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 in 2004, an increase of $4,450 or 217% from $2,050 in 2003.
Our term debt of $3,400 and accrued interest was repaid in full in the third
quarter of 2003. The term debt had an annual interest rate of 6%.

OTHER INCOME (EXPENSE)

     2005 Compared to 2004

     Other income (expense) in 2005 primarily included exchange gains (losses)
on transactions that are denominated in currencies other than the subsidiaries'
functional currency and subsidies received from foreign governments related to
increasing trade in other countries. The increase in other income (expense) of
$1,045 in 2005 over 2004 primarily reflects changes in exchange gains and
losses. We reported exchange gains of $330 in 2005 compared to exchange losses
of $538 in 2004. We implemented a hedging program in the second quarter of 2005
to minimize the impact of changes in currency rates.

     2004 Compared to 2003


                                       30

<PAGE>

     Other income (expense) in 2004 primarily included exchange gains (losses)
on transactions that are denominated in currencies other than the subsidiaries'
functional currency. The increase in other expense of $654 in 2004 over 2003
primarily reflects an increase in exchange losses of $684 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 shareholders' equity section of
the consolidated balance sheet.

INCOME TAXES

     2005 Compared to 2004

     Income tax expense for 2005 was $3,827 and compares to expense of $1,880 in
2004. The expense related primarily to our subsidiaries in Belgium, the
Netherlands and Singapore, whose tax loss carryforward was fully utilized in
2005. The effective tax rate in 2005 was 33.2%, a decrease of 3.4 percentage
points from 36.6% in 2004. The tax loss carryforward in Singapore utilized in
2005 reduced 2005 tax expense by approximately $180. The tax rate also reflected
an improvement in earnings in countries in which we continue to have a tax loss
carryforward.

     2004 Compared to 2003

     Income tax expense for 2004 was $1,880 and compares to expense of $397 in
2003. The expense related 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% in 2003. The
Belgian tax loss carryforward utilized in 2003 reduced 2003 tax expense by
approximately $739.

     Loss Carryforwards Available

     At December 31, 2005, the Company has U. S. net operating loss
carryforwards of $25,810 and foreign net operating loss carryforwards of $4,595.
Such losses are available to offset future taxable income in the respective
jurisdictions. The U. S. loss carryforwards expire in varying amounts beginning
in 2012 and continuing through 2018. The foreign loss carryforwards have no
expiration dates. 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.

LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 2005, the Company had net cash balances (total cash, cash
equivalents and restricted cash less bank borrowings), totaling $13,970 and no
outstanding term debt. Cash generated from operating activities was $7,542
during the year ended December 31, 2005. During 2005, we used $4,456 for
investing activities, primarily related to the acquisition of AOS-Hagenuk, and
generated $6,614 in financing activities, primarily consisting of an increase in
bank borrowing and proceeds from the exercise of stock options. Capital
expenditures were $507 for the year ended December 31, 2005.

     Cash generated from operating activities was $2,877 during the year ended
December 31, 2004. During 2004, we used $94 in investing activities and
generated $54 in financing activities consisting of a proceeds from the exercise
of stock options and warrants partially offset by dividends paid on our
preferred stock. Capital expenditures were $252 for the year ended December 31,
2004.

     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 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


                                       31

<PAGE>

$4,000 in cash and 2,000,000 shares of Common Stock. Under the terms of the
Purchase Agreement, the Company paid $3,000 to Ubizen and issued 2,000,000
shares of Common Stock on July 25, 2003. An additional $1,000 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. 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 carried a 5% dividend and was convertible
into 4,000,000 shares of Common Stock at a fixed price of $2.00 per share. The
net proceeds from the sale totaled $7,260 of which $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 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 dividend and was recorded to accumulated deficit.

     On February 4, 2005, the Company acquired all of the share capital of
A.O.S. Hagenuk B.V. ("AOS") 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 was held in escrow for the benefit of
the seller for a period of twelve (12) months. 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 is a wholly owned subsidiary of the Company.

     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.

     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
either 3,500 Euros or U.S. dollars. 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, 2005, 327 Euros or U.S.
dollars were available under the overdraft agreement as there were borrowings or
$3,173 outstanding under the agreement as part of our currency hedging program.
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 2005 activity resulted in an increase in net cash of
$5,750 and a net cash balance of $13,970 at December 31, 2005, compared to
$8,220 at the end of 2004. Our working capital at December 31, 2005 was $16,325,
an increase of $6,330 from $9,995 at December 31, 2004. The change is primarily
attributable to the generation of positive cash flow from operations in 2005.
Our current ratio was 2.03 to 1.0 at December 31, 2005. 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 2006, will be sufficient to meet our anticipated
cash needs for the next twelve months.

     The net effect of 2004 activity resulted in an increase in cash of $3,403
and a total cash balance of $8,220 at December 31, 2004, compared to $4,817, at
the end of 2003. Our working capital at December 31, 2004 was $9,995, an
increase of $4,777 from $5,218 at December 31, 2003. The change is primarily
attributable to the generation of positive cash flow from operations in 2004.
Our current ratio was 2.41 to 1.0 at December 31, 2004.

     We believe that our financial resources and current borrowing arrangements
are adequate to meet our operating needs. There is risk, however, that our
revenue and cash receipts will not be sufficient to meet the


                                       32
<PAGE>

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.

CONTRACTUAL OBLIGATIONS

     The Company has the following contractual obligations:

<TABLE>
<CAPTION>
                                                Payments Due by Period
                                   ------------------------------------------------
                                            Less than     1-3      3-5    More than
                                    Total     1 year     years    years    5 years
                                   ------   ---------   ------   ------   ---------
<S>                                <C>      <C>         <C>      <C>      <C>
Operating lease obligations        $4,580     $1,048    $1,825   $1,302      $405
Purchase obligations                1,160      1,160        --       --        --
Deferred warranty                     338         83       250        5        --
                                   ------     ------    ------   ------      ----
   Total contractual obligations   $6,078     $2,291    $2,075   $1,307      $405
                                   ======     ======    ======   ======      ====
</TABLE>

     "Management's Discussion and Analysis of Financial Condition and Results of
Operations" discusses our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the U.
S. 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.

Revenue Recognition

     We recognize revenue in accordance with AICPA Statement of Position ("SOP")
97-2 and SEC Staff Accounting Bulletin ("SAB") 104. Revenue is recognized when
there is persuasive evidence that an arrangement exists, delivery has occurred,
the fee is fixed or determinable and collection of the revenue is probable.

     Hardware Revenue and License Fees: Revenues from the sale of computer
security hardware or the license of software are recorded upon shipment or, if
an acceptance period is allowed, at the later of shipment or customer
acceptance. No significant obligations or contingencies exist with regard to
delivery, customer acceptance or rights of return at the time revenue is
recognized.

     Support Agreements: Support agreements generally call for us to provide
technical support and software updates to customers. Revenue on technical
support and software update rights is deferred and recognized ratably over the
term of the support agreement.

     Consulting and Education Services: We provide consulting and education
services to our customers. Revenue from such services is recognized during the
period in which the services are performed.


                                       33

<PAGE>

     Multiple-Element Arrangements: We allocate revenues to the various elements
of the arrangements based on the estimated fair value of each deliverable as
required by SOP 97-2 and Emerging Issues Task Force ("EITF") Issue No. 00-21.
The fair value for each element is based on the price charged when that element
is sold separately, price lists, renewal rates and other methods. When discounts
are given in a multiple-element arrangement, a proportionate amount of the
discount is applied to each element based on each element's fair value without
regard to the discount. The estimated fair value of undelivered elements is
deferred and recorded as revenue when services are performed or products are
delivered.

     Sales to distributors and resellers are recognized on the same basis as
sales made directly to customers. Revenue is recognized when there is persuasive
evidence that an arrangement exists, delivery has occurred, the fee is fixed or
determinable and collection of the revenue is probable.

     For large-volume transactions, we may negotiate a specific price that is
based on the number of users of the software license or quantities of hardware
supplied. The per unit prices for large-volume transactions are generally lower
than transactions for smaller quantities and the price differences are commonly
referred to as volume-purchase discounts.

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. The allowance is based on a specific review of
all significant past-due 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 based on a detailed valuation analysis. On an ongoing basis, we
review information made available by SSI through its filings with the SEC and
its press releases and consider it within the context of the assumptions made in
the valuation analysis. 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 us to reduce
the value of our investment in SSI.

     The investment in SSI as of December 31, 2005 was $820, consisting of $220
remaining on the note receivable and $600 for the preferred shares, common
shares and dividend receivable. SSI has made its note payment in January 2006,
but has not made its note payments in February or March 2006. We have granted
SSI a 90-day extension on the note in order to facilitate their planned capital
raise. On February 28, 2006, SSI filed a Form 8-K report announcing a new
financing arrangement, initially for $2,500, with a potential additional $2,500.
If SSI is unsuccessful in executing their business plan, the remaining amount of
our investment is at risk. We hold a security interest in the software sold to
SSI under the terms of the installment note.

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


                                       34

<PAGE>

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. We assess 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 our software products, or both may be
reduced significantly.

     The total amount of goodwill and other intangible assets as of December 31,
2005 was $7,719 and the full amount is at risk of impairment. See footnotes 1
and 2 to the consolidated 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. We have no idle facility expense or wasted
material charges. This statement is effective for our 2006 fiscal year. SFAS No.
151 will not have a significant impact on 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 our 2006 fiscal year. Adoption of this
statement is not expected to have a material impact on our results of operations
or financial position.

     In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment,
("SFAS 123R"). This statement is a revision of SFAS 123 and supersedes APB
Opinion no. 25, Accounting for Stock Issued to Employees. SFAS 123R requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the financial statements based on their fair value. The SEC
issued guidance on April 14, 2005 announcing that public companies will now be
required to adopt SFAS 123R by their first fiscal year beginning after June 15,
2005. Accordingly, we will adopt SFAS 123R in our first quarter of fiscal year
2006. We are currently evaluating the provisions of this statement to determine
the impact on our consolidated financial statements. It is, however, expected to
have a negative effect on consolidated net income, comparable to the pro forma
amounts for prior years shown in footnote 1.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

                                 (IN THOUSANDS)


                                       35

<PAGE>

     Foreign Currency Exchange Risk - In 2005, approximately 93% of our business
was conducted outside the United States, primarily 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.

     Interest Rate Risk - We have minimal interest rate risk. Our outstanding
debt at December 31, 2005 was $3,173 and was at fixed interest rates 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 $170 annually.

     Impairment Risk - At December 31, 2005, we had goodwill of $6,665 and other
intangible assets of $1,054 related mostly to the acquisition of AOS in 2005 and
to technology purchased in 2001 as part of our acquisition of Identikey. We will
assess the net realizable value of the goodwill and other 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, 2005, 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-22 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 Annual Report on Form 10-K, and in other reports required to be filed
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission for such
filings. As required by Rule 13a-15(b) under the Exchange Act, 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. Based on that review and
evaluation, the Chief Executive Officer and Chief Financial Officer, along with
the management of the Company, have determined that the disclosure controls and
procedures were and are effective as designed to ensure that information
relating to the Company and its consolidated subsidiaries would be accumulated
and communicated to them, as appropriate, to allow timely disclosures regarding
required disclosures.

CHANGES IN INTERNAL CONTROLS

     There were no significant changes in the Company's internal controls during
the year ended December 31, 2005.


                                       36

<PAGE>

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

     The management of VASCO Data Security International, Inc. is responsible
for establishing and maintaining adequate internal control over financial
reporting. Our internal control system was designed to provide reasonable
assurance to the company's management and board of directors regarding the
preparation and fair presentation of published financial statements. Internal
control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f)
promulgated under the Securities Exchange Act of 1934 as a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers and effected by the company's board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:

     -    Pertain to the maintenance of records that in reasonable detail
          accurately and fairly reflect the transactions and dispositions of the
          assets of the company;

     -    Provide reasonable assurance that transactions are recorded as
          necessary to permit preparation of financial statements in accordance
          with generally accepted accounting principles, and that receipts and
          expenditures of the company are being made only in accordance with
          authorizations of management and directors of the company; and

     -    Provide reasonable assurance regarding prevention or timely detection
          of unauthorized acquisition, use or disposition of the company's
          assets that could have a material effect on the financial statements.

     Our management, including our Chief Executive Officer and Chief Financial
Officer, do not expect that our disclosure controls and procedures or internal
control over financial reporting will prevent all error and all fraud. A control
system, no matter how well designed and implemented, can provide only
reasonable, not absolute, assurance that the control system's objectives will be
met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues within a company are detected. The inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple errors or mistakes. Controls can also be
circumvented by the individual acts of some persons, by collusion of two or more
people or by management override of the controls. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and may not be detected.

     Our management assessed the effectiveness of its internal control over
financial reporting as of December 31, 2005. In making this assessment, it used
the criteria based on the framework set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in "Internal Controls - Integrated
Framework" (COSO). Based on our assessments we believe that, as of December 31,
2005, our internal control over financial reporting is effective based on those
criteria.

     Our independent registered public accounting firm, KPMG LLP, has issued an
audit report on our assessment of our internal control over financial reporting.
Their report on management's assessment and their opinion on the effectiveness
of the Company's internal control over financial reporting appear below.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
VASCO Data Security International, Inc.:

We have audited management's assessment, presented in Management's Annual Report
on Internal Control over Financial Reporting, that VASCO Data Security
International, Inc. maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). VASCO Data
Security International, Inc.'s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.


                                       37

<PAGE>

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.

In our opinion, management's assessment that VASCO Data Security International,
Inc. maintained effective internal control over financial reporting as of
December 31, 2005, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, VASCO Data Security International, Inc.
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
VASCO Data Security International, Inc. and subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of operations, comprehensive
income, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 2005, and our report dated March 15, 2006
expressed an unqualified opinion on those consolidated financial statements.


(signed) KPMG LLP

Chicago, Illinois
March 15, 2006

ITEM 9B - OTHER INFORMATION

     None.


                                       38

<PAGE>

                                    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 62 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
56 years old.

     JOHN N. FOX, JR. -- Mr. Fox has been a director since April 2005 and
currently serves a one-year term. He is a member of our Audit Committee and our
Compensation Committee and our Governance and Nominating Committee. From 1998 to
2003, Mr. Fox served as a Vice Chairman of Deloitte & Touche and the Global
Director, Strategic Clients for Deloitte Consulting. He held various other
positions with Deloitte Consulting from 1968 to 2003, and served on the board of
Deloitte Touche Tohmatsu from 1998 to 2003. Mr. Fox currently serves on a
variety of non-profit boards of directors. Mr. Fox received his B.A. degree from
Wabash College and his MBA from the University of Michigan. Mr. Fox is 63 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 66 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 59 years old.


                                       39

<PAGE>

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.

     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 54 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, we believe that for the year
period ended December 31, 2005, 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.

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, 2005, 2004 and 2003 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").


                                       40
<PAGE>

<TABLE>
<CAPTION>
                                                                             LONG-TERM COMPENSATION
                                                ANNUAL COMPENSATION                  AWARDS
                                         --------------------------------   -----------------------
                                                                 OTHER      RESTRICTED   SECURITIES   PAYOUTS
                                                                ANNUAL         STOCK     UNDERLYING     LTIP      ALL OTHER
                                          SALARY    BONUS    COMPENSATION    AWARD(S)      OPTIONS    PAYOUTS   COMPENSATION
NAME AND PRINCIPAL POSITION       YEAR     ($)       ($)          ($)         ($)(1)      /SARS(#)      ($)          ($)
---------------------------       ----   -------   -------   ------------   ----------   ----------   -------   ------------
<S>                               <C>    <C>        <C>      <C>            <C>          <C>          <C>       <C>
T. KENDALL HUNT                   2005   260,000    90,000           --           --            --       --          --
Chairman and Chief Executive      2004   225,000    90,000           --           --       125,000       --          --
Officer                           2003   173,750        --           --           --       125,000       --          --

JAN VALCKE (2)                    2005   321,547   111,305      625,895       97,500       100,000       --          --
President and Chief Operating     2004   321,256    59,310           --           --       100,000       --          --
Officer                           2003   277,991        --           --           --       100,000       --          --

CLIFFORD K. BOWN                  2005   200,000    60,000           --       63,800        50,000       --          --
Executive Vice President, Chief   2004   175,000    60,000           --           --        50,000       --          --
Financial Officer and Secretary   2003   150,000        --           --                     75,000       --          --
</TABLE>

(1)  Reflects the value of restricted stock granted on January 14, 2005. The
     restricted stock vests 25% per year on the award anniversary date over a
     four year period

(2)  Mr. Valcke's salary and bonus for 2005 and 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 is the
     value realized from the exercise of stock options in 2005.

                      OPTION/SAR GRANTS IN LAST FISCAL YEAR

     The following table sets forth all options granted to the Named Executive
Officers during 2005.

<TABLE>
<CAPTION>
                                     INDIVIDUAL GRANTS
                   ----------------------------------------------------    POTENTIAL REALIZABLE
                    NUMBER OF        PERCENT                                 VALUE AT ASSUMED
                    SECURITIES       OF TOTAL                             ANNUAL RATES OF STOCK
                    UNDERLYING    OPTIONS/ SARS   EXERCISE                  PRICE APPRECIATION
                     OPTIONS/       GRANTED TO     OF BASE                 FOR OPTION TERM (2)
                   SARS GRANTED    EMPLOYEES IN     PRICE    EXPIRATION   ---------------------
NAME                    (1)        FISCAL YEAR     ($/SH)       DATE         5% ($)   10% ($)
----               ------------   -------------   --------   ----------   ---------   ---------
<S>                <C>            <C>             <C>        <C>          <C>         <C>
T. Kendall Hunt            --           --            --            --          --          --
Jan Valcke            100,000         29.6%         6.38       1/14/12     260,000     605,000
Clifford K. Bown       50,000         14.8%         6.38       1/14/12     130,000     303,000
</TABLE>

(1)  Vesting schedule is based on a time period of 48 months, with 1/48th of the
     options vesting monthly.

(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.


                                       41

<PAGE>

              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, 2005
of exercised and unexercised stock options held by the named executive officers.

<TABLE>
<CAPTION>
                                                 NO. OF SECURITIES
                                               UNDERLYING UNEXERCISED         VALUE OF UNEXERCISED
                    NO. SHARES                      OPTIONS/SARS           IN-THE-MONEY OPTIONS/SARS
                   ACQUIRED ON     VALUE         AT FISCAL YEAR END        AT FISCAL YEAR-END ($)(1)
                     EXERCISE    REALIZED   ---------------------------   ---------------------------
NAME                   (#)          ($)     EXERCISABLE   UNEXERCISABLE   EXERCISABLE   UNEXERCISABLE
----               -----------   --------   -----------   -------------   -----------   -------------
<S>                <C>           <C>        <C>           <C>             <C>           <C>
T. Kendall Hunt           --           --     596,388         48,612       4,345,939       362,611
Jan Valcke           100,000      625,895     317,776        115,972       2,444,442       558,333
Clifford K. Bown          --           --     191,318         58,682       1,586,816       285,434
</TABLE>

(1)  Market value of underlying securities is based on the closing price of the
     Common Stock as reported on the Nasdaq SmallCap Market on December 31, 2005
     ($9.86) minus the exercise price.

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 2005 were: Michael A. Mulshine,
Michael P. Cullinane, John R. Walter and John N. Fox, Jr.

     Each of our directors received a quarterly cash payment of $5,000 in
connection with his service on the Board of Directors in 2005. 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 2005, options to
purchase 20,000 shares of our Common Stock were issued to each of Messrs.
Cullinane, Mulshine, and Walter, at a per share exercise price of $6.38. Options
to purchase 15,000 shares of our Common Stock were issued to Mr. Fox at a per
share exercise price of $6.47. In January, 2006, each non-employee director was
awarded 6,500 shares of restricted stock. Such shares vest fully in one year.

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 2005, Mr. Hunt
received a base salary of $260,000, and earned a $90,000 bonus to be paid in
2006. 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 2006 annual base
salary is $270,000 with a target bonus, if specific objectives are met, of
$175,000. In January, 2006, Mr. Hunt was awarded 35,000 restricted shares, which
vest fully in one year.

     Mr. Valcke's salary and bonus are determined pursuant to an Independent
Contractor Employment Agreement (the "Agreement") dated June 29, 2005. 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 2005, Mr. Valcke received 260,000 Euros, $321,547 using the average
exchange rate for 2005, in base compensation, 100,000


                                       42
<PAGE>

stock options, 15,000 shares of restricted stock and earned a bonus of 90,000
Euros to be paid in 2006. In the event Mr. Valcke 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. Valcke will continue to receive his base pay and any applicable
Incentive Compensation over a 24-month period. In the event of such termination,
Mr. Valcke has agreed to abide by several non-compete restrictions. Mr. Valcke's
2006 base compensation is 270,000 Euros with a target bonus, if specific
objectives are met of 175,000 Euros. In January, 2006, Mr. Valcke was awarded
35,000 restricted shares, which vest fully in one year.

     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 2005, Mr. Bown
received a base salary of $205,000, 50,000 stock options, 10,000 shares of
restricted stock and earned a $60,000 bonus to be paid in 2006. 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 2006 annual base salary is $220,000 with a target
bonus, if specific objectives are met of $120,000. In January, 2006, Mr. Bown
was awarded 20,000 restricted shares, which vest fully in one year.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

     The current members of our Compensation Committee are Messrs. Mulshine,
Cullinane, Fox and Walter. None of these individuals were at any time during
fiscal year 2005 an officer or employee of ours. In addition, none or our
executive officers serves as a member of the board of directors or compensation
committee of any entity that has one or more executive officers serving as a
member of our Board or Compensation Committee.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

     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:

<TABLE>
<CAPTION>
                                                                        NUMBER OF SECURITIES
                                                                      REMAINING AVAILABLE FOR
                          NUMBER OF SECURITIES     WEIGHTED-AVERAGE    FUTURE ISSUANCE UNDER
                           TO BE ISSUED UPON      EXERCISE PRICE OF     EQUITY COMPENSATION
                        EXERCISE OF OUTSTANDING      OUTSTANDING          PLANS (EXCLUDING
                         OPTIONS, WARRANTS AND    OPTIONS, WARRANTS   SECURITIES REFLECTED IN
PLAN CATEGORY                    RIGHTS               AND RIGHTS            COLUMN (A))
-------------           -----------------------   -----------------   -----------------------
                                   (a)                   (b)                    (c)
<S>                     <C>                       <C>                 <C>
Equity compensation
   plans approved by
   security holders            2,217,847                $3.27                5,018,238

Equity compensation
   plans not approved
   by security holders            none              not applicable         not applicable
</TABLE>

     The following table sets forth certain information with respect to the
beneficial ownership of our Common Stock as of February 28, 2006 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.


                                       43

<PAGE>

<TABLE>
<CAPTION>
                                       AMOUNT AND
                                        NATURE OF
                                       BENEFICIAL
NAME AND ADDRESS OF BENEFICIAL OWNER    OWNERSHIP     PERCENT OF CLASS
------------------------------------   ----------     ----------------
<S>                                    <C>            <C>
T. Kendall Hunt                        10,538,224(1)       28.63%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

Oberweis Asset Management, Inc.         2,171,410           6.00%
333 Warrenville Road, Suite 500
Lisle, IL 60532

Arbor Capital Management, LLC           1,819,600           5.03%
One Financial Plaza
120 South Sixth Street, Suite 210
Minneapolis, MN 55402
</TABLE>

(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. The amount also includes 613,749 shares that may be
     acquired pursuant to options which are exercisable at February 28, 2006 or
     become exercisable within 60 days.

     The table below sets forth certain information with respect to the
beneficial ownership of our Common Stock as of February 28, 2006 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.

<TABLE>
<CAPTION>
                                         AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL OWNER   BENEFICIAL OWNERSHIP (1)   PERCENT OF CLASS
------------------------------------   ------------------------   ----------------
<S>                                    <C>                        <C>
T. Kendall Hunt                              10,538,224(2)             28.63%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

Jan Valcke                                      393,999(3)              1.08%
Koningin Astridlaan 164
B-1780 Wemmel, Belgium

Cliff Bown                                      248,124(4)              0.68%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

Michael P. Cullinane                            111,000(5)              0.31%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

Michael A. Mulshine                              91,000(6)              0.25%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

John R. Walter                                   79,000(7)              0.22%
1901 S. Meyers Road
</TABLE>


                                       44

<PAGE>

<TABLE>
<S>                                    <C>                        <C>
Ste. 210
Oakbrook Terrace, IL 60181

John N. Fox                                      17,000(8)              0.05%
1901 S. Meyers Road
Ste. 210
Oakbrook Terrace, IL 60181

All Executive Officers and Directors         11,478,347                30.53%
as a Group (7 persons)
</TABLE>

(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 February 28, 2006 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. The amount also includes 613,749 shares that may be
     acquired pursuant to options which are exercisable at February 28, 2006 or
     become exercisable within 60 days.

(3)  Includes 339,999 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

(4)  Includes 203,124 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

(5)  Includes 104,500 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

(6)  Includes 84,500 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

(7)  Includes 52,500 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

(8)  Includes 7,500 shares that may be acquired pursuant to options which are
     exercisable at February 28, 2006 or become exercisable within 60 days.

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 seven
directors currently 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 2,000,000 shares 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. We valued the
transaction at approximately $1.6 million, using a discounted value of the
payment streams expected from the note and preferred stock. SSI has since merged
with a public company and its common stock is traded on the OTC Bulletin Board.

     SSI has made all of its note payments through January 2006, but has not
made its note payments in February or March 2006. We have granted SSI a 90-day
extension on the note in order to facilitate their planned capital raise. On
February 28, 2006, SSI filed a Form 8-K report announcing a new financing
arrangement for an


                                       45
<PAGE>

initial $2.5 million, with a potential additional $2.5 million. If SSI is
unsuccessful in executing their business plan, the remaining amount of our
investment is at risk. We hold a security interest in the software sold to SSI
under the terms of the installment note.

     As of February 28, 2006, Mr. Hunt had a beneficial ownership share of 8% in
SSI. VASCO does not use the equity method to account for its investment in SSI
because we believe that he does not have "significant influence" over the
operating and finance policies of SSI. Accounting Principles Board Opinion 18
established 20% ownership as a benchmark indicator of significant influence.
Emerging Issues Task Force (EITF) Issue 02-14 "Whether an Investor Should Apply
the Equity Method of Accounting to Investments Other Than Common Stock"
describes situations where side agreements or ownership of instruments other
than common stock can indicate the existence of significant influence. No such
side agreements exist and VASCO's investment in convertible preferred shares
does not create significant influence.

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 2005 and 2004 (in
thousands):

     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 $367 for fiscal year ended 2005, and
$251 for the fiscal year ended December 31, 2004.

     AUDIT-RELATED FEES: There were no audit-related fees paid in 2005 or 2004.

     TAX FEES: The aggregate fees billed by KPMG LLP for tax compliance and tax
advice were $2 in 2005 and $39 in 2004. The fees for 2005 and 2004 primarily
related to the filing of the Company's tax returns.

     ALL OTHER FEES: Fees for due diligence and reviews of registrations related
to the acquisition of AOS Hagenuk aggregated $55 in 2005. There were no such
fees in 2004.

     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 2005 and 2004.

                                     PART IV

ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(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, 2005 and 2004

     Consolidated Statements of Operations for the Years Ended December 31,
     2005, 2004 and 2003

     Consolidated Statements of Comprehensive Income (Loss) for the Years Ended
     December 31, 2005, 2004 and 2003

     Consolidated Statements of Stockholders' Equity for the Years Ended
     December 31, 2005, 2004 and 2003

     Consolidated Statements of Cash Flows for the Years Ended December 31,
     2005, 2004 and 2003


                                       46

<PAGE>

     Notes to Consolidated Financial Statements

(2)  The following consolidated financial statement schedule of the Company is
     included in this Form 10-K:

     -    Schedule II - Valuation and Qualifying Accounts

     All other financial statement schedules are omitted because such schedules
     are not required or the information required has been presented in the
     aforementioned consolidated financial statements.

(3)  The following exhibits are filed with this Form 10-K or incorporated by
     reference as set forth at the end of the list of exhibits:

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                 DESCRIPTION
 -------                                -----------
<S>        <C>
    +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.
</TABLE>


                                       47

<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                 DESCRIPTION
 -------                                -----------
<S>        <C>
   +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).
</TABLE>


                                       48

<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                 DESCRIPTION
 -------                                -----------
<S>        <C>
  +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.
</TABLE>


                                       49

<PAGE>

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                 DESCRIPTION
 -------                                -----------
<S>        <C>
   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.

   10.55   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
           (Incorporated by reference - Form 8-K filed February 8,2005.

   10.56   Registration Rights Agreement by and among A.O.S. Holding B.V.,
           Filipan Beheer B.V., Mr. Mladen Filipan, Pijnenburg Beheer N.V. and
           VASCO Data Security International, Inc., dated February 4, 2005
           (Incorporated by reference - Form 8-K filed February 8,2005.

   10.57   Employment Agreement by and between VASCO Data Security
           International, Inc. and Jan Valcke effective as of January 1, 2005
           (Incorporated by reference - Form 8-K filed July 1, 2005.

      21   Subsidiaries of Registrant. (Incorporated by reference - Form S-1
           filed February 27, 2006.)

      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 15, 2006.

    31.2   Statement Under Oath of Principal Financial Officer pursuant to
           Section 302 of the Sarbanes-Oxley Act of 2002, dated March 15, 2006.

    32.1   Statement Under Oath of Principal Executive Officer pursuant to
           Section 906 of the Sarbanes-Oxley Act of 2002, dated March 15, 2006.

    32.2   Statement Under Oath of Principal Financial Officer pursuant to
           Section 906 of the Sarbanes-Oxley Act of 2002, dated March 15, 2006.
</TABLE>

----------
+    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.


                                       50

<PAGE>


(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.


                                       51
<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULE

<TABLE>
<S>                                                                          <C>
FINANCIAL STATEMENTS
   Report of Independent Registered Public Accounting Firm                   F-2
   Consolidated Balance Sheets as of December 31, 2005 and 2004              F-3
   Consolidated Statements of Operations for the Years Ended
      December 31, 2005, 2004 and 2003                                       F-4
   Consolidated Statements of Comprehensive Income (Loss) for the Years
      Ended December 31, 2005, 2004 and 2003                                 F-5
   Consolidated Statements of Stockholders' Equity for the Years Ended
      December 31, 2005, 2004 and 2003                                       F-6
   Consolidated Statements of Cash Flows for the Years Ended
      December 31, 2005, 2004 and 2003                                       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-23
</TABLE>

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

<PAGE>
             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 as of December 31, 2005 and 2004,
and the related consolidated statements of operations, comprehensive income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2005. 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 Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of VASCO Data Security
International, Inc. and subsidiaries as of December 31, 2005 and 2004, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2005, 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.

We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of VASCO Data
Security International, Inc.'s internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 15, 2006 expressed an unqualified
opinion on management's assessment of, and the effective operation of, internal
control over financial reporting.


(signed) KPMG LLP
Chicago, Illinois
March 15, 2006

                                      F-2
<PAGE>
                     VASCO DATA SECURITY INTERNATIONAL, INC.
                           CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                   DECEMBER 31,   DECEMBER 31,
                                                                                       2005           2004
                                                                                   ------------   ------------
<S>                                                                                <C>            <C>
ASSETS
   CURRENT ASSETS:
      Cash and equivalents                                                           $ 16,962       $  8,138
      Restricted cash                                                                     181             82
      Accounts receivable, net of allowance for doubtful accounts of $156
         and $160 in 2005 and 2004, respectively                                       12,083          5,965
      Inventories, net                                                                  1,570          1,346
      Prepaid expenses                                                                    726            791
      Deferred income taxes                                                               117             23
      Foreign sales tax receivable                                                         89            313
      Other current assets                                                                451            404
                                                                                     --------       --------
          Total current assets                                                         32,179         17,062

   Property and equipment:
      Furniture and fixtures                                                            1,893          1,683
      Office equipment                                                                  2,155          2,008
                                                                                     --------       --------
                                                                                        4,048          3,691
      Accumulated depreciation                                                         (3,066)        (2,853)
                                                                                     --------       --------
         Property and equipment, net                                                      982            838

   Intangible assets, net of accumulated amortization of $5,219
      and $4,479 in 2005 and 2004, respectively                                         1,054          1,243
   Goodwill, net of accumulated amortization of $973 in 2005 and 2004                   6,665            250
   Note receivable and investment in SSI                                                  600            820
   Other assets                                                                            25             37
                                                                                     --------       --------
         TOTAL ASSETS                                                                $ 41,505       $ 20,250
                                                                                     ========       ========

LIABILITIES AND STOCKHOLDERS' EQUITY
   CURRENT LIABILITIES:
      Bank borrowing                                                                 $  3,173       $     --
      Accounts payable                                                                  4,753          3,065
      Deferred revenue                                                                  1,765            620
      Accrued wages and payroll taxes                                                   2,329          1,887
      Income taxes payable                                                              1,547            435
      Other accrued expenses                                                            2,287          1,060
                                                                                     --------       --------
         Total current liabilities                                                     15,854          7,067
      Deferred warranty revenues                                                          256            152

      STOCKHOLDERS' EQUITY :
         Series D 5% cumulative convertible voting preferred stock, $10,000 par
            value - 500,000 shares authorized - no shares and 208 shares issued
            and outstanding at December 31, 2005 and 2004, respectively                    --          1,504
         Common stock, $.001 par value - 75,000,000 shares authorized;
            36,180,425 shares issued and outstanding in 2005,
            33,581,689 shares issued and outstanding in 2004                               36             34
         Additional paid-in capital                                                    59,625         51,825
         Deferred compensation                                                           (403)            --
         Accumulated deficit                                                          (32,985)       (40,672)
         Accumulated other comprehensive income (loss) -
            Cumulative translation adjustment                                            (878)           340
                                                                                     --------       --------
            Total stockholders' equity                                                 25,395         13,031
                                                                                     --------       --------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                               $ 41,505       $ 20,250
                                                                                     ========       ========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       F-3

<PAGE>

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                         For the Years Ended December 31,
                                                         --------------------------------
                                                              2005      2004      2003
                                                            -------   -------   -------
<S>                                                      <C>          <C>       <C>
Net revenues                                                $54,579   $29,893   $22,866
Cost of goods sold                                           20,141     9,184     9,010
                                                            -------   -------   -------
Gross profit                                                 34,438    20,709    13,856
                                                            -------   -------   -------
Operating costs:
   Sales and marketing                                       14,784     9,160     7,028
   Research and development                                   3,579     2,441     1,955
   General and administrative                                 4,556     3,191     3,211
   Restructuring expenses (recoveries)                         (172)      (32)       --
   Amortization of purchased intangible assets                  738       397       539
                                                            -------   -------   -------
      Total operating costs                                  23,485    15,157    12,733
                                                            -------   -------   -------
 Operating income from continuing operations                 10,953     5,552     1,123
 Interest income (expense), net                                  69       120       (80)
 Other income (expense), net                                    506      (539)      115
                                                            -------   -------   -------
 Income before income taxes                                  11,528     5,133     1,158
 Provision for income taxes                                   3,827     1,880       397
                                                            -------   -------   -------
   Net income from continuing operations                      7,701     3,253       761

 Discontinued operations:
   Income from discontinued operations, net of tax               --        --       638
   Gain on sale of discontinued operations, net of tax           --        --     1,357
                                                            -------   -------   -------
      Net income                                              7,701     3,253     2,756

 Preferred stock beneficial conversion option                    --        --    (3,720)
 Preferred stock accretion and dividends                        (14)     (232)     (751)
                                                            -------   -------   -------
 Net income (loss) available to common shareholders         $ 7,687   $ 3,021   $(1,715)
                                                            =======   =======   =======

 Basic net income (loss) per common share:
   Income (loss) from continuing operations                 $  0.22   $  0.09   $ (0.13)
   Income from discontinued operations                           --        --      0.07
                                                            -------   -------   -------
      Net income (loss)                                     $  0.22   $  0.09   $ (0.06)
                                                            =======   =======   =======
 Diluted net income (loss) per common share:
   Income (loss) from continuing operations                 $  0.21   $  0.09   $ (0.13)
   Income from discontinued operations                           --        --      0.07
                                                            -------   -------   -------
      Net income (loss)                                     $  0.21   $  0.09   $ (0.06)
                                                            =======   =======   =======
Weighted average common shares outstanding:
   Basic                                                     35,429    32,216    29,270
                                                            =======   =======   =======
   Dilutive                                                  37,244    33,128    29,270
                                                            =======   =======   =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       F-4

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                       For the Years Ended December 31,
                                       --------------------------------
                                             2005     2004     2003
                                           -------   ------   ------
<S>                                    <C>           <C>      <C>
Net income                                 $ 7,701   $3,253   $2,756
Other comprehensive income (loss) -
   Cumulative translation adjustment        (1,218)     687      133
                                           -------   ------   ------
Comprehensive income                       $ 6,483   $3,940   $2,889
                                           =======   ======   ======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       F-5
<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
                        (IN THOUSANDS EXCEPT SHARE DATA )

<TABLE>
<CAPTION>
                                                                                                              Accumulated    Total
                                    Preferred Stock      Common Stock     Additional  Deferred                 Other Com-    Stock-
                                   -----------------  ------------------    Paid-In    Compen-  Accumulated    prehensive   holders'
               Description          Shares    Amount    Shares    Amount    Capital    sation     Deficit    Income (Loss)   Equity
               -----------         --------  -------  ----------  ------  ----------  --------  -----------  -------------  -------
<S>                                <C>       <C>      <C>         <C>     <C>         <C>       <C>          <C>            <C>
BALANCE AT DECEMBER 31, 2002        150,000  $ 9,108  28,389,484    $28    $36,763     $  --     $(42,608)      $  (480)    $ 2,811
                                   ========  =======  ==========    ===    =======     =====     ========       =======     =======
Net income                               --       --          --     --         --        --        2,756            --       2,756
Foreign currency translation
   adjustment                            --       --          --     --         --        --           --           133         133
Exercise of stock options                --       --      35,800     --         63        --           --            --          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        --           --            --      (4,000)
Issuance of series D preferred
   stock                                800    5,786          --     --      5,194        --       (3,720)           --       7,260
Dividend payable                         --       --          --     --         --        --         (121)           --        (121)
Non-cash compensation                    --       --          --     --         41        --           --            --          41
                                   --------  -------  ----------    ---    -------     -----     --------       -------     -------
BALANCE AT DECEMBER 31, 2003            800  $ 5,786  30,425,284    $30    $47,167     $  --     $(43,693)      $  (347)    $ 8,943
                                   ========  =======  ==========    ===    =======     =====     ========       =======     =======
Net income                               --       --          --     --         --        --        3,253            --       3,253
Foreign currency translation
   adjustment                            --       --          --     --         --        --           --           687         687
Exercise of stock options                --       --     118,062      1        188        --           --            --         189
Conversion of series D preferred
   stock                               (592)  (4,282)  2,960,000      3      4,279        --           --            --          --
Cash dividend on series D
   preferred stock                       --       --          --     --         --        --         (182)           --        (182)
Dividend paid in common stock on
   series D preferred stock              --       --      64,843     --        144        --          (23)           --         121
Dividend payable                         --       --          --     --         --        --          (27)           --         (27)
Conversion of series D warrants          --       --      13,500     --         47        --           --            --          47
                                   --------  -------  ----------    ---    -------     -----     --------       -------     -------
BALANCE AT DECEMBER 31, 2004            208  $ 1,504  33,581,689     34    $51,825     $  --     $(40,672)      $   340     $13,031
                                   ========  =======  ==========    ===    =======     =====     ========       =======     =======
Net income                               --       --          --     --         --        --        7,701            --       7,701
Foreign currency translation
   adjustment                            --       --          --     --         --        --           --        (1,218)     (1,218)
Exercise of stock options                --       --     690,807      1      1,902        --           --            --       1,903
Common stock issued for
   acquisitions                          --       --     331,104     --      2,278        --           --            --       2,278
Restricted stock awards                  --       --      84,500     --        538      (403)          --            --         135
Conversion of series D preferred
   stock                               (208)  (1,504)  1,040,000      1      1,503        --           --            --          --
Cash dividend on series D
   preferred stock                       --       --          --     --         --        --          (14)           --         (14)
Conversion of warrants                   --       --     447,250     --      1,552        --           --            --       1,552
Dividend paid in common stock on
   series D preferred stock              --       --       5,075     --         27        --           --            --          27
                                   --------  -------  ----------    ---    -------     -----     --------       -------     -------
BALANCE AT DECEMBER 31, 2005             --  $    --  36,180,425    $36    $59,625     $(403)    $(32,985)      $  (878)    $25,395
                                   ========  =======  ==========    ===    =======     =====     ========       =======     =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                      F-6
<PAGE>
                     VASCO DATA SECURITY INTERNATIONAL, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In Thousands)

<TABLE>
<CAPTION>
                                                                              For the Years ended December 31,
                                                                              --------------------------------
                                                                                   2005      2004      2003
                                                                                 -------   -------   -------
<S>                                                                           <C>          <C>       <C>
Cash flows from operating activities:
   Net income from continuing operations                                         $ 7,701   $ 3,253   $   761
      Adjustments to reconcile net income from continuing operations
         to net cash provided by operating activities:
         Depreciation and amortization                                             1,076       734     1,061
         Deferred tax expense (benefit)                                             (122)       46       (70)
         Non-cash compensation and other expenses                                    146        16        41
         Changes in assets and liabilities, net of effects of acquisitions:
            Accounts receivable, net                                              (7,114)   (3,002)      697
            Inventories, net                                                        (438)     (168)      670
            Other current assets                                                      73      (260)     (207)
            Accounts payable                                                       2,342     1,138      (370)
            Income taxes payable                                                   1,257       598       (86)
            Accrued expenses                                                       1,686       202      (141)
            Other current liabilities                                                935       320      (275)
      Net cash provided by discontinued operations                                    --        --       328
                                                                                 -------   -------   -------
Net cash provided by operations                                                    7,542     2,877     2,409
                                                                                 -------   -------   -------

Cash flows from investing activities:
   Business acquisitions, net of cash acquired                                    (3,990)       --        (7)
   Additions to property and equipment                                              (507)     (252)     (124)
   Other assets                                                                     (182)      (64)        3
   Increase in restricted cash                                                      (127)      (82)       --
   Disposals of property, plant and equipment, net                                     7        --       140
   Payments received on note receivable                                              343       304       116
                                                                                 -------   -------   -------
Net cash provided by (used in) investing activities                               (4,456)      (94)      128
                                                                                 -------   -------   -------

Cash flows from financing activities:
   Proceeds from bank borrowing                                                    3,173        --        --
   Repayment of debt                                                                  --        --    (3,590)
   Proceeds from exercise of stock options and warrants                            3,455       236        63
   Purchase and retirement of Series C preferred stock                                --        --    (4,000)
   Net proceeds from issuance of Series D preferred stock                             --        --     7,260
   Dividends paid on preferred stock                                                 (14)     (182)       --
                                                                                 -------   -------   -------
Net cash provided by (used in) financing activities                                6,614        54      (267)
Effect of exchange rate changes on cash                                             (876)      484       (69)
Net increase in cash                                                               8,824     3,321     2,201
Cash and equivalents, beginning of year                                            8,138     4,817     2,616
                                                                                 -------   -------   -------
Cash and equivalents, end of year                                                $16,962   $ 8,138   $ 4,817
                                                                                 =======   =======   =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       F-7

<PAGE>

                     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) design, develop, market and support 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 $330, $(538)
and $146 are included in other income (expense) for 2005, 2004 and 2003,
respectively. We implemented a hedging program in the second quarter of 2005 to
minimize the impact of changes in currency rates.

Revenue Recognition

     The Company recognizes revenue in accordance with AICPA Statement of
Position ("SOP") 97-2 and SEC Staff Accounting Bulletin ("SAB") 104. Revenue is
recognized when there is persuasive evidence that an arrangement exists,
delivery has occurred, the fee is fixed or determinable and collection of the
revenue is probable.

     Hardware Revenue and License Fees: Revenues from the sale of computer
security hardware or the license of software are recorded upon shipment or, if
an acceptance period is allowed, at the later of shipment or customer
acceptance. No significant obligations or contingencies exist with regard to
delivery, customer acceptance or rights of return at the time revenue is
recognized.

     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 deferred and 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 recognized
during the period in which the services are performed.

     Multiple-Element Arrangements: The Company allocates revenues to the
various elements of the arrangements based on the estimated fair value of each
deliverable as required by SOP 97-2 and Emerging Issues Task Force ("EITF")
Issue No. 00-21. The fair value for each element is based on the price charged
when that element is sold separately, price lists, renewal rates and other
methods. When discounts are given in a multiple-element arrangement, a
proportionate amount of the discount is applied to each element based on each
element's fair value without regard to the discount. The estimated fair value of
undelivered elements is deferred and recorded as revenue when services are
performed or products are delivered.

     Sales to distributors and resellers are recognized on the same basis as
sales made directly to customers. Revenue is recognized when there is persuasive
evidence that an arrangement exists, delivery has occurred, the fee is fixed or
determinable and collection of the revenue is probable.


                                      F-8

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

     For large-volume transactions, the Company may negotiate a specific price
that is based on the number of users of the software license or quantities of
hardware supplied. The per unit prices for large-volume transactions are
generally lower than transactions for smaller quantities and the price
differences are commonly referred to as volume-purchase discounts.

Cash and equivalents

     The Company classifies as cash and equivalents amounts on deposit in banks
and cash invested temporarily in various instruments with maturities of three
months or less at time of purchase.

     Restricted cash of $181 at December 31, 2005 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 2005 and it
is the Company's intention to fulfill remaining deliveries during the first
quarter of 2006.

Accounts Receivable and Allowance for Doubtful Accounts

          The Company records trade accounts receivable at invoice values, which
are generally equal to fair value. The Company maintains allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make payments for goods and services. The Company analyzes 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. The allowance is based on a specific review of all significant
past-due accounts. If the financial condition of our customers deteriorates,
resulting in an impairment of their ability to make payments, additional
allowances may be required.

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. The Company maintains reserves for inventory
where it appears that the carrying cost of the inventory may not be recovered
through subsequent sale of the inventory. The Company analyzes 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.

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 $3,579, $2,441 and $1,955 for
2005, 2004 and 2003, respectively.

Software Development 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".


                                      F-9

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

Research costs and software development costs, prior to the establishment of
technological feasibility, determined based upon the creation of a working
model, are expensed as incurred. 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. 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, 2005, 2004 and 2003.

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.

     The Company has significant net operating loss carryforwards in the U. S.
and other countries which are available to reduce the liability on future
taxable income. A valuation reserve has been provided to offset these future
benefits because we have not determined that their realization is more likely
than not.

Fair Value of Financial Instruments

     At December 31, 2005 and 2004 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, 2005 and 2004.

Use of Estimates

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

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 in 2003 as consideration for assets of the VACMAN
Enterprise business unit. Based on a detailed valuation, we established the
initial value of the consideration received from SSI, using a discounted value
of the payment streams expected from the note and the preferred stock. Interest
income on the note is recorded over time at the discount rate. On an ongoing
basis, the Company


                                      F-10

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

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.

     As of February 28, 2006, the Company's Chief Executive Officer, T. Kendall
Hunt, had a beneficial ownership share of 8% in SSI. The Company does not use
the equity method to account for its investment in SSI because we believe that
Mr. Hunt does not have "significant influence" over the operating and finance
policies of SSI. Accounting Principles Board Opinion 18 established 20%
ownership as a benchmark indicator of significant influence. Emerging Issues
Task Force (EITF) Issue 02-14 "Whether an Investor Should Apply the Equity
Method of Accounting to Investments Other Than Common Stock" describes
situations where side agreements or ownership of instruments other than common
stock can indicate the existence of significant influence. No such side
agreements exist and the Company's investments in convertible preferred shares
and the note do not create significant influence.

     SSI has made all of its note payments through January 2006, but has not
made its note payments in February or March 2006. The Company granted SSI a
90-day extension on the note in order to facilitate their planned capital raise.
On February 28, 2006, SSI filed a Form 8-K report announcing a new financing
arrangement for an initial $2,500 and a potential additional $2,500. If SSI is
unsuccessful in executing their business plan, the remaining amount of the
Company's investment is at risk. The Company holds a security interest in the
software sold to SSI under the terms of the installment note. EITF Issue No.
03-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" provides guidelines for valuation of these investments.
Based on a review of the facts, the Company has concluded that the current
decline in fair value, if any, is temporary in nature. The Company has the
ability and intent to hold the investment until its carrying value is realized.
At December 31, 2005, 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, proprietary technology. Intangible assets other than patents
with definite lives are amortized over the useful life, generally three to seven
years for proprietary technology. Patents are amortized over the life of the
patent, generally 20 years in the U. S.

     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 2005. 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, 2005, the Company had a stock-based employee compensation
plan, which is described more fully in Note 9. 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 for options is reflected in net income,
as all options granted under this plan had an exercise price equal to the market
value of the underlying Common Stock on the date of grant. In 2005, the Company
granted restricted stock awards for 90,000 common shares, which will vest over a
four year period. Compensation costs will be recorded on a straight-line basis
over the vesting


                                      F-11
<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

period. 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:

<TABLE>
<CAPTION>
                                                                     Year Ended December 31,
                                                                   --------------------------
                                                                    2005      2004      2003
                                                                   ------   -------   -------
<S>                                                                <C>      <C>       <C>
Net income (loss) available to common shareholders as reported     $7,687   $ 3,021   $(1,715)
Incremental stock-based employee compensation determined
   under fair-value-based methods for options, net of tax            (726)   (1,065)   (1,016)
                                                                   ------   -------   -------
      Pro forma net income (loss)                                  $6,961   $ 1,956   $(2,731)
                                                                   ======   =======   =======
Non-cash compensation cost included in net income (loss) for
   restricted stock or option awards (no tax effect, due to NOL)   $  135   $    --   $    41
                                                                   ======   =======   =======
Basic net income (loss) per common share
   As reported                                                     $ 0.22   $  0.09   $ (0.06)
   Pro forma                                                       $ 0.20   $  0.06   $ (0.09)

Diluted net income (loss) per common share
   As reported                                                     $ 0.21   $  0.09   $ (0.06)
   Pro forma                                                       $ 0.19   $  0.06   $ (0.09)
</TABLE>

     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 2005, 2004 and 2003: dividend yield of 0%;
expected volatility of 69%, 104%, 120%, respectively; risk free interest rates
ranging from 4.21% to 4.23%, 4.08% to 4.27% and 4.07% to 4.19%, respectively;
and expected lives ranging from 4 to 7 years. The pro forma compensation cost
for options is reduced for expected prevesting forfeitures and is amortized on a
straight-line basis over the vesting period. Pro forma compensation cost is
adjusted for actual forfeitures when they differ significantly from expected
forfeitures.

     Effective January 1, 2006, the Company will adopt SFAS 123(R), "Share-Based
Payment". This statement will require that fair value of options granted be
included in expense over the vesting period. It is expected that the expense
amounts recorded will be comparable to the estimated pro forma amounts reported
under SFAS 123 in the table above.

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. The Company has historically experienced minimal
actual claims over the warranty period.

Earnings 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. A reconciliation of
the shares included in the basic and fully diluted earnings per share
calculations is as follows:


                                      F-12

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                           Year Ended December 31,
                                                    ------------------------------------
                                                       2005         2004         2003
                                                    ----------   ----------   ----------
<S>                                                 <C>          <C>          <C>
Weighted average common shares outstanding
   Basic                                            35,429,000   32,216,000   29,270,000
   Incremental shares for the effect of dilutive:
      Stock options                                  1,577,000      816,000           --
      Warrants                                         154,000       28,000           --
      Restricted stock awards                           84,000           --           --
      Identikey acquisition shares                          --       68,000           --
                                                    ----------   ----------   ----------
         Dilutive                                   37,244,000   33,128,000   29,270,000
                                                    ==========   ==========   ==========
</TABLE>

     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:

<TABLE>
<CAPTION>
                               2005       2004        2003
                              ------   ---------   ---------
<S>                           <C>      <C>          <C>
Stock options                 25,000     300,500   2,926,375
Warrants                          --          --     600,000
Convertible preferred stock       --   2,320,260   4,000,000
                              ------   ---------   ---------
   Total                      25,000   2,620,760   7,526,375
                              ======   =========   =========
</TABLE>

     The net income available to common shareholders for the years ended
December 31, 2005 and 2004 would have been increased by $14 and $232,
respectively, by adding back dividends related to the convertible preferred
stock. Additionally, the net loss applicable to common stockholders for the year
ended December 31, 2003 would have been decreased by adding back interest
expense related to the convertible term loan of approximately $153 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.

Reclassifications

     Certain prior year amounts in the consolidated financial statements have
been reclassified to conform to the 2005 presentation, primarily to reflect
amortization expense on the income statement as a separate line item and to
reclassify certain payroll-related items from other accrued liabilities to
accrued payroll on the balance sheet.

NOTE 2 - GOODWILL AND OTHER INTANGIBLES

     Intangible asset activity for the three years ended December 31, 2005 is as
follows:


                                      F-13

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                    Capitalized    Patents &           Intangible
                                     Technology   Trademarks   Other     Assets     Goodwill
                                    -----------   ----------   -----   ----------   --------
<S>                                 <C>           <C>          <C>     <C>          <C>
Net balance at December 31, 2002      $ 1,875        $ 57      $  35    $ 1,967      $  250
   Additions                                7          --         --          7          --
   Amortization expense                  (504)        (12)       (35)      (551)         --
                                      -------        ----      -----    -------      ------
Net balance at December 31, 2003        1,378          45         --      1,423         250
   Additions                              150          67         --        217          --
   Amortization expense                  (394)         (3)        --       (397)         --
                                      -------        ----      -----    -------      ------
Net balance at December 31, 2004        1,134         109         --      1,243         250
   Additions                              178           4        367        549       6,415
   Amortization expense                  (355)        (16)      (367)      (738)         --
                                      -------        ----      -----    -------      ------
Net balance at December 31, 2005      $   957        $ 97      $  --    $ 1,054      $6,665
                                      =======        ====      =====    =======      ======
December 31, 2005 balance at cost     $ 6,157        $116      $  --    $ 6,273      $7,638
   Accumulated amortization            (5,200)        (19)        --     (5,219)       (973)
                                      -------        ----      -----    -------      ------
Net balance at December 31, 2005      $   957        $ 97      $  --    $ 1,054      $6,665
                                      =======        ====      =====    =======      ======
</TABLE>

Estimated amortization expense for the years ended:

<TABLE>
<S>                                <C>
December 31, 2006                  $392
December 31, 2007                   392
December 31, 2008                   120
December 31, 2009                    41
December 31, 2010 and thereafter    109
</TABLE>

(1)  2005 amount reflects an intangible asset for firm purchase orders of AOS at
     the date of acquisition. The 2002 amount relates to customer lists obtained
     in a 1996 acquisition.

NOTE 3 - ACQUISITIONS

     On February 4, 2005, the Company acquired all of the share capital of
A.O.S. Hagenuk B.V. ("AOS") a private limited liability company organized and
existing under the laws of the Netherlands. The primary purpose for the
acquisition was to obtain engineering expertise which is complimentary to our
existing product lines. 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.
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 operated as a
wholly-owned subsidiary of the Company, accounted for using the purchase method
in accordance with SFAS No. 141, Business Combinations.

     The aggregate purchase price was $7,263, consisting of $4,374 of cash,
262,641 shares of Common Stock valued at approximately $2,128, the assumed
liability due AOS of $616 and direct costs of the acquisition of $145. The fair
value of the common stock was determined based on the average market price of
the Company's Common Stock over the period including several days before the
closing date, February 4, 2005. The following table summarizes the fair value of
the assets acquired and the liabilities assumed at the date of acquisition:


                                      F-14
<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                  February 4, 2005
                                  ----------------
                                    (Unaudited)
<S>                               <C>
Cash                                   $  529
Accounts receivable, net                  466
Inventory                                  11
Prepaid expenses                           47
Other current assets                      608
Property and equipment, net               122
                                       ------
   Total assets acquired                1,783
                                       ------
Accounts payable                           47
Deferred revenue                        1,071
Deferred income taxes                      28
Accrued expenses                          156
                                       ------
   Total liabilities assumed            1,302
                                       ------
   Net assets acquired                 $  481
                                       ======
</TABLE>

     The total purchase price was allocated as follows:

<TABLE>
<CAPTION>
                                 Amount
                              -----------
                              (Unaudited)
<S>                           <C>
Net assets acquired              $  481
Capitalized purchase orders         367
Goodwill                          6,415
                                 ------
                                 $7,263
                                 ======
</TABLE>

     The following summarized unaudited pro forma financial information for the
years ended December 31, 2005 and 2004 and assumes the AOS acquisition occurred
as of January 1 of each year:

<TABLE>
<CAPTION>
                                                  2005          2004
                                              -----------   -----------
                                              (Unaudited)   (Unaudited)
<S>                                           <C>           <C>
Net revenues                                    $55,185       $34,449
Net income available to common shareholders       7,441         1,833
Basic net income per common share               $  0.21       $  0.06
Diluted net income per common share                0.20          0.06
</TABLE>

     The pro forma results include the amortization of intangibles acquired and
a reduction of revenue related to the estimated fair value of the deferred
revenue acquired. The Company does not record amortization expense related to
goodwill, but rather reviews the carrying value of the asset for impairment at
least annually in accordance with the provisions of SFAS No. 142, Goodwill and
Other Intangible Assets. The pro forma results are not necessarily indicative of
the results that would have occurred if the acquisition had actually been
completed on January 1, 2005 or 2004, nor are they necessarily indicative of
future consolidated results.

NOTE 4 - INVENTORIES

     Inventories, net of valuation allowance of $239 and $198 at December 31,
2005 and 2004, respectively, are comprised of the following:


                                      F-15

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                       December 31,
                                     ---------------
                                      2005     2004
                                     ------   ------
<S>                                  <C>      <C>
Component parts                      $  601   $  601
Work-in-process and finished goods      969      745
                                     ------   ------
   Total                             $1,570   $1,346
                                     ======   ======
</TABLE>

NOTE 5 - INCOME TAXES

     At December 31, 2005, the Company has U. S. net operating loss
carryforwards approximating $25,810 and foreign net operating loss carryforwards
approximating $4,595. Such losses are available to offset future taxable income
in the respective jurisdictions. The U. S. loss carryforwards expire in varying
amounts beginning in 2012 and continuing through 2018. The foreign loss
carryforwards have no expiration dates. 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:

<TABLE>
<CAPTION>
                             For the Years Ended December 31,
                             --------------------------------
                                  2005     2004      2003
                                -------   ------   -------
<S>                          <C>          <C>      <C>
Domestic:
   Continuing operations        $   634   $1,128   $(1,989)
   Discontinued operations           --       --     1,995
                                -------   ------   -------
      Total domestic                634    1,128         6
Foreign                          10,894    4,005     3,147
                                -------   ------   -------
   Total                        $11,528   $5,133   $ 3,153
                                =======   ======   =======
</TABLE>

     The provision (benefit) for income taxes consists of the following:

<TABLE>
<CAPTION>
                       For the Years Ended December 31,
                       --------------------------------
                             2005     2004    2003
                            ------   ------   ----
<S>                    <C>           <C>      <C>
Current:
   Federal                  $   20   $   25   $ --
   Foreign                   3,713    1,809    467
                            ------   ------   ----
      Total current          3,733    1,834    467
                            ------   ------   ----
Deferred:
   Foreign                      94       46    (70)
                            ------   ------   ----
      Total deferred            94       46    (70)
                            ------   ------   ----
      Total                 $3,827   $1,880   $397
                            ======   ======   ====
</TABLE>

     The differences between income tax provision computed using the statutory
federal income tax rate of 35% and the provision for income taxes reported in
the consolidated statements of operations are as follows:


                                      F-16

<PAGE>
                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                For the Years Ended December 31,
                                                                --------------------------------
                                                                     2005     2004     2003
                                                                    ------   ------   ------
<S>                                                             <C>          <C>      <C>
Expected tax benefit at statutory rate                              $4,035   $1,797   $1,103
Increase (decrease) in income taxes resulting from:
   Change in valuation allowance due to the net
      utilization of net operating loss carryforwards                 (315)     (26)    (739)
  Foreign taxes at rates other than the federal statutory rate          92       --       15
  Other, net                                                            15      109       18
                                                                    ------   ------   ------
      Total                                                         $3,827   $1,880   $  397
                                                                    ======   ======   ======
</TABLE>

     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 2004 and 2003.

     The deferred income tax balances are comprised of the following:

<TABLE>
<CAPTION>
                                               As of December 31,
                                              -------------------
                                                2005       2004
                                              --------   --------
<S>                                           <C>        <C>
Deferred tax assets:
   U.S. net operating loss carryforwards      $ 10,086   $ 10,356
   Foreign net operating loss carryforwards      1,562      1,800
   Accounts receivable                               6          6
   Inventory                                        32         23
   Fixed assets                                     (5)        11
   Accrued expenses                                169         53
   Deferred revenue                                 --         26
                                              --------   --------
      Total gross deferred tax assets           11,850     12,275
      Less valuation allowance                 (11,733)   (12,252)
                                              --------   --------
         Net deferred income taxes            $    117   $     23
                                              ========   ========
</TABLE>

     The net change in the total valuation allowance for the years ended
December 31, 2005, 2004 and 2003 was an increase (decrease) of $(519), $22 and
$(215), 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 2005 and 2004, the Company utilized $560 and $1,060 of its U. S.
net operating loss carryforwards. In 2005, the Company also utilized $1,235 of
foreign net operating loss carryforwards and generated $936 of new foreign net
operating loss carryforwards. The Company has provided a valuation allowance at
December 31, 2005 for all of the gross deferred tax assets except for those
associated with its Belgian operating entity. The Company anticipates realizing
this deferred tax asset in the future as the Company expects to generate taxable
income in Belgium in 2006.

NOTE 6 - DEFERRED WARRANTY

     The Company's standard practice is to provide a warranty on its Digipasses
for two years after the date of purchase. Customers may purchase extended
warranties covering periods from one to four 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.

     Deferred warranty at December 31, 2005 which will be earned in 2006 is $83
and is included in other current assets. The long-term deferred warranty revenue
as of December 31, 2005 will be recognized as income as follows:


                                      F-17
<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
  Year     Amount
--------   ------
<S>        <C>
2007        $116
2008          99
2009          36
2010           5
            ----
   Total    $256
            ====
</TABLE>

NOTE 7 - DEBT

     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
3,500 U.S. Dollars or 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, 2005, borrowings under
the agreement totaled $3,173. 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.

     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.

     Interest expense related to debt was $120, $0 and $157 for the years ended
December 31, 2005, 2004 and 2003, respectively.

NOTE 8 - STOCKHOLDERS' EQUITY

Preferred Stock

     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 mandatory
conversion of all outstanding shares of the Series D Preferred Stock. The
accrued dividends through the conversion date of $14 were paid. In addition,
5,075 shares of Common Stock were issued as dividends to the Series D preferred
stockholders in the first quarter of 2005.

     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 carried a 5% dividend and was convertible into 4,000,000 shares of Common
Stock at a fixed price of $2.00 per share. 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-18

<PAGE>

                     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.

Warrants

     Warrant activity for the years ended December 31, 2005, 2004 and 2003 is
summarized below:

<TABLE>
<CAPTION>
                                                    Weighted
                                    Number of   Average Exercise
                                     Shares           Price        Exercise Price
                                   ----------   ----------------   --------------
<S>                                <C>          <C>                <C>
Outstanding at December 31, 2002    1,239,474        $11.10        $4.25 - $15.00
   Granted                            600,000          3.47                  3.47
   Cancelled                       (1,239,474)        11.10         4.25 - 15.00
                                   ----------
Outstanding at December 31, 2003      600,000          3.47                  3.47
   Exercised                          (13,500)         3.47                  3.47
                                   ----------
Outstanding at December 31, 2004      586,500          3.47                  3.47
   Exercised                         (447,250)         3.47                  3.47
                                   ----------
Outstanding at December 31, 2005      139,250          3.47                  3.47
                                   ==========
</TABLE>

NOTE 9 - 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 have been for a period of either seven or
ten years, are granted at a price equal to the fair market value of the Common
Stock on the date of the grant and have 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.


                                      F-19

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

     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 have been granted at a price equal
to the fair market value of the Common Stock on the date of the grant, and have
contained vesting requirements and/or restrictions as determined by the
Compensation Committee at the time of grant. Non-cash compensation expense of
$135, $0 and $41 was recognized in 2005, 2004 and 2003, 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 was for restricted stock granted in 2005 and for
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, 2005, the Compensation Plan was authorized to issue
options representing up to 7,236,085 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.

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

<TABLE>
<CAPTION>
                                     Options Outstanding       Options Exercisable
                                   -----------------------   ----------------------
                                                Weighted -               Weighted -   Weighted-Average
                                    Number of     Average    Number of     Average      Fair Value of
                                     Shares        Price       Shares       Price      Options Granted
                                   ----------   ----------   ---------   ----------   ----------------
<S>                                <C>          <C>          <C>         <C>          <C>
Outstanding at December 31, 2002    4,609,000      $3.12     1,917,056      $3.63
   Granted                            591,000       0.75                                    $ .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                         (623,375)      1.90
                                   ----------
Outstanding at December 31, 2004    2,626,438       2.75     1,947,612       3.10
                                   ----------
   Granted                            338,000       6.38                                     4.27
   Exercised                         (690,807)      2.75
   Forfeited                          (55,784)      4.02
Outstanding at December 31, 2005    2,217,847       3.27     1,708,304       3.27
                                   ==========
</TABLE>

     In 2004, the Company included 577,000 stock options that were not accepted
by employees in the forfeited line.

     The following table summarizes information about stock options outstanding
at December 31, 2005:

<TABLE>
<CAPTION>
                                      Options Outstanding                Options Exercisable
                           -----------------------------------------   ----------------------
                                          Weighted -      Weighted -               Weighted -
                                            Average         Average                  Average
                           Number of       Remaining       Exercise    Number of    Exercise
Range of Exercise Prices     Shares    Contractual Life      Price       Shares       Price
------------------------   ---------   ----------------   ----------   ---------   ----------
<S>                        <C>         <C>                <C>          <C>         <C>
Under $2.00                  777,899       6.6 years        $ 0.96       698,566     $ 0.99
$2.00 to $4.00               745,987       6.8 years          2.49       551,806       2.49
$4.00 to $6.00               210,000       1.5 years          4.29       210,000       4.29
$6.00 to $8.00               323,711       9.0 years          6.38        87,703       6.39
Over $8.00                   160,250       4.4 years         10.43       160,250      10.43
                           ---------                                   ---------
                           2,217,847                                   1,708,325
                           =========                                   =========
</TABLE>


                                      F-20
<PAGE>

                     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, 2005
and 2004.

     In 2005, the Company granted restricted stock awards for 90,000 common
shares to employees. These awards vest over a four year period. Compensation
cost equal to the market value of the stock of $6.38 on the date granted will be
recorded on a straight-line basis over the vesting period. Restricted shares
outstanding at December 31, 2005 were 84,500.

NOTE 10 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                                     For the Years ended December 31,
                                                                   ------------------------------------
                                                                      2005         2004         2003
                                                                   ----------   ----------   ----------
<S>                                                                <C>          <C>          <C>
Supplemental disclosure of cash flow information:
   Interest paid                                                   $       91   $       17   $      157
   Income taxes paid                                               $    2,641   $    1,294   $      749

Supplemental disclosure of non-cash investing activities:
   Common stock issued in connection with acquisition              $    2,278   $       --   $       --
   Note receivable and preferred stock received
      from sale of business unit                                   $       --   $       --   $    1,553
   Accrued capitalized technology                                  $       --   $      150   $       --

Supplemental disclosure of non-cash financing activities:
   Common stock issued to redeem Series C preferred stock
      and warrants (in shares)                                             --           --    2,000,000
   Common stock issued to redeem Series D preferred stock
      upon conversion of preferred shares (in shares)               1,040,000    2,960,000           --
   Common stock issued to redeem Series D preferred stock          $    1,504   $    4,282   $       --
   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 (5,075 and 64,843 shares in 2005 and 2004)      $       27   $      144   $       --
</TABLE>


                                      F-21

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)


NOTE 11 - DISCONTINUED OPERATIONS

     In July 2003, VASCO sold its VACMAN Enterprise ("VME") business, originally
known as Intellisoft and/or Snareworks, to SecureD Services, Inc. ("SSI"). 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 for book purposes, and
2,000,000 shares of Convertible Preferred Stock from SSI, valued at $600 for
book purposes, 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. The valuation reserve taken on each asset received, that
is the difference between the face value and the amount recorded for both the
note and the preferred stock, reflects the Company's detailed assessment of the
value of each of the financial instruments received. In its assessment, the
Company considered, among other factors, the start-up nature of SSI, its
business plan, its need for future financing, the trading activity of SSI's
stock in the open market and a market rate of return for investments in start-up
companies.

     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. There were no assets of and
liabilities related to discontinued operations as of December 31, 2005 and 2004.
The results of the operations of VME for the twelve months ended December 31,
2003 have been reported as results of discontinued operations. 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.

NOTE 12 - EMPLOYEE BENEFIT PLAN

     The Company maintains a defined contribution pension plan for its U. S.
employees 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, 2005, 2004 and 2003, the
Company contributed $31, $21 and $23, respectively, to this plan.

     The Company also maintains a pension plan for its Belgian employees, in
compliance with Belgian law. The plan is a defined contribution plan, but has a
minimum return guarantee under Belgian law. Returns guaranteed by the pension
plan administrator are essentially equal to the legal requirement. For the years
ended December 31, 2005, 2004 and 2003, the Company contributed $160, $127 and
$84, respectively, to this plan.

                                      F-22

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)


NOTE 13 - GEOGRAPHIC AND CUSTOMER INFORMATION

     The Company records revenue in country that has responsibility for the
transaction. Information regarding geographic areas for the years ended December
31, 2005, 2004 and 2003 is as follows and has been restated in 2003 to reflect
discontinued operations:

<TABLE>
<CAPTION>
                                                     United States    Europe    Other     Total
                                                     -------------   -------   -------   -------
<S>                                                  <C>             <C>       <C>       <C>
                       2005
Revenue                                                  $3,687      $39,219    11,673   $54,579
Gross profit                                              3,232       25,253     7,443    34,438
Long-lived assets                                           755        7,706       901     3,128

                       2004
Revenue                                                  $3,105      $24,245   $ 2,543   $29,893
Gross profit                                              2,816       15,891     2,002    20,709
Long-lived assets                                         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
</TABLE>

     For the years 2005, 2004 and 2003, the Company's top 10 customers
contributed 64%, 60% and 71%, respectively, of total worldwide revenues. In
2005, two customers accounted for 13.5% and 11.3% of the Company's 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.

NOTE 14 - 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:

<TABLE>
<CAPTION>
Year         Amount
----         ------
<S>          <C>
2006         $1,048
2007            950
2008            875
2009            738
2010            564
Thereafter      405
             ------
   Total     $4,580
             ======
</TABLE>

     Rent expense under operating leases aggregated approximately $836, $851 and
$685 for the years ended December 31, 2005, 2004 and 2003, respectively. Rent
expense is recorded on a straight-line basis over the life of the lease
agreement.

     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 15 - 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. In 2005, the Company resolved all issues associated with the
closure of the French operation and reversed reserves that were no longer
needed, some of which had been recorded prior to the decision to close the
operation, resulting in a gain of $172. In 2004, $32 was reversed from
restructuring accruals as a result of the renegotiation of the Corporate
Headquarters' office lease.


                                      F-23

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)


NOTE 16 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     No material fourth quarter adjustments were recorded in 2005 or 2004. The
quarterly results of operations are as follows:

<TABLE>
<CAPTION>
                         FIRST     SECOND    THIRD     FOURTH
                        QUARTER   QUARTER   QUARTER   QUARTER
                        -------   -------   -------   -------
<S>                     <C>       <C>       <C>       <C>
         2005
Net sales               $11,443   $12,345   $13,272   $17,519
Gross profit              7,220     8,049     8,134    11,035
Operating expenses        5,298     5,764     5,596     6,827
Operating income          1,922     2,285     2,538     4,208
Net income                1,407     1,581     1,751     2,962
Net income per share:
   Basic                $  0.04   $  0.04   $  0.05   $  0.08
   Fully diluted           0.04      0.04      0.05      0.08

         2004
Net sales               $ 6,021   $ 7,174   $ 7,400   $ 9,298
Gross profit              4,446     5,075     5,156     6,032
Operating expenses        3,547     3,596     3,475     4,539
Operating income            899     1,479     1,681     1,493
Net income                  583       953     1,201       516

Net income per share:
   Basic                $  0.02   $  0.03   $  0.03   $  0.02
   Fully diluted           0.02      0.03      0.03      0.02
</TABLE>

     Due to rounding in earnings per share, the sum of the quarters may not be
equal to the full year.


                                      F-24

<PAGE>

                     VASCO DATA SECURITY INTERNATIONAL, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                 (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)

                                   SCHEDULE II

                     VASCO DATA SECURITY INTERNATIONAL, INC.

                        VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                  Beginning     Expense      Accounts     Ending
                                   Balance    (Recovery)   Written Off   Balance
                                  ---------   ----------   -----------   -------
<S>                               <C>         <C>          <C>           <C>
Allowance for Doubtful Accounts
for Trade Accounts Receivable
Year ended December 31, 2005         $160       $  31         $(36)        $156
Year ended December 31, 2004          471        (108)         (203)        160
Year ended December 31, 2003          461          92          (82)         471
</TABLE>

<TABLE>
<CAPTION>
                                               Obsolescence
                                   Beginning      Expense      Inventory     Ending
                                    Balance     (Recovery)    Written Off   Balance
                                   ---------   ------------   -----------   -------
<S>                                <C>         <C>            <C>           <C>
Reserve for Obsolete Inventories
Year ended December 31, 2005          $198         $ 68          $(27)        $239
Year ended December 31, 2004           252           (3)          (51)         198
Year ended December 31, 2003           112          140            --          252
</TABLE>

   See accompanying report of independent registered public accounting firm.


                                      F-25

<PAGE>

                                   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 15, 2006.

                                        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 15, 2006.

                                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, 2005 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.

<TABLE>
<CAPTION>
                SIGNATURE                               TITLE
                ---------                               -----
<S>                                     <C>


/s/ T. Kendall Hunt                     Chief Executive Officer and Chairman
-------------------------------------   (Principal Executive Officer)
T. Kendall Hunt


/s/ Jan Valcke                          President and Chief Operating Officer
-------------------------------------   (Principal Operating Officer)
Jan Valcke


/s/ Clifford K. Bown                    Chief Financial Officer and Secretary
-------------------------------------   (Principal Financial Officer and
Clifford K. Bown                         Principal Accounting Officer)


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


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


/s/ John R. Walter                      Director
-------------------------------------
John R. Walter


/s/ John N. Fox, Jr.                    Director
-------------------------------------
John N. Fox, Jr.
</TABLE>