AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY , 2001
REGISTRATION NO. 333-
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
CHIPCARDS, INC.
(Exact name of Small Business Issuer as specified in its Charter)
------------------------------------------------
CALIFORNIA 3612 94-3191805
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Classification Identification No.)
incorporation or Code Number)
organization)
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CITICORP CENTER
ONE SANSOME STREET, 19TH FLOOR
SAN FRANCISCO, CALIFORNIA 94104
(415) 951-1078
(Address, including zip code, and telephone number,
including area code, of Principal Executive Offices)
------------------------------------------------
Allen Yue
Chipcards, Inc.
Citicorp Center, One Sansome Street, 19th Floor
San Francisco, California 94104
(415) 951-1078
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Copies to:
Scott A. Ziegler, Esq.
Ziegler, Ziegler & Altman, LLP
1330 Avenue of the Americas, Eleventh Floor
New York, New York 10019
(212) 319-7600
Michael D. DiGiovanna, Esq.
Parker Duryee Rosoff & Haft
529 Fifth Avenue
New York, New York 10017
(212) 599-0500
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [X]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
=======================================================================================================
CALCULATION OF REGISTRATION FEE
=======================================================================================================
Title of each class Amount Proposed maximum Proposed maximum Amount of
of securities to be to be offered price per aggregate offering registration
registered registered share price (1) fee
=======================================================================================================
Units, each
consisting of: 1,150,000(2) $8.10 $9,315,000 $2,328.85
(i) one share of
common stock, no par
Par value, and
(ii) one warrant to
purchase one share
of common stock
Common stock, no par
value, issuable upon
exercise of the warrants 1,150,000(3) $8.40 $9,660,000 $2,415.00
Underwriter's warrants 100,000(4) $.01 $1,000.00 $0
Units issuable upon
exercise of underwriter's
warrants, each
consisting of: 100,000 $9.72 $972,000 $243.00
(i) one share of common
stock, no par value
per share, and
(ii) one warrant to
purchase one share
of common stock
Common stock, no par
value, issuable upon
exercise of the warrants
underlying the
underwriter's warrants 100,000(3) $8.40 $840,000 $210.00
=======================================================================================================
Total: $5,196.85
=======================================================================================================
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457 promulgated under the Securities Act of 1933, as amended.
(2) Includes 150,000 units which the underwriter may purchase to cover
over-allotments, if any.
(3) Pursuant to Rule 416, there are also being registered such additional
securities as may become issuable pursuant to the anti-dilution provisions
contained in the warrants.
(4) Represents warrants to be issued to the underwriter, consisting of warrants
to purchase 100,000 units. No registration fee is required pursuant to Rule 457
of the Securities Act of 1933, as amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This preliminary prospectus is
not an offer to sell these securities and it is not soliciting an offer to buy
these securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED __________, 2000
PROSPECTUS
1,000,000 UNITS CONSISTING OF
1,000,000 SHARES OF COMMON STOCK AND
1,000,000 REDEEMABLE COMMON STOCK PURCHASE WARRANTS
CHIPCARDS, Inc.
This is an initial public offering of 1,000,000 units, each consisting
of one share of common stock of Chipcards, Inc. and one redeemable common stock
purchase warrant. The common stock and the warrants are being sold in units and
will be separately tradeable immediately upon issuance. Each warrant entitles
the registered holder to purchase one share of our common stock at a price of
$8.40 per share during the five year period commencing on the date of this
prospectus. There is currently no public market for our common stock, the
warrants or the units.
-----
We have applied for quotation of the common stock and warrants on the
Nasdaq SmallCap Market and Boston Stock Exchange under the symbol "__________"
and __________. We currently estimated that the initial public offering price
per unit will be $8.10.
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PER UNIT TOTAL
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Initial public offering price.......................................... $8.10 $8,100,000
Underwriting discounts and commissions................................. $0.648 $ 648,000
Proceeds to Chipcards, Inc. before expenses............................ $7.452 $7,452,000
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Chipcards, Inc. has granted the underwriters an option for a period of
45 days to purchase up to 150,000 additional units.
These securities are being offered on a "firm commitment" basis by The
Thornwater Company, L.P. as representative of the underwriters. The Thornwater
Company, L.P. expects to deliver the shares against payment on or about
, 2001.
-----
These securities are speculative. Investing in our common stock
involves a high degree of risk. See "Risk Factors" beginning on page 4.
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Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined that
this prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
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THE THORNWATER COMPANY L.P.
TABLE OF CONTENTS
Page
Prospectus Summary
Risk Factors
Cautionary Note Regarding Forward Looking Statements
Use of Proceeds
Dividend Policy
Dilution.
Capitalization
Management's Discussion and Analysis of Financial Condition and Results of Operations
Description of Business
Management
Compensation of Directors and Officers
Principal Stockholders
Certain Relationships and Related Party Transactions
Description of Securities
Shares Eligible for Future Sale
Transfer Agent and Registrar
Underwriting
Legal Matters
Experts
Where You Can Find Additional Information
Indemnification for Securities Act Liabilities
Index to Financial Statements
You should rely only on the information contained in this document or
to which we have referred you. We have not authorized anyone to provide you with
different information. We are not making an offer of these securities in any
state where the offer is not permitted. You should not assume that the
information provided by this prospectus is accurate as of any date other than
the date on the front page of this prospectus.
Dealer Prospectus Delivery Obligation
Until , 2001, all dealers that buy, sell or trade our
common stock, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in
this prospectus. This summary may not contain all the information important to
you. It does not contain all the information that is or may be important to you.
To understand this offering fully, you should read the entire prospectus
carefully, including "Risk Factors" and the consolidated financial statements
and related notes. Except as otherwise indicated, all information in this
prospectus assumes that the underwriter does not exercise the option granted by
us to purchase additional units in this offering.
As used in this prospectus, unless the context otherwise indicates,
the terms "Chipcards," "we," "us," or "our" refer to Chipcards, Inc., the term
"common stock" refers to our common stock, no par value, and the terms "units"
refers to the units offered by this prospectus. In addition, we refer to
prospective investors as "you" or the "investors."
Our fiscal year ends on December 31 of each year. Where this document
refers to a particular year, this means the fiscal year unless otherwise
indicated.
CHIPCARDS, INC.
Since 1997 we have been engaged in the installation of production
lines for the manufacture of smart cards. We provide our customers with the
technology, equipment, supplies, installation, training and support for a
turnkey smart card operation. To date all of our sales of production lines have
been to customers located in China. We have filed three Provisional Patent
Applications for inventions relating to smart card production technology, and we
intend to file corresponding non-provisional patent applications in order to
continue pursuing patent protection for these inventions. We have also marketed
finished smart cards since 1998. We have made arrangements with the purchasers
of our production lines giving us the right to purchase a portion of their
production in order to secure a supply of smart cards for marketing. In
addition, we have developed, and intend to market, ancillary products for
use in smart card systems. We plan to utilize the proceeds of this offering to
increase our capacity to install production lines, commence our own production
of smart cards, market newly developed products and expand our geographical
markets. Our ultimate aim is to become an integrated global smart card
competitor combining technology, production and marketing of smart cards as
well as the continuation of our installation business. We believe our
technology, supply sources, expertise and contacts will position us favorably
in connection with this strategy.
Our production lines consist of six separate pieces of equipment that
we integrate into a fully automated turnkey factory capable of performing all of
the operations needed to manufacture smart cards. We have developed proprietary
designs and processes through which we assemble and customize various components
into the precision machinery required to make smart cards. We use a contract
manufacturer to perform most of the assembly and construction work based on our
specifications and under our supervision. Our equipment focuses on the
production of "contactless" cards, which represent the most recent development
in smart card technology. Contactless cards have an antenna embedded inside the
card, which is attached to a computer chip. The chip and antenna together
provide wireless communication between the card and a read/write device
integrated into a mechanism such as an ATM, kiosk, vending machine, door lock or
subway turnstile. Contactless smart cards can be read at a short distance from
the read/write device, making them well adapted to small and rapid handshake
transactions. Because
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transactions are conducted without physical contact between the card and the
reader/writer, smart card systems undergo minimal mechanical wear, require
little maintenance, and can be virtually vandal-proof.
Prior to entering the smart card capital equipment business in 1997,
we designed equipment for the manufacture of electromagnetic components. This
background enabled us to develop the advanced machinery needed to produce
contactless smart cards.
Due to the projected growth in demand for smart cards, in 1998 we
began to market finished smart cards. We have been certified as an approved
smart card supplier by Siemens, Philips Semiconductors, Motorola and other
leading companies. We have entered into arrangements giving us the right to buy
finished cards from parties which have purchased our production lines. In most
cases we must source components and other raw materials for the card
manufacturer at a set price as a condition to our receipt of product. At
the completion of this offering, we intend to install an in-house smart card
production line in order to stabilize our supply of cards and reduce our
reliance on third party vendors.
Our ancillary products include a read/write device designed for use in
keyless entry security systems, a card handling system that tests and
initializes the computer chips embedded in finished smart cards, and a chip
testing system that checks the quality of the smart card integrated chip before
the start of manufacturing. We have only begun limited marketing of these
products, but intend to significantly expand our efforts after the completion of
this offering.
Since the usage of smart cards has experienced strong acceptance and
growth overseas, our sales of both capital equipment and finished smart cards
have been concentrated in foreign markets. We have therefore established
overseas sales offices in China and South Korea. We also have an independent
sales force that currently covers the United Kingdom, France, Italy, Germany and
Argentina.
A smart card is a wallet-sized plastic card that contains an embedded
computer chip. This chip carries accessible data that can be retrieved upon
demand by a "read/write" device or "reader/writer" that processes the
information. Smart cards are capable of integrating a variety of everyday
functions with security features. They are used in numerous applications
including:
o access to restricted areas (replacing keys and identification cards);
o public transportation fare collection (replacing tokens and tickets);
o point of sale purchases (replacing cash or credit cards at cafeterias,
newsstands and other point of sale locations where speed of purchase
is important);
o vending machines;
o public telephones;
o industrial applications such as quality control, warehousing,
inventory control, distribution and warranty;
o health care (replacing patients' paper files in hospitals and HMOs);
and
o cellular phones.
We were incorporated in California in November 1993 under the name
American Pacific Technologies, Inc. and changed our name to Chipcards, Inc. in
August, 2000. Our executive offices are located at Citicorp Center at One
Sansome Street, 19th Floor, San Francisco, California. Our telephone number is
(415) 951-1078 and our fax number is (415) 951-1046.
2
THE OFFERING
Securities offered: 1,000,000 units, each consisting of
one share of common stock and one
common stock purchase warrant which
entitles the holder to purchase one
share of common stock at an exercise
price of $8.40 per share. Upon the
closing of this offering, the shares
of common stock and the warrants
included in the units will be
separately traded.
Common stock outstanding
prior to the offering: 10,641,250 (1)
Common stock outstanding
after the offering: 11,641,250 (2)
Use of Proceeds: We expect to have net proceeds of
approximately $6,764,000 after
payment and deduction of the expenses
of the offering. We intend to use the
net proceeds from the offering to
fund the following:
- purchase of capital equipment;
- project finance;
- construction of an additional
production facility;
- increased sales and marketing
expenditures;
- potential future acquisitions;
- employee recruitment; and
- working capital and other
general corporate purposes.
See "Use of Proceeds" for more detailed
information.
Proposed Nasdaq SmallCap Symbol: CHIP
Proposed Boston Stock Exchange Symbol: CHP
Risk Factors and Dilution: You should carefully consider the
risks of investing in the securities
discussed in the "Risk Factors" and
the matters discussed in the
"Dilution" section before you decide
to purchase units.
Dividend Policy: We do not intend to pay cash
dividends on our common stock in the
foreseeable future. "Dividend Policy"
for more information.
(1) Based on shares outstanding as of December 31, 2000. Does not
include 1,015,000 shares of common stock issuable upon the exercise of
outstanding options issued in May 2001 and 10,000 shares of
3
common stock issuable upon the vesting of contingent stock grants to a sales
representative.
(2) Does not include units issuable upon exercise of the underwriter's
overallotment option, shares of common stock issuable upon the exercise of the
warrants included in the units being offered, or units issuable upon exercise of
the underwriter's warrants.
SUMMARY FINANCIAL INFORMATION
You should read the following summary financial information in
conjunction with our financial statements and related notes, together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". The selected financial data for the years ended December 31, 2000
and December 31, 1999 are derived from our audited financial statements. All of
this financial information is presented elsewhere in this prospectus. The
results of operations during periods presented are not necessarily indicative of
our future operations.
For all of the periods covered by the summary financial information we
have leased our San Diego facility from Ampac Technology LLC, a limited
liability company owned by two of our principal shareholders. From a financial
reporting standpoint, the accounts of Ampac Technology, LLC have been
consolidated with those of Chipcards, based on the joint control and economic
interdependence between these two entities during the relevant periods.
Accordingly, the San Diego property is included as an asset in the balance sheet
data notwithstanding the fact that title is not held by Chipcards. We have
agreed to purchase the San Diego property from Ampac Technology LLC upon the
completion of this offering, at a price of $150,000 plus assumption of existing
liabilities. See "Description of Business - Properties and Equipment."
2000 1999
Revenues $6,453,739 $4,340,156
Loss before Extraordinary Item (325,437) (830,264)
Basic and diluted net loss before extraordinary item per common share (0.03) (0.13)
Net Loss (325,437) (571,307)
Basic and diluted net loss per common share (0.03) (0.09)
Total assets 2,920,881 3,463,589
Long-term debt (excluding current portion) 1,101,163 1,082,473
RISK FACTORS
An investment in our securities involves a high degree of risk. In
addition to the other information contained elsewhere in this prospectus, you
should carefully consider the following risk factors when evaluating an
investment in our securities. Furthermore, our securities should only be
considered for purchase if you can afford the risk of losing your entire
investment.
RISKS RELATED TO OUR BUSINESS
We have a history of operating losses and we may not be profitable in the
future.
Our business is capital intensive. We have incurred, and expect that
we will continue to incur, substantial costs to manufacture our production line
equipment and develop our products and services. We may not achieve
profitability and, if we do achieve profitability, we may not be able to
maintain profitability. We incurred operating losses of $822,293 for the year
ended December 31, 1999 and $345,227 for the year ended December 31, 2000, and
net losses of $325,437 and $521,307 for the years ended December 31, 2000 and
1999.
The planned expansion of our business may require additional capital, and we may
not be able to obtain the necessary funds to operate.
4
We will need the proceeds of this offering in order to implement our
business plan, including the planned expansion of our sales and manufacturing
capabilities. In addition, even if this offering is successful, we may need to
obtain additional funding in order to support our future operating requirements.
We intend to obtain any required funding by increasing our lines of credit or by
raising additional funding from the public or private capital markets. Such
additional funding may not be available on terms acceptable to us, or at all.
Failure to raise additional funding when needed could jeopardize our plans for
growth and our ability to operate our business. If additional funds are raised
through the issuance of equity securities, the ownership percentages of our
stockholders would be reduced. Furthermore, such equity securities might have
rights, preferences or privileges senior to those of our common stock.
Need for Improved Operating Controls.
To improve our results, we must continue to implement and improve our
financial, accounting and management information systems and to hire, train,
motivate and manage new employees. Our failure to improve management controls
would have a material adverse effect on our business and on our ability to
execute our business strategy successfully.
We are subject to risks of doing business in foreign markets.
Although we conduct most of our design, technology and product
development operations in the United States, to date all of our production line
sales and a majority of our smart card sales have been to foreign customers. We
have established overseas offices to support our sales activities, and we intend
to expand our international operations. We expect that international sales will
continue to account for a significant percentage of our net revenue into the
foreseeable future. Accordingly, we are subject to a variety of potential risks,
including:
o political and economic instability;
o the impact of possible recessions in economies outside the U.S.;
o difficulties and costs of staffing and managing foreign operations;
o lack of complete business experience in foreign markets;
o difficulty in enforcing intellectual property rights outside the U.S.;
o tariffs, export controls and other trade barriers;
o potentially adverse tax consequences; and
o language and cultural barriers.
There can be no assurance that we will be able to sustain or increase
international revenues, or that the foregoing factors will not have a material
adverse affect on our future international revenues and, consequently, on our
business. Although a stronger market exists abroad, there is no assurance that
the acceptance of smart card systems in other countries will be sustained. We
face the risk that smart card technologies generally will not be chosen to
replace existing technologies or will not otherwise achieve market acceptance.
There is a risk that our operations could be disrupted and any remedies limited
because we do business in China
5
We anticipate that for the foreseeable future, sales to the Chinese
market will continue to account for a significant percentage of our production
line business and Chinese manufacturers will continue to be a primary source of
finished product for our smart card sales business. As a result, our business is
subject to significant political, economic, taxation, legal and other
uncertainties associated with selling products in China. Over the past several
years, the Chinese government has pursued economic reform policies including the
encouragement of private economic activity, greater economic decentralization
and the opening of markets to foreign businesses. However, changes in the
political environment or government policies could result in revisions to laws,
regulations or the interpretation and enforcement thereof, increased taxation,
restrictions on imports, import duties or currency revaluations. In addition,
any destabilization of relations between China and the United States could
result in restrictions or prohibitions on the sale of products in China, which
would substantially impair our profitability and market position and could
jeopardize our ability to continue our operations.
The legal system of China relating to foreign trade is relatively new
and continues to evolve. There can be no certainty as to the application of its
laws and regulations in particular instances. Enforcement of existing laws or
agreements may be sporadic and implementation and interpretation of laws
inconsistent. Moreover, there is a high degree of fragmentation among regulatory
authorities resulting in uncertainties as to which authorities have jurisdiction
over particular parties or transactions. Even where adequate law exists in
China, it may not be possible to obtain swift and equitable enforcement of that
law.
Our production line installation contracts are generally governed by
Chinese law. Therefore, if we should fail to receive full payment from a Chinese
customer, we may not have any legal recourse within the United States. Even if
we are able to obtain a judgement in the U.S., it may not be collectible in this
country if substantially all of the defaulting party's assets are located
overseas. In such event, we would be required to seek redress within China. This
would entail the various risks inherent in the Chinese legal system, and any
litigation could involve substantial costs. Additionally, any judgments we may
seek or obtain against foreign governments or governmental authorities may be
unattainable or unenforceable due to sovereign immunity. The inability to obtain
a substantial payment or payments could have a material adverse effect on our
business.
We have limited experience in selling our production lines in markets other than
China.
To date, our production line sales have been limited to customers
located in the People's Republic of China. We intend to expand sales of our
equipment in other territories. However, our lack of experience outside of China
may make it difficult for us to penetrate other markets and diversify our
customer base, which could limit our growth potential and cause us to remain
vulnerable to the risks of doing business in China.
Because the market for smart card products is not well developed in the United
States and may not grow, we may be dependent on foreign markets.
Demand for smart card products in the United States at present is
limited. Current participants in the smart card business rely upon anticipated
growth in demand, which may not occur to the extent projected, or at all. The
expansion of the smart card market in the United States may depend on the
ability of market participants to convince potential customers to adopt a smart
card system in lieu of existing or alternative systems such as magnetic stripe
card and paper-based systems. Smart card-based systems may not prove
economically feasible for some potential customers. Moreover, to an extent sales
of smart card
6
products will depend upon emerging communications and commerce networks, such
as the Internet. If growth in the domestic market does not occur, this will
limit our opportunities for growth and will require us to continue to
rely on, and be subject to the inherent risks of, foreign sales.
Our revenues from smart card production lines are restricted due to our limited
manufacturing capacity.
We currently derive a substantial part of our revenue from the
construction of smart card production lines. Since a large part of the assembly
work is done through a subcontractor, we rely on the subcontractor's
manufacturing capacity. At present we can only undertake approximately six
installations at any one time. Each production line takes from four to nine
months to complete. Until we can add internal capacity with the proceeds of this
offering, our capital equipment business will remain dependent on a small number
of customers at any given time.
We rely on contract manufacturers to build our production lines; we have
recently retained a new contract manufacturer.
We rely on a single contract manufacturer to perform most of the
assembly and construction work for our smart card production lines. Although we
intend to add in-house manufacturing capacity with the proceeds of this
offering, this will not eliminate the need to outsource a significant amount of
work. Our success is therefore dependent on the reliability and skill of our
manufacturer. To reduce operating risks, we recently replaced our previous
contractor with a new company which we believe will provide comparable or better
service than our prior contractor. However, the new manufacturer has only
recently begun limited production work for us on a trial basis, and therefore we
do not yet have a sufficient basis for fully evaluating its performance or its
ability to meet our production needs and quality standards. If this manufacturer
fails to perform to our satisfaction, we may not be able to find another
manufacturer in time to meet our delivery schedules, or at all, which could
result in lost sales. Even if our new manufacturer meets all of our
requirements, there is no assurance that we will be able to maintain this
arrangement for any specified period of time. If such arrangement should
terminate for any reason, we would be required to find alternate manufacturers.
Any failure to maintain our manufacturing arrangement on satisfactory terms may
have an adverse effect on our business. We do not maintain insurance against the
failure or inability of manufacturers to supply product.
Even if our current manufacturing arrangement can be successfully
maintained, our reliance on a third party manufacturer involves several
production related risks, including lack of flexibility in controlling levels of
output and limited control over product reliability, safety and quality. If this
manufacturer is unable to meet all future demand and we fail to secure
additional capacity, we could lose sales. Moreover, we may not have the ability
or resources to adequately monitor quality control and safety procedures of our
manufacturer. Failure of our current manufacturer, or any future manufacturer,
to adhere to our product designs and specifications and quality standards could
have a material adverse effect on sales of our products and could increase the
risk of litigation, either of which could have a material adverse affect on our
business.
Because we have a relatively small number of smart card customers, the loss of a
customer could significantly reduce or revenues.
7
We expect that we will continue to depend upon a relatively small
number of customers for a majority of our revenues from the sale of smart cards.
During the year ended December 31, 2000, our five largest customers accounted
for approximately 85 percent or revenues from the sale of smart cards.
Our customers generally do not enter into long term smart card
purchase commitments with us, and most of our arrangements with our large
customers do not provide us with guarantees that purchases will be maintained at
any level. In addition, our customers could reduce or cease their use of our
products as a result of:
o manufacture of products similar to ours by competitors; or
o efforts by our customers to develop their own products.
The loss of a major customer, or significant reductions in sales of
smart cards to any of our largest customers could substantially reduce our
revenues.
We are dependent on third party vendors to provide components for our production
lines.
We are dependent on a large number of third-party vendors to supply
the bulk of the materials and equipment that form the components of our
production lines. We also rely on third parties to supply finished smart cards
for our direct card sales business. In addition, we outsource a substantial
portion of our post-processing and peripheral services, including printing,
magnetic striping and personalization. Our reliance upon third party vendors is
expected to continue and involves several risks, including limited control over
the availability of components and/or product, delivery schedules, pricing and
product quality. Should we lose a significant number of vendors, any delays,
expenses and lost sales incurred in locating and qualifying alternative
suppliers could have a material adverse effect on our business.
We are subject to risks associated with obligations under our capital equipment
contracts.
We are required to provide two of our recent production line customers
with all of the components and raw materials needed for their manufacture of
smart cards. We have agreed to provide such materials at a fixed price per
finished unit. The price is determined based on the quantity of materials needed
to make one card. We may not be able to obtain all of the raw materials we are
contractually obligated to supply, particularly in view of a continuing shortage
of the leading type of smart card microprocessor. Moreover, if our cost of
sourcing smart card raw materials exceeds the fixed price at which we have
agreed to sell them to our customers, we will incur a loss.
Our ability to purchase smart cards is limited by our reliance on limited
sources of supply.
8
At present, we do not have any in-house capability to manufacture
smart cards. Therefore, we must rely on third party suppliers to meet our
requirements for cards. Currently, our sole sources of supply are two customers
to which we have sold production lines. We have entered into agreements under
which we have the right to buy smart cards from these customers at agreed prices
for a period of three years. Quantities will be based on our forecasted
requirements. These arrangements are expected to give us a stable source of
supply, and we believe that the prices we have negotiated are competitive under
current market conditions. We may not be able to continue these arrangements
beyond the three-year period during which they will be in effect. In addition,
there is no assurance that the manufacturers will comply with their obligations
to sell us cards on the agreed-upon terms, or at all. Since the manufacturers
are both located in China, any efforts to enforce our rights could be very
costly and would be subject to the risks of litigation or arbitration in a
foreign jurisdiction. The loss of any supplier could materially affect our
ability to maintain an adequate inventory of finished cards and to sell smart
card products at competitive prices.
Because of a worldwide shortage of microprocessors, we have experienced, and may
continue to experience, a shortage in supply of smart cards.
Since the third quarter of 1999, there has been a worldwide shortage
in the supply of Mifare microprocessors, which is the predominant type of
microprocessor for smart card systems. This has had a material impact on our
smart card sales. We presently depend on our production line customers as our
sole source of finished cards. We are obligated to provide these customers with
the components needed to manufacture cards, including microprocessors. Because
of the Mifare shortage, we have been unable to obtain adequate microprocessors
for our customers, which in turn has restricted our supply of cards and exposes
us to claims for damages. As a result, we have been forced to substantially
curtail fulfillment of orders beginning in January 2000. This has caused
cancelled orders and impeded our ability to expand smart card sales.
Approximately $80,000 of card orders were cancelled during the year ended
December 31, 1999 and approximately $443,000 of orders were cancelled during the
year ended December 31, 2000. We incurred losses from the sale of smart cards of
$163,000 and $126,000 in 2000 and 1999.
We are seeking to address the microprocessor shortage and currently
have non-binding written commitments from Philips and non-binding verbal
commitments from Infineon Technologies to sell us substantial quantities of
Mifare microprocessors for 2001. However, we have no assurance that these
commitments will be fulfilled for the maximum quantity, or at all. Even if these
commitments are fulfilled, we will not have sufficient units to meet the
requirements of our manufacturers, and we may not be successful in securing
additional sources of microprocessors. Although alternatives to the Mifare
platform are now available, this will not materially alleviate our shortage of
supply, since over 90 percent of our customers still use smart card systems that
require Mifare platform cards.
Our future success depends on our ability to keep pace with technological
changes.
The smart card industry is subject to rapid technological change. The
emerging markets for our products and services is characterized by rapid
technological developments and evolving industry standards. These factors will
require us to continually improve the performance features of our products and
services and to introduce new and enhanced products and services at competitive
prices and as quickly as possible, particularly in response to offerings from
our competitors. As a result, we will be required to expend substantial funds
for, and commit significant resources to, continuing product development. We may
not be successful in developing and marketing new products and services that
respond to competitive and technological developments and changing customer
needs. Any failure by us to anticipate or respond adequately to technological
developments, customer requirements, or new design and production
9
techniques, or any significant delays in product development or introduction,
could have a material adverse impact on our business.
We operate in highly competitive markets.
For both our production line and smart card sales businesses, the
markets in which we operate are intensely competitive and characterized by
rapidly changing technology. We cannot assure you that our business will respond
successfully to competitive pressures. Many of our current and potential
competitors in both the capital equipment and direct card sales sectors include
well-established companies, many of which have longer operating histories in the
smart card industry and significantly greater financial, technical, sales,
customer support, marketing, research and development and other resources, as
well as greater name recognition and a larger installed base of their products
and technologies than us. Additionally, there can be no assurance that new
competitors will not enter our business segments. Competition has resulted in
price reductions, and increased competition would likely result in additional
price reductions, reduced margins and loss of market share, any of which would
have a material adverse effect on our business. We experience competition from
a number of companies across our range of businesses.
Our technology is not patented and we may not be able to adequately protect our
proprietary rights.
We have filed three Provisional Patent Applications in the United
States with respect to certain designs and processes used in the manufacture of
our production lines. We intend to file corresponding non-provisional patent
applications in order to continue pursuing patent protection for these
inventions. There is no assurance, however, that we will be successful in
obtaining patents for any of the inventions claimed in these applications. We
currently do not have any issued patents. Furthermore, we do not have any
registered trademarks for any of our products nor any registered copyrights for
any of the computer programs we have developed.
We seek to establish and protect the proprietary aspects of our
products by relying on applicable patent, copyright, and trade secret laws and
on confidentiality and other contractual arrangements, all of which may afford
only limited protection. Notwithstanding our efforts to protect our proprietary
rights, it may be possible for unauthorized third parties to copy certain
portions of our products or to reverse engineer or obtain and use technology
that we regard as proprietary. In addition, the laws of certain countries in
which we sell our products do not protect our proprietary rights to the same
extent as do the laws of the U.S. Accordingly, there can be no assurance that we
will be able to protect our proprietary technology against unauthorized copying
or use, which could adversely affect our competitive position.
Our products and technologies incorporate subject matter that we
believe is in the public domain or is otherwise within our right to use, such as
products and technologies designed and provided by third parties. There can be
no assurance, however, that third parties will not assert patent or other
intellectual property infringement claims against us with respect to their
products and technologies. Regardless of its merit, any such claim can be
time-consuming, result in costly litigation and require us to enter into royalty
and licensing agreements. Such royalty or licensing agreements may not be
offered or be available on terms acceptable to us. If a successful claim is made
against us and we fail to timely develop or license a substitute technology, our
business could be materially adversely affected.
10
We are dependent on current management and key personnel.
We anticipate that significant and rapid expansion of our operations
will be required to address potential growth in our customer base and market
opportunities. This is expected to place a significant strain on our management,
operational and financial resources. Currently, we have nineteen employees in
the U.S. and abroad, including six officers and/or significant employees. We are
substantially dependent on the continued services and performance of these
employees, and will remain so dependent in the foreseeable future. The loss of
services of any such key employee or the inability of any of them to devote
sufficient time to their duties could have a material adverse effect on our
business.
We have entered into three-year employment agreements with our
President and our Executive Vice President. See section entitled "Management -
Employees." However, there is no assurance that these officers or any other key
personnel will remain with us for any specified period of time.
Our future success may also depend on our ability to identify,
attract, hire, train, and retain other highly skilled technical, sales and
marketing personnel. Competition for such personnel is intense, and there can be
no assurance that we will be able to successfully attract and retain
sufficiently qualified personnel. The failure to hire and retain the necessary
personnel could have a material adverse effect on our business.
Product defects.
Our production line products contain complex machinery that may
contain undetected defects in design or in components we purchase from third
parties, including software errors or hardware defects that could be difficult
to detect and correct when first introduced or as new versions are released.
There is no assurance that, despite testing by us and customers, errors will not
be found in new or enhanced products after commencement of commercial shipments.
Moreover, there can be no assurance that once detected, such errors can be
corrected in a timely manner, if at all. Software errors may take several days
to correct, if they can be corrected at all, and hardware defects may take even
longer to rectify. The occurrence of any such software, hardware or other
errors, as well as any delay in correcting them, could result in delays in
shipment of products, loss of market acceptance of our products, additional
warranty expense, diversion of engineering and other resources from our product
development efforts or the loss of credibility with our customers, any of which
could have a material adverse effect on our business. In addition, we could face
potential litigation if any malfunction or defect in our equipment is claimed to
cause injury to persons or property.
In addition to purchasing components for our production lines, we are
currently required to source components for two card manufacturers. Defects can
also occur in the microprocessors and other
11
components we purchase for these manufacturers, and there is no assurance that
we will be able to detect potential problems before providing the components to
our customers.
Litigation risks.
We may be subject to litigation risks arising out of our two initial
capital equipment contracts entered into in 1998 and 1999. Under these
contracts, we agreed to buy smart cards from, and to source raw materials for,
the manufacturer after installation was completed. Because of a worldwide
shortage of microprocessors, we have been unable to obtain the required raw
materials for these customers One of these customers brought an arbitration
proceeding in China seeking damages for breach of contract. Although this action
was dismissed, this party could attempt to bring additional claims against us in
the future. In addition, our other initial customer could seek to claim that we
are obligated to resume supplying raw materials, or that it is entitled to
damages for our failure to perform our contractual obligations. If any such
claims are successful, we may ultimately become obligated to pay damages, or to
provide raw materials to, and purchase cards from, these customers. We may also
be subject to similar claims by our new capital equipment customers if we are
unable to provide them with raw materials once their production lines are
installed and operational. Any potential litigation, whether or not ultimately
found to be meritorious, could consume significant resources and affect our
ability to carry on normal operations.
The expansion of our business could strain our capacity.
The proposed expansion of our sales and manufacturing operations will
require the implementation of enhanced operational and financial systems and
will require additional management, operational, financial and personnel
resources. Failure to implement these systems and add these resources could have
a material adverse effect on our operations. Given our limited number of
employees and lean infrastructure, there is no assurance that we will be able to
manage our expanding operations effectively or that we will be able to maintain
or accelerate our growth. We may not be able to attract and hire persons with
the appropriate talents, skills and experience needed to grow our business,
particularly if we do not strengthen our financial position. In addition, there
can be no assurance of the viability of our products in new geographic regions
or particular local markets.
Our expansion plans include the addition of in-house capacity to
assemble production lines. Due to our historical reliance on contract
manufacturers, we have limited experience in performing assembly work. The
anticipated efficiencies of creating internal capability may not be achieved if
we fail to successfully implement our future manufacturing operations.
We may experience fluctuations in our quarterly operating results.
We expect to experience significant fluctuations in our future
quarterly operating results due to a variety of factors, many of which are
outside our control. Our production line installation contracts generally
require us to incur substantial costs in advance of payment. Thus quarterly
results can fluctuate based on the timing and amount of such expenditures and
payments. Furthermore, we defer recognition of profits on our installation
contracts until we are assured of cash payment. We also defer recognition of a
portion of our revenues on equipment sales if we own a joint venture interest in
the customer or if we are obligated to purchase the customer's finished smart
cards. These accounting practices can result in further fluctuations in our
quarterly results.
12
Additional factors that may adversely affect our quarterly operating
results include: (i) our ability to retain and attract customers; (ii) the level
of competition in the smart card industry; (iii) our ability to upgrade and
develop our products and technology and attract new personnel in a timely and
effective manner; (iv) the amount and timing of operating costs and capital
expenditures relating to expansion of our business, operations and
infrastructure; (v) the emerging nature of the markets in which we compete; and
(vi) general economic conditions and economic conditions specific to the smart
card industry.
RISKS RELATED TO THIS OFFERING
No public market; the market price of our common stock may fluctuate
significantly; immediate and substantial dilution.
There is no public market for our common stock and there can be no
assurance that an active public market for our common stock will develop or be
sustained after this offering. The stock market in general and the market for
shares of technology companies in particular have recently experienced extreme
price fluctuations, which have often been unrelated to the operating performance
of the affected companies. We believe that the principal factors that may cause
price fluctuations are:
o fluctuations in our financial results;
o general conditions or developments in the technology and smart card
products industries and the worldwide economy;
o sales of our common stock into the marketplace;
o the number of market makers for our common stock;
o announcements of technological innovations or new or enhanced products
by us or our competitors or customers;
o announcements of major contracts by us or our competitors;
o a shortfall in revenue, gross margin, earnings or other financial
results from operations; and
o developments in our relationships with our customers and suppliers.
We cannot be certain that the market price of our common stock will
not experience significant fluctuations in the future, including fluctuations
that are adverse and unrelated to our performance. To the extent that the
trading volume of our securities is low, this may increase the risk that the
market price will be affected by factors such as those described above, among
others.
All of the currently outstanding shares of common stock were issued at
prices substantially lower than the price of the shares included in the units
offered hereby. Purchasers of units offered hereby will experience immediate and
substantial dilution in net tangible book value with respect to the shares
included in such units and may incur additional dilution upon the exercise of
outstanding stock options. See Section entitled "Dilution."
Control by principal shareholders, officers and directors.
Prior to and upon completion of this offering, a significant
percentage of the outstanding common stock will be beneficially owned by our
directors, officers and principal stockholders and affiliates. As a result, upon
completion of this offering, you may not be able to (i) elect, or defeat the
13
election of, the directors, (ii) amend or prevent amendment of the Articles of
Incorporation or Bylaws, or (iii) effect or prevent a merger, sale of assets or
other corporate transaction. You will not be able to control the outcome of
these or any other matters submitted to a vote of the stockholders unless you
and other investors can exercise more than 50% of the outstanding voting power.
A limited exception exists in the election of directors, since shareholders are
entitled to a number of votes equal to the total amount of shares owned by the
holder multiplied by the number of directors to be elected. Such cumulated
number of votes can be cast for any one or more directors. This generally makes
it easier for a minority group of shareholders to elect a director of their
choosing. However, in any given election, voting may still be controlled by the
officers, directors and principal stockholders notwithstanding the existence of
cumulative voting rights. Accordingly, you should not purchase units offered
herein unless you are willing to entrust all aspects of the affairs of our
company to our current management.
Future sales of our common stock by our existing stockholders could
have adverse effects on the market price of our common stock.
As of May 18, 2001, all of the 10,641,250 shares of our common stock
currently issued and outstanding will be eligible for sale under Rule 144
promulgated under the Securities Act of 1933, provided the conditions thereof
are met, and subject to the volume limitations imposed thereunder. This does not
include the shares of common stock that may be sold under this prospectus. Any
sale of the shares being registered or any sales under Rule 144 could cause the
market price of our common stock to drop significantly, even if our business is
doing well. All of our current shareholders will be subject to "lock-up"
agreements pursuant to which these persons will agree not to sell or otherwise
transfer any shares for a period of twelve months after the date of this
prospectus except with the prior written consent of the underwriter.
Determination of the offering price
The offering price of the units was determined in negotiations between
us and the underwriter based upon such factors as our financial needs, estimates
of our business potential, the stage of development of our business and the
general condition of the securities market. The offering price should not,
however, be considered an indication of the actual value of our company or our
securities. The offering price does not bear any relationship to the assets, net
worth, results of operations, other objective criteria of value applicable to
our company. Moreover, the offering price should not be viewed as an indication
of the future value of the shares or the warrants included in the units.
Accordingly, there can be no assurance that the shares or the warrants included
in the units offered hereby can be resold at the offering price, if at all.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains statements about future events and
expectations which are characterized as forward-looking statements.
Forward-looking statements are based on our management's beliefs, assumptions
and expectations of our future economic performance, taking into account the
information currently available to them. Because of this, you should not rely
too extensively on such forward-looking statements contained in this prospectus.
These forward-looking statements involve known and unknown risks, uncertainties
and other factors which may cause our actual results, levels of activity,
performance or achievements, or industry results, to be materially different
from any future results, levels of activity, performance or achievements
expressed or implied by these forward-looking statements. Some
14
of these forward-looking statements can be identified by the use of
forward-looking terminology including "believes," "expects," "may," "will,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategies that involve risks and
uncertainties. You should read statements that contain these words carefully
because they:
o discuss our future expectations;
o contain projections of our future operating results or of our future
financial condition; or
o state other "forward-looking" information.
We believe it is important to communicate our expectations to you, but
events may occur in the future over which we have no control and which we are
not accurately able to predict. We assume no obligation to publicly update or
revise these forward-looking statements for any reason, or to update the reasons
actual results could differ from those anticipated in these forward-looking
statements, even if new information becomes available in the future.
USE OF PROCEEDS
Our net proceeds from the sale of the units being offered in this
offering at an assumed public offering price of $8.10 per unit are estimated to
be $6,764,000, after deducting the 8% underwriting discount, the two and
one-half percent non-accountable expense allowance payable to the underwriter,
$120,000 payable to the underwriter for services under a consulting agreement,
and an additional $365,500 in estimated offering expenses payable by us. This
assumes that the underwriter's over allotment option is not exercised. If the
underwriter's over allotment option is exercised in full, our net proceeds are
estimated to be $7,851,425.
We intend to use the net proceeds as described in the following table:
Approximate Dollar Approximate
Amount of Net Proceeds Percentage
---------------------- -----------
Capital Equipment (1) $2,600,000 38.4%
Project Financing (2) 2,000,000 29.6%
Machinery & Equipment (3) 500,000 7.4%
Additional Facilities(4) 350,000 5.2%
Product Development 250,000 3.7%
Advertising & Marketing 200,000 3.0%
Purchase of Real Property (5) 150,000 2.2%
General working capital 714,000 10.5%
---------- ------
Total $6,764,000 100%
========== ======
(1) Installation of a smart card production line at our San Diego
facility. This equipment will be designed to produce 2,000 contactless
cards per hour, with complete magnetic striping and printing
capabilities.
(2) Represents cash requirements associated with the manufacture of
production lines for sale to current customers.
15
(3) Expansion of in-house capabilities for manufacture of capital
equipment.
(4) Includes costs of opening and publicizing new Sales/Representative
offices.
(5) Represents the cost of purchasing the San Diego facility from two of
our principal shareholders. This facility and related debt are
included in the consolidated financial statements for the year ended
December 31, 2000.
The working capital amounts will be dedicated to general corporate
purposes, including salaries and general and administrative expenses. Our
management will have broad discretion concerning the allocation and use of a
significant portion of the net proceeds of this offering. In the event the
representative of the underwriters exercises the over-allotment option, we
intend to utilize such additional proceeds for working capital and general
corporate purposes.
We reserve the right to reallocate proceeds to different uses,
including ways which differ from the specific proposed uses described in this
prospectus if management determines the needs of the business so require. In
addition, a large portion of the proceeds is allocated to discretionary
purposes. Investors may not agree with the allocation or reallocation. Based on
our operating plan, we believe that the net proceeds of this offering, together
with available funds on hand and cash flow from future operations, will be
sufficient to satisfy our working capital requirements for at least 12 months
following this offering. Our belief is based upon assumptions, including
assumptions about our contemplated operations and economic and industry
conditions. In addition, contingencies may arise that may require us to obtain
additional capital.
We cannot be sure that we will be able to obtain additional capital on
favorable terms or at all. Until the net proceeds of this offering are used, we
intend to invest the net proceeds in short-term, interest-bearing, investment
grade securities or similar quality investments.
DIVIDEND POLICY
On April 18, 2000, we declared a stock dividend for each holder of
record of shares of common stock as of March 18, 2000 (the "Record Date") in the
amount of 2.65 shares of fully paid and nonassessable common stock for each
share of common stock held by such holder as of the Record Date. We have not
paid any cash dividends on our common stock and do not anticipate paying any
cash dividends in the foreseeable future. Our dividend policy is to retain
earnings, if any, to support the expansion of our operations. If we were to
change this policy, any future cash dividends would depend upon factors which
our board of directors deems relevant, including, without limitation, future
earnings and our estimated capital requirements.
DILUTION
Investors purchasing common stock in this offering will incur an
immediate and substantial dilution in net tangible book value per share.
Accordingly, investors will bear a disproportionate part of the financial risk
associated with our business while effective control will remain with existing
stockholders. Assuming the maximum number of units are sold (excluding the
overallotment option), investors in this offering will collectively own
1,000,000 shares of our common stock or approximately 8.6% of the outstanding
shares, for which they will have paid $8,000,000 or $8.00 per share, and
warrants to purchase 1,000,000 shares of common stock, for which they will
have paid $0.10 per warrant (assuming that $0.10 is attributed to each warrant
included in the units offered hereby and no exercise of the underwriter's
warrants).
At December 31, 2000, we had a negative net tangible book value of
$1,747,294 and a negative net tangible book value per share of $0.16. "Net
tangible book value per share" represents our total tangible assets less our
total liabilities, divided by the number of shares of common stock outstanding
16
or issuable upon the exercise of outstanding warrants, options and contingent
rights. Our San Diego facility is included as an asset for purposes of
determining total tangible assets, despite that fact that title is formally held
by two of our principal shareholders, because this property is consolidated for
financial statement purposes. (See "Management's Discussion and Analysis of
Financial Condition" for further explanation.) After giving effect only
to the sale of 1,000,000 shares (which are part of the units) offered hereby,
the reduction of the underwriter's commission and associated estimated
offering expenses associated with the entire offering, and the use of the
proceeds of the offering described in the "Use of Proceeds", our pro forma
net tangible book value at December 31, 2000 would have been approximately
$5,016,706 or $0.43 per share. This represents an immediate increase in net
tangible book value per share of $0.59 to existing stockholders and an
immediate dilution of $7.57 per share to the investors purchasing shares of
common stock at the initial public offering price. The following table
illustrates this dilution in net tangible book value to new investors:
Initial public offering price per share of common stock $ 8.00
Net tangible book value per share before offering $ (0.16)
Increase per share attributable to new investors $ 0.59
-------
Pro forma tangible book value per share after offering $ 0.43
-------
Dilution to new investors $ 7.57
=======
The following table sets forth, as of December 31, 2000, the number of
shares of common stock purchased from us, the effective cash contribution made,
and the average price per share paid by existing stockholders and by new
investors purchasing shares sold by us in the offering at an assumed initial
offering price of $8.10/unit and $0.10 per warrant.
Shares Purchased Total Consideration Average
Price Per
Number Percent Amount Percent Share
------ ------- ------ ------- -----
Existing stockholders 10,641,250 91.4% $581,600 6.7% $0.05
New investors 1,000,000 8.6% $8,100,000 93.3% $8.10
--------- ----- ---------- ----- ------
Total 11,641,250 100% $8,681,600 100% $0.75
========== ===== ========== ===== ======
17
CAPITALIZATION
The following table sets forth the current portion of long-term debt
and other short-term debt obligations and the consolidated capitalization as of
December 31, 2000, on an historical basis and on a pro forma basis, adjusted to
reflect the sale of the units offered in this registration statement and the
application of the estimated net proceeds as described in "Use of Proceeds".
This table should be read in conjunction with the consolidated financial
statements and related notes, and the notes to the financial statements included
elsewhere in this prospectus.
AS OF DECEMBER 31, 2000
ACTUAL AS ADJUSTED
DEBT:
Long-Term Debt (including current maturities)...... $ 1,129,233 $ 1,129,233
Short Term Advances ............................... 14,500 14,500
---------- ----------
Total debt.................................... $ 1,143,733 $ 1,143,733
STOCKHOLDERS' EQUITY:
Common Stock, no par value,
25,000,000 shares authorized;
10,641,250 shares issued and
outstanding and 11,641,250
shares pro forma as adjusted(1)............... $ 685,100 $ 7,349,100
Accumulated Deficit................................ (2,432,394) (2,332,394)
----------- -----------
Total stockholders' equity (deficit).......... $(1,747,294) $ 5,016,706
----------- -----------
Total capitalization.......................... $ (603,561) $ 6,160,439
=========== ===========
(1) Pro forma share amount does not give effect to: (i) any exercise
of the underwriter's overallotment option (ii) any exercise of the warrants
purchased in this offering, (ii) any exercise of the underwriter's warrants, or
(iii) any exercise of currently outstanding warrants, options or other
contingent rights.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
The following discussion and analysis should be read in conjunction
with the consolidated financial statements, including the notes thereto,
appearing elsewhere in this prospectus. The following discussion and analysis
contains certain "forward-looking statements" (as defined in Section 27A of the
Securities Act of 1933), which are generally identified by the words
"anticipates," "believes," "expects," "plans," "intends," and similar
expressions. Such statements are subject to certain risks, uncertainties and
contingencies, including, but not limited to, those set forth under the heading
"Risk Factors" and elsewhere in this prospectus, which could cause our actual
results, performance or achievements to differ materially from those expressed
in, or implied by, such statements. See "Special Note Regarding Forward-Looking
Statements."
NOTWITHSTANDING THE FOREGOING, THE SAFE HARBOR PROVISIONS OF SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934 DO NOT APPLY TO THIS REGISTRATION STATEMENT.
Background
Our revenues have historically been derived principally from the sale
of smart card production lines and, to a lesser extent, the direct sale and
marketing of smart cards. We have also developed certain ancillary smart card
products, including a reader/writer for use in security systems, a card testing
and initialization system, and a smart card chip testing system. However, we
have only begun limited marketing activities and have not produced significant
revenues from these products. In addition, while we have historically generated
revenues from the sale of smart card raw materials to purchasers of our capital
equipment, we do not consider this to be a part of our core business. In
general, we engage in the sale of raw materials only at our customers' request.
In 1997 we first applied our expertise in factory automation to the
design and assembly of smart card production lines. We began generating revenues
from production line sales in 1998. Our capital equipment revenues are a
function of our ability to secure contracts for the sale of production lines and
produce equipment that meets our customers' requirements on a timely basis.
Installation contracts generally provide for payment to be made in the final
stages of a project. Our revenue stream is therefore subject to periods of
fluctuation based on the timing of project commencement and the length of
production. Seasonal factors generally do not have a material effect on our
operations. To date, all of our capital equipment revenues have come from
international sales. Our past and current customers are all based in China, a
market in which we had earlier conducted business as a manufacturer of
electromagnetic components. Our future revenues will be affected in part by our
ability to penetrate other geographic markets and diversify our customer base.
Our ability to generate production line revenues is limited by our
capacity and the capacity of our contract manufacturer. Each smart card
production line takes between four to nine months to complete, and at present,
we can only undertake approximately six installation projects at any one time.
We plan to expand our capacity and decrease our dependence on contract
manufacturers by hiring additional qualified engineering and technical personnel
and installing additional in-house adding testing equipment and other machinery
used in the production process.
19
We recognize revenues from long-term installation contracts on the
percentage-of-completion method. This means that, at any given date, revenues
are measured by the percentage of actual costs incurred to date relative to
then-current estimated total costs to be incurred on the contract. Due to
historical renegotiation of contract terms with our Chinese customers, the
actual profit from a contract cannot be reasonably estimated until payment is
received. Therefore, profit is estimated to be zero until we can be assured of
collection of profit based on cash receipts. If a loss under a contract is
estimated it is recorded in the first period known. Accordingly, equal amounts
of revenue and costs are recognized until final payment is received. Further,
we defer revenue on equipment sales to customers in which we receive a joint
venture equity interest in the entity acquiring the equipment. The deferral
amount is the percentage of our equity interest multiplied by total gross
profit. The deferral is then amortized to revenue over the term of the joint
venture. We defer revenue on equipment sales in a similar fashion when we are
obligated to purchase a customer's finished smart card output.
In our smart card sales sector, we began receiving revenues during the
1999 fiscal year. This revenue stream has been adversely affected by a shortage
of cards. Our sole sources of smart cards from1999 through the end of 2000 were
two manufacturers in China which had previously purchased capital equipment from
us. We were responsible for procuring raw materials for these manufacturers. A
critical component was the Mifare platform microprocessor, which is the most
widely used integrated chip for smart card applications. Beginning in the third
quarter of 1999, we were unable to obtain adequate quantities of these
microprocessors because of a worldwide shortage in supply. As a result, we had
to curtail fulfillment of orders, and customers began to cancel orders.
Approximately $80,000 of card orders were cancelled during the year ended
December 31, 1999 and approximately $443,000 of orders were cancelled during the
year ended December 31, 2000. We incurred losses from the sale of smart cards of
$163,000 and $126,000 in 2000 and 1999.
We believe that, with the recent installation of three production
facilities for two new customers, we will be able to partially address our
shortage of smart cards. The purchasers of these facilities have given us the
right to buy smart cards at a fixed price per card over a period of three years,
based on our forecasted requirements. We are still obligated to source raw
materials (including integrated chips) for these plants as requested by the
customer at fixed prices. However, various alternatives to the Mifare
microprocessor are now available, and our equipment has the capability to
accommodate these new platforms as well as the Mifare platform. We believe
that as non-Mifare platforms gain acceptance by operators of smart card systems,
the risk of microprocessor shortages will be alleviated by allowing us to seek
alternate sources of supply. However, this will not materially alleviate our
shortage of supply in the short term, since over 90 percent of our customers
still use smart card systems that require Mifare cards. We have secured
non-binding written commitments from Philips to sell us approximately 1.7
million Mifare microprocessors by June 30, 2001, of which approximately 450,000
units have been delivered to date. We also have a non-binding verbal
commitment from Infineon Technologies to sell us 500,000 Mifare microprocessors
per month from June through August of 2001 and 1 million per month from
September through December of 2001. If we receive these microprocessors, we
believe we will have sufficient units to meet outstanding orders. However, there
is no assurance that this quantity will be provided. If we receive fewer units
than anticipated from Philips and Infineon, we will need to secure other
sources. Any inability to do so could result in a loss of customers and our
ability to generate revenues from smart card sales could be materially affected.
In addition, we could face claims for damages resulting from our failure to meet
orders.
Our plans for growth include expanding our international sales force,
increasing our capital equipment production capacity and creating in-house
capacity for smart card production. We plan to
20
expand our customer base for smart card sales by acting as a supplier of cards
for the chip manufacturers who are promoting new smart card platforms. We also
intend to actively market our ancillary smart card products, including a keyless
home security system based on our reader/writer technology. In addition, we plan
to develop and promote new technologies including cards that can be used in GSM
(Global System for Mobile Communications) chip-based cellular telephone systems.
Key developments during fiscal year 2000 include entering into
contracts providing for the installation of three new production lines. All of
these lines have been installed and successfully tested, and the customers have
begun card production. In 2001 we entered into a contract providing for the
installation of two new production lines. We expect that these lines will be
delivered by year end 2001.
During 2000, we also completed the development of our read/write
device designed from use in security systems or as a developer's kit, and we
developed a prototype card handling system for testing and initializing the
computer chips used in smart cards. We also developed a smart card chip testing
system used to inspect integrated chips before the start of manufacturing.
For all of the periods covered by the financial statements included in
this prospectus, we have leased our San Diego facility from Ampac Technology
LLC, a limited liability company owned by two of our principal shareholders.
From a financial reporting standpoint, the accounts of Ampac Technology, LLC
have been consolidated with those of Chipcards, based on the joint control and
economic interdependence between these two entities during the relevant periods.
Accordingly, the San Diego property is included as an asset, and related bank
debt is included as a liability on the consolidated balance sheets
notwithstanding the fact that title is not held by Chipcards. We have agreed to
purchase the San Diego property from Ampac Technology LLC upon the completion
of this offering, at a price of $150,000 plus assumption of existing
liabilities of approximately $1.1 million. See "Description of Business -
Properties and Equipment."
Results of Operations
Comparison of Years Ended December 31, 2000 and December 31, 1999
Total revenues for the year ended December 31, 2000 were approximately
$6.5 million, an increase of 49 percent from $4.3 million in 1999. This included
approximately $5.4 million of revenue from production line sales in 2000
compared to $1.5 million in 1999. In connection with our production line sales,
we recorded revenue of approximately $138,000 from the sale of raw materials in
2000 and $1.5 million in the prior year. We also received approximately $960,000
of revenue from finished smart card sales in 2000 compared to $1.3 million in
1999. Production line sales increased substantially as we improved our
competitive position through more favorable pricing. We also believe that we
benefitted from having implemented improvements to our manufacturing processes
during 1998 and 1999, which resulted in increased efficiency, flexibility and
quality in our production machinery. Smart card sales declined primarily as a
result of a worldwide shortage in smart card microprocessors using the Mifare
platform (which is the most widely used platform for smart card applications).
To date we have bought cards only from our production line customers, and we are
required to provide these customers with requested quantities of the raw
materials needed to manufacture cards. The microprocessor shortage has limited
our ability to supply our manufacturers, which in turn has curtailed our supply
of finished cards. For the year ended December 31, 2000, this resulted in the
cancellation of approximately $443,000 of smart card orders from customers who
required Mifare cards. Cancelled orders in 1999 totaled approximately $80,000.
21
Our cost of sales for the year ended December 31, 2000 was
approximately $5.0 million, an increase of 54 percent from $3.2 million in the
prior year. This included production line cost of sales of approximately $3.8
million in 2000 compared to $550,000 in 1999, and smart card cost of sales of
approximately $1.1 million in 2000 compared to $1.4 million in 1999. Overall,
the increased cost of sales reflects the fact that we commenced work on three
new production line orders in 2000. In addition, we performed work on additional
production line orders for which work had commenced in 1999. However, smart card
cost of sales declined primarily due to the fact that in 1999 we focused on, and
dedicated resources to, developing the sales and marketing of cards in order to
establish this as a core business.
Our gross profit for the year ended December 31, 2000 was
approximately $1.5 million, representing an increase of 32% from a gross profit
of $1.1 million for the prior year. This is due primarily to increased profits
from our production line business. Our gross margin was 23 percent for the year
ended December 31, 2000, compared to a gross margin of 26 percent for the prior
year. Broken down by product offerings, we had gross margins of 29 percent on
production line sales and negative 17 percent on smart card sales in the year
ended December 31, 2000, and we had gross margins of 64 percent on production
line sales and negative 10 percent on smart card sales in the year ended
December 31, 1999. Margins on production line sales decreased because we decided
to offer more favorable pricing on our installation contracts in order to
improve our competitive position and generate increased sales. Further, we
recognized a portion of the deferred profit on production line contracts
completed in late 1998 and early 1999, with no associated costs. The deferral
resulted from our contractual requirement to purchase the finished smart card
output from these customers. Margins on smart card sales also declined because
of a decision to offer competitive pricing in order to maintain market share.
General and administrative expenses for 2000 were approximately $1.7
million, compared to approximately $1.1 million for the prior year. This
resulted primarily from the strengthening of our support functions. Selling
expenses for 2000 were approximately $120,000, compared to $760,000 in the prior
year. This decline was due primarily to a restructuring of our compensation
structure resulting in the significant reduction of commissions to employees. We
did not incur any direct research and development costs in fiscal 2000. All of
our research and development activities during this period were conducted in
connection with specific installation work, and employee time allocated to these
activities was included in cost of sales. Research and development expenses for
the year ended December 31, 1999 were approximately $99,000, reflecting our
focus on enhancing our production equipment.
Other income includes approximately $181,000 in recovery of previously
written-off accounts receivable.
Income taxes represent United States Federal and State income taxes on
taxable income. Taxable income includes gross revenue on percentage of
completion contracts which is partially deferred for book purposes resulting in
deferred tax assets. We have set up an allowance against the deferred tax
assets.
22
Liquidity and Capital Resources
We rely on a combination of equity capital, short-term bank financing
and internationally-generated cash flows from sales of equipment and smart cards
to fund our ongoing operations. In fiscal 2000 we raised aggregate gross
proceeds of approximately $575,000 from a private placement of our common stock.
This cash was used primarily to pay operating costs including expenses
associated with building production lines, and to establish working capital for
ongoing requirements.
As of December 31, 2000, we had outstanding short-term indebtedness
pursuant to various line of credit agreements in the amount of $14,500. We
currently have no material outstanding indebtedness other than purchase property
mortgages on our San Diego property in the amount of approximately $1.12
million.
At present, our primary commitments for capital expenditures are the
costs of production line assembly. The timing of our capital equipment costs and
revenues is linked to the completion of projects. We typically receive the bulk
of our payment for installation contracts upon delivery and acceptance of
equipment. Therefore, during the assembly stage, we may incur substantial
expenditures without corresponding cash receipts, creating potential cash flow
shortages. We currently have commitments to complete two installation projects
over the next nine months, which will require estimated capital expenditures of
$2.0 million in the aggregate.
In order to meet our liquidity requirements for current projects, we
have secured a line of credit with Trans Pacific National Bank, backed by a
guarantee from the Export-Import Bank of the United States. The line of credit
allows us to borrow up to $1.95 million for working capital purposes. Advances
are available to finance installation projects secured by our receipt of standby
letters of credit from equipment purchasers. Borrowings cannot exceed 90% of the
value of all outstanding letters of credit. We will seek to increase this line
of credit to reflect our increased capital equipment business, as we expect that
letters of credit having an aggregate value of over $12 million will be issued
over the course of the next 12 months in connection with current projects. We
believe that we will be able to meet our present commitments through a
combination of increasing our credit line and allocating a portion of the
proceeds from this offering.
Operating cashflows were a net use of cash in 1999 of approximately
$1.8 million and a source of cash in 2000 of approximately $170,000. The
difference represents the timing of inventory build-up in 1999 using cash of
approximately $1.1 million and ultimate sale in 2000 resulting in sources of
cash of approximately $150,000.
We expect that our requirements for working capital and liquidity will
increase as a result of our undertaking to provide raw materials to two
companies which recently purchased production lines from us. We have agreed to
obtain raw materials for these customers over a three-year period at a fixed
price per card. These parties have purchased a total of three production lines
which, at full capacity, could manufacture a total of 18 million cards per year.
Thus we could be required to supply substantial quantities of microprocessors
and other components for these factories. One of the manufacturers has the right
to offset all or a portion of its payment obligation for the purchase of raw
materials against the price of finished cards to be sold to us in the future.
This will further impact our liquidity by extending the time between purchasing
raw materials and receiving payment. In either case, we will need substantial
capital in order to obtain the required components. The manufacturers must issue
letters of credit to secure their purchase obligations. We believe that these
letters of credit will enable us to obtain financing sufficient to fund a
substantial portion of our raw materials costs.
23
Our requirements for working capital and liquidity will also increase
upon implementation of our growth strategy. This includes the installation of
our own smart card production line in our San Diego facility at an estimated
cost of $2.6 million, as well as the expansion of our in-house manufacturing
capability and the diversification of our capital equipment product line to the
GSM technology and other markets, which is projected to cost approximately
$350,000. We have also agreed to purchase the San Diego property currently being
leased from Ampac Technology LLC (an entity controlled by two of our principal
stockholders) at a price of $150,000 plus the assumption of the existing
mortgages with an outstanding balance of approximately $1.1 million. We intend
to use proceeds from this offering for this purchase.
We anticipate that we will be able to draw on bank and other
facilities which, together with anticipated working capital, including the
proceeds of this offering, and internally generated cash flow, we believe will
be sufficient to fund such commitments. However, if any of these resources are
not available or generate less capital than projected, we would need to obtain a
major source or sources of financing. Any resulting debt could substantially
impact liquidity.
Impact of Inflation
Although our operations are influenced by general economic trends, we
do not believe that inflation had a material impact on our operations for the
periods presented.
New Accounting Pronouncement
In June 1998, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 requires companies to recognize all derivatives
contracts as either assets or liabilities in the balance sheet and to measure
them at fair value. If certain conditions are met, a derivative may be
specifically designated as a hedge, the objective of which is to match the
timing of gain or loss recognition on the hedging derivative with the
recognition of (i) the changes in the fair value of the hedged assets or
liability that are attributable to the hedged risk, or (ii) the earnings'
effect of the hedged forecasted transaction.
For a derivative not designated as a hedging instrument, the gain and
loss is recognized in income in the period of change. SFAS No. 133, amended by
SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning
after June 15, 2000.
Historically, the Company has not entered into derivative contracts
either to hedge existing risks or for speculative purposes. Accordingly, the
adoption of the new standard on January 1, 2001 had no effect on the Company's
financial statements.
24
DESCRIPTION OF BUSINESS
Introduction
Chipcards, Inc. (formerly known as American Pacific Technologies,
Inc.), was incorporated under the laws of the State of California on November 3,
1993. Since 1997 we have been engaged in the installation of production lines
for the manufacture of smart cards. To date all of our sales of production lines
have been to customers located in China. We have also marketed finished smart
cards since 1998. In addition, we have developed, and intend to market,
ancillary products for use in smart card systems. Prior to entering the smart
card capital equipment business, we designed equipment for the production of
electromagnetic components.
Our installation of production lines encompasses providing the customer
with the technology, equipment, supplies, installation, training and support for
a turnkey operation. We have filed three Provisional Patent Applications
relating to our smart card production technology, and we intend to file
corresponding non-provisional patent applications in order to continue pursuing
patent protection for these inventions. We have made arrangements with the
purchasers of our production lines to sell us all or a portion of their
production in order to secure a supply of smart cards for marketing. We plan to
utilize the proceeds of this offering to increase our capacity to install
production lines, commence our own production of smart cards, market newly
developed products and expand our geographical markets. Our ultimate aim is to
become an integrated global smart card competitor combining technology,
production and marketing of smart cards as well as the continuation of our
installation business. We believe our technology, supply sources, expertise and
contacts will position us favorably in connection with this strategy.
Strategy
We intend to establish a stronger market position in both the smart
card sales and smart card capital equipment areas through a comprehensive plan
that includes:
o expanding our international distribution network;
o promoting new applications for our capital equipment such as smart
labels;
o diversifying our range of smart card products by developing
dual-interface cards, cards that are compatible with new operating
platforms, and cards that can be used in the GSM market;
o replacing vendors with internal equipment-making capability, thus
reducing delivery time to customers and costs borne by us;
o bringing our own factory automation to market by creating in-house
capacity to manufacture smart cards; and
o marketing and promoting our ancillary smart card products.
We are presently focusing our efforts on increasing our international
sales activities, specifically in Europe and Asia, through our network of
independent sales representatives and our employees abroad. We are planning to
hire our German sales representative as a full-time employee to open a new sales
office in Munich, and we are in active discussions with persons who could
potentially serve as new sales representatives in the Middle East.
In the area of new equipment applications, we have developed designs
for manufacturing smart labels with our existing production machinery. We do not
anticipate marketing this product until
25
after the completion of this offering. We have also developed designs and/or
processes for manufacturing all of the new smart card products described above.
Although we are in active negotiations with a potential customer for
dual-interface cards, we have not otherwise commenced marketing efforts for any
of these products. In addition, we have completed development of three ancillary
products, a reader/writer for security systems, a card handling system and a
chip testing system, but marketing has not commenced.
We have not begun the process of expanding our equipment-making
capacity or creating in-house card production capacity, as we will require the
proceeds of this offering to implement these plans.
In general, we intend to use the proceeds of this offering to implement
a substantial part of the plans described above. If we do not sell all of the
units being offered, we may be required to scale back or modify our plans. Even
if we complete the full offering, there is no assurance that we will be
successful in implementing any of these plans.
Smart Card Technology
A smart card is similar in appearance to a traditional credit card, but
stores information on an integrated circuit chip embedded within the card rather
than on a magnetic stripe on the surface. While a typical magnetic stripe card
stores approximately 212 bytes of information, (generally consisting of a user's
name, account, and personal identification number) a smart card can store
approximately 64 kilobytes or more of information, which is 300 times the
capacity of a typical magnetic stripe card. Smart cards are more secure than
magnetic stripe cards, which carry information on the outside of the card and
can therefore be more easily damaged, copied, or accidentally erased. In
addition, because the integrated circuit chip can also process data for
encryption, smart cards offer greater protection against loss or theft of
information.
Smart card systems include a read/write device which performs
applications by processing the data stored on the chip. Smart cards are used in
a variety of applications, including:
o access to restricted areas (replacing keys and identification cards);
o public transportation fare collection (replacing tokens and tickets);
o point of sale purchases (replacing cash or credit cards at
cafeterias, newsstands and other point of sale locations where speed
of purchase is important);vending machines;
o public telephones;
o industrial applications such as quality control, warehousing,
inventory control, distribution and warranty;
o health care (replacing patients' paper files in hospitals and HMOs);
and
o cellular phones.
Smart cards are further classified as contact, contactless,
dual-interface or hybrid. A contact card must be inserted into a reader or
writer in order to process data. A contactless smart card receives information
and power through an embedded antenna, and therefore needs not physically
contact a reader/writer in order for the embedded chip to perform applications.
This electronic transfer of information utilizes inductive coupling (commonly
known as "radio frequency" radiation). Contactless cards can be read at a short
distance from the reader/writer, making them uniquely well-adapted to small and
rapid handshake transactions. Because transactions are conducted without
physical contact between the card and the reader/writer, contactless smart card
systems undergo minimal mechanical wear, require
26
little maintenance, and can be virtually vandal-proof. A dual interface smart
card utilizes a single chip that can function in either a contact or contactless
environment, and a hybrid card utilizes two chips that enable it to function in
a contact or contactless environment.
The chips used in smart cards are similar to those used in computers,
but have significantly smaller memory. A variety of chips can be used depending
on the complexity of the application the smart card is designed to perform. In
recent years, technological advances in the design of smart card chips have
occurred at a rapid rate, resulting in substantially enhanced storage and
processing capabilities. At the same time, the costs of chip production are
declining.
The manufacture of smart cards involves the integration of chip modules
into plastic cards. In the case of contactless cards, the module (which is the
encasing of the chip) is integrated into a plastic sheet, and a wire antenna is
ultrasonically implanted into the sheet around the chip module. Then an
interconnect is formed between the wire leads of the antenna and the chip module
by thermal compression welding. In the case of contact cards, a cavity is milled
into a finished plastic card, and the chip module is glued into the cavity. Both
contact and contactless cards may also incorporate magnetic stripes to be
compatible with an existing stripe card infrastructure.
Overview of the Smart Card Industry
The total number of smart cards in use world wide was approximately 1.6
billion in 1999, and by 2001 it is projected that 3.4 billion smart cards will
be in use (Source: Frost & Sullivan). By financial worth, the smart card market
is projected to rise from $2.1 billion in year 2000, to more than $6.5 billion
in 2005. (Source: SJB Research). To date, smart card usage has gained acceptance
primarily outside the U.S. The leading markets for smart card sales at present
are Europe, Asia and South America.
The smart card industry is an expanding market with new applications
being developed at a rapid pace. The major areas where smart cards are in use
today are mass transit, toll collection, electronic purse, access control,
banking, medical, and Internet commerce. Although the U.S. market has been slow
to develop, we believe that awareness and acceptance of smart cards in this
country is on the rise. For example, American Express has recently released
their new Blue card, which features an embedded contact chip with an Online
Wallet application. On e-commerce web sites that support the Online Wallet, a
reader/writer attached to a user's computer verifies the user's personal code
against a value stored on the chip, creating a high level of security. VISA is
also promoting the use of smart cards because they are believed to reduce fraud
and theft. We believe that smart cards will play a pivotal role in the future of
secure electronic commerce, and that consumers will prefer to make purchases on
web sites that support the added level of security that smart cards can provide.
The accessibility of the Internet, coupled with the security of the
smart card, will also present other opportunities. In e-purse applications, such
as transportation cards, individuals can add dollar value via a secure Internet
connection from home without having to use an inconvenient public kiosk. In
banking and medical applications, users can view their records and make updates
with a level of security not present in today's systems. Computers are currently
available with an integrated smart card interface. We believe that the increase
in computer networks and the emergence of the Internet as the means of both
electronic communication and commerce will create an increase in the growth of
the smart card market. Smart cards linked to an individual's computer are
capable of storing large amounts of personalized user information, and can be
used to access corporate networks, store the user's preferences, and conduct
27
financial transactions over the Internet with a high level of security. These
applications would make a smart card a direct, secure extension of a PC network.
In fact, Microsoft has already integrated smart card support directly into their
Windows 2000 environment.
Products and Services
Our production line business offers a complete array of equipment and
services that enables us to provide our customers with a turnkey smart card
operation. This includes the technology, equipment, supplies, installation,
training, and support required for full-scale production. Our equipment designs
focus on the contactless platform. We believe that our designs are more advanced
than those offered by many of our competitors because we use fully-automated
technology that allows for minimal operator intervention by the card
manufacturer. Our robotic-based systems provide a high degree of precision in
the card manufacturing process, resulting in faster lead times and higher
yields. In contrast, systems designed by our competitors generally have fewer
computer-guided operations and require more manual labor in the manufacturing
process.
We have specialized in factory automation since 1994, when we began to
design equipment that produces electromagnetic components. This background in
electromagnetism enabled us to develop extremely precise machinery that we later
applied to the manufacture of smart cards. For example, we designed equipment
for the production of surface mount inductors, which are miniature devices used
to regulate the flow of radio frequencies. The same basic technology is used to
regulate the radio signals through which a smart card communicates with the
reader/writer. We also designed equipment for the production of components used
in cellular phones. This technology involved a miniature coil winding process
for wrapping copper wire around a ceramic core. The same process is used for
winding wire around the periphery of a smart card. Having developed these
technologies, we became aware of the potential to transition into the smart card
industry. In addition, as a result of doing business in foreign markets, we
became cognizant of a growing worldwide demand for smart cards. Therefore,
beginning in 1997, we decided to discontinue our electronic components business
and began to develop and design equipment for the production of smart cards,
which we believed to be a higher-margin business with a far greater potential
for growth.
In 1999 we began our direct smart card sales activities by purchasing
finished cards from our equipment manufactures for re-sale to end users. Also in
1999, we began the development of certain ancillary smart card products,
including a reader/writer device for keyless entry security systems, a product
for testing and initializing the chips contained in smart cards, and a smart
card ship testing system for inspecting and qualifying integrated chips.
We also provide post-processing and peripheral services including
printing, embossing, magnetic striping and personalization of finished smart
cards. The principal customers for these services are companies involved in
smart card systems integration.
Smart Card Production Lines
Our smart card capital equipment consists of various components
acquired from third parties that we integrate into an automated production line
based on our designs and processes. We have three Provisional Patent
Applications pending with respect to these technologies, for which we intend to
file corresponding non-provisional patent applications. Our equipment utilizes
robotic workcell technology to
28
create a fully automated production line. Full automation makes the equipment
especially well suited for countries where labor costs are of concern or highly
trained personnel are scarce.
Unlike many of our competitors, we do not produce factories dedicated
to a specific type of chip, antenna or card. These fixed systems limit
flexibility, since the machinery cannot readily accommodate alternate designs.
Many of these fixed systems also rely on expensive premanufactured
sub-assemblies, such as etched antenna sheets. We believe that our factories are
better able to adapt to changes in antenna design and smart card design. Our
machines employ software based formats that can be easily changed to serve our
customers' needs. The software enables the manufacturer to change specifications
and other design parameters in order to produce different types of smart card
products. Thus, while we principally design contactless card systems, our
production lines can be modified to produce several other types of smart cards,
including contact, dual interface and hybrid cards, as well as labels, key fobs
and coins.
Our contactless smart card production lines require only the most basic
raw materials: plastic sheets, chips and copper wire. This enables our customers
to reduce their manufacturing costs by eliminating the need to buy more
expensive pre-manufactured parts. In addition, flexibility is built into the
production machinery, allowing owners to easily adapt to advances made in smart
card technology. These rapid advances in the industry have already been
demonstrated by a 75% reduction in the chip size over the last three years. Our
turnkey factory lines are also designed for rapid startup, typically enabling
customers to manufacture product within approximately four to nine months after
making the initial downpayment. Under our capital equipment installation
agreements, we will generally supply raw materials, temporary factory
management, training and transfer of knowledge to accelerate the start-up
process.
We have developed new designs for the production of equipment that can
manufacture "smart labels." This is a thin piece of paper (rather than a plastic
card) that has an embedded chip and can be used in place of a magnetic stripe or
barcode. Although this is a very recent development in contactless technology,
we believe commercial opportunities are rapidly developing. UPS and Federal
Express have recently announced the replacement of their bar-coded labels with
the smart label. We have successfully tested a prototype for producing smart
labels and intend to market this equipment in the future as a new product line.
We believe this product will expand the types of applications for which our
technologies can be used.
Recently we completed a total of three production line installations
for two customers in China. All lines have been tested and accepted by the
customer and full-scale production has commenced. Currently we have a contract
to install two new production lines for another customer based in China. During
1997 and 1998 we developed the designs and processes that form the core of our
capital equipment technology. Between 1998 and 1999 we installed our first two
production lines for customers in China, after which we focused on implementing
various enhancements and upgrades to our production machinery. We believe these
improvements put us in a strong competitive position and helped us secure the
capital equipment contracts that are now in place. The payment structure on
these contracts is based on a percentage of completion method whereby we receive
an initial cash deposit, with the balance payable based on the completion of the
project.
Our turnkey factories consist of six separate pieces of equipment
(otherwise known as workcells) that are assembled into a fully automated
production line:
29
Hole Punching Workcell. This workcell is used to punch precisely
measured cavities into plastic sheets in order to accommodate the chip module
that is inserted into the cavity at a later stage in the assembly process.
Module Pick and Place Workcell. This system is designed to install the
modules containing a microprocessor onto a specified sheet matrix.
Antenna Embedding Workcell. This system is designed to embed the wire
into the plastic sheet through the use of ultrasonic power. We believe that
ultrasonic embedding is superior to other existing processes, such as etching,
as it results in a much more stable card.
Bonding Workcell. This system is used to form the bond between the
module and the wire antenna, using thermo-compression techniques.
Dual Mode Lamination Workcell. This system laminates the plastic sheets
and can load up to 12 sheets at each opening.
Card Cutting Workcell. This workcell is used to punch laminated inlays
into precise card bodies in accordance with precise specifications.
The antenna embedding, module pick and place and bonding workcells are
considered core components. We have developed proprietary designs and processes
for the assembly and integration of these machines. Approximately 50% of this
assembly work is done through a contract manufacturer, based on our requirements
and under the supervision of our engineers. The dual mode lamination, hole
punching and card cutting machines are considered off the shelf components and
are purchased as-is through outside vendors. After assembly is completed by our
subcontractor, all finished components are shipped to our San Diego facility to
be assembled and inspected by us and our customers, and are then packaged and
shipped to the customer. Our personnel are sent to the customer's location to
supervise final installation and testing. Our capital equipment products are all
designed according to customer specifications and sold as complete production
lines.
Smart Cards
Although we intend to install a smart card production line in our San
Diego facility, at present we do not have any in-house capability to manufacture
cards. Therefore, we have entered into agreements giving us the right to buy
finished product at a fixed price from certain companies that purchase our
capital equipment. We also have agreements with other capital equipment
customers under which we are obligated to buy specified quantities of cards at a
fixed price. These arrangements are expected to give us a stable source of
supply, and we believe that the prices we have negotiated are competitive under
current market conditions. We also believe that sourcing cards from our
equipment customers will ensure high quality product, since our machinery
undergoes stringent inspection and testing before customers begin production. We
have been designated as an approved smart card supplier by several leading
companies, including Philips, Siemens, Motorola and NEC.
We also offer post-processing and peripheral services in order to
customize cards for end-users. These services include printing, embossing,
magnetic striping and personalization of finished cards.
30
We use third-party vendors for most of the post-processing services, except for
personalization, which we conduct in-house.
In the past, we obtained finished smart cards from two manufacturers in
China who purchased production lines from us. These manufacturers no longer
supply us with cards, as we have been unable to meet our obligation to source
computer chips for them due to a worldwide shortage of smart card
microprocessors. However, we have recently installed three new production lines
for two customers from which we will have the ability to purchase finished
cards. Upon the completion of our current installation projects, we will be
entitled to purchase a substantial portion of the output from as many as six
more production lines. These arrangements will continue for a period of three
years after our customers have commenced production. These lines are all
designed to produce technologically advanced high frequency smart cards. With
these direct strategic alliances, we believe we will be able to offer high
frequency cards at a lower price than the leading competitors.
We conduct extensive testing of smart cards upon receipt from the
manufacturer. Card functionality is tested through our card handling system,
which our own engineers have designed. We also conduct a torsion test and a pull
test to check the strength of both the card and the bond between the antenna and
the chip module. All testing is done by randomly selecting cards from each
shipment we receive.
We believe that the card industry recognizes high frequency contactless
smart cards as the best platform in terms of business and technology. We further
believe that with our advanced production lines, we will be in a strong position
to deliver cards that compete in nearly the same price range as the low
frequency cards.
Assuming the successful completion of this offering, we intend to
install an in-house production line in our San Diego facility. This will
position us to offer new smart card products, including dual-interface cards,
cards utilizing alternate smart card platforms, and cards for use in GSM
cellular phones.
o Dual-Interface Cards. Also known as "combi" cards, they contain one
chip with both a contact interface and a contactless interface. These
two interfaces allow for greater compatibility with older
contact-only systems. There is a strong market for this product in
Korea for use in banking applications. We are currently negotiating a
potential sale of these cards to a leading Korean systems integrator.
We anticipate that the need for dual-interface cards will expand to
other markets as demand for secure applications increases.
o Alternate Smart Card Platforms. We believe there is also a growing
market for smart cards compatible with various new operating
platforms that are now available. The ongoing microprocessor shortage
has prompted a number of chip manufacturers to develop and actively
market alternatives to the Mifare platform. We intend to promote our
capability to supply cards to the developing market for non-Mifare
smart cards. These platforms have now been standardized to encourage
and accelerate development.
o GSM Cellular Phones. The Global System for Mobile Communications is a
chip-based cellular telephone system. GSM cellular phones utilize a
miniature smart card for account verification in place of an
electronic identification number assigned to each unique
31
cellphone. This allows for greater convenience because the card
is detachable and interchangeable with other GSM phones. This
technology is widely used in Europe and Asia, and we believe that
it is gaining acceptance in the U.S. We believe we are in a
favorable position to take advantage of this expected growth
market, as our machinery is well-suited to produce the precision
components required for GSM use.
Our overall goal is to create in-house manufacturing capacity in order
to take advantage of opportunities that are expected to arise in dual-interface
cards, alternate-platform cards and GSM cards. Although we could rely on our
outside vendors to supply these products, using our own on-site equipment will
increase our margins, give us greater control over quality and delivery time,
and give use greater flexibility to respond to movements in demand.
Ancillary Smart Card Products
We have designed a smart card reader/writer for use in keyless entry
security systems. This device is available either as a stand-alone product, or
as an OEM circuit board, which is the basic unit that a manufacturer can modify
for its own specialized applications.
As a stand-alone unit, the reader/writer board has been enhanced with
switching devices that actuate electronic locks and alarm systems without
additional interface boards. In contrast, the typical security system requires
two interface boards, one which reads the card and one which powers the locks.
We believe our product is more cost effective for customers because it uses less
power and does not require the addition of a second board. We intend to market
the stand-alone product primarily to homeowners as an alternative to traditional
locks and alarm systems. We anticipate that reader/writers will be manufactured
by a contract manufacturer based on our designs.
The OEM circuit board or developer's kit can be used to design smart
card systems on any platform. The target market for the developer's kit is
engineering personnel. Our development kit includes the reader/writer,
platform-independent software and sample cards. This kit allows developers to
integrate our technology into their networks and systems. This method of
introduction is well known and accepted in the electronics industry.
In addition to direct sales, our goal is to act as a supplier for smart
card systems integrators in order to accelerate the growth of our contactless
smart card business. While we have not yet commenced sales of our smart card
peripheral products, we believe the door access and secured electronic access
markets have the potential to offer a high volume of business for both
reader/writers and the high frequency cards used in security systems. High
frequency cards offer several advantages over other entry devices, including low
frequency cards: high frequency cards are more streamlined and therefore easier
to handle; price differentials between high and low frequency cards have
decreased; and high frequency cards are capable of more extensive cryptology
than low frequency cards, making them better suited for high security
applications.
We have recently developed a card handling system that automatically
tests and initializes the computer chip embedded in each card. This desktop unit
is designed to meet the trend towards programming cards at the end user's site.
Several of our installation projects include this unit as a component of the
production system. We also intend to market this unit as a stand-alone product
to existing card manufacturers who desire to add testing and initialization
capability to their production
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systems. We have also developed a smart card chip testing system that
automatically tests smart card integrated chips before manufacturing begins.
This unit is designed to enhance production quality control. Several of our
installation projects include this unit as a component of the production system.
We also intend to market this unit as a stand-alone product to existing card
manufacturers who desire to add a greater degree of quality control to their
production systems.
Production Line Contracts
In order to secure installation contracts in China we generally engage
the services of general agents and sub-agents. It is customary practice in the
Chinese business community to use these agents in significant transactions. The
total fees payable to a general agent and sub-agents in connection with an
installation contract typically range from 10% to 25% of the total contract
price. We also use general agents and sub-agents to introduce us to potential
smart card customers in China. The fees payable to agents with respect to smart
card sales are generally between 6% to 13% of the total sale price. Similar
business practices exist in connection with the sale of equipment and smart
cards in Korea, Japan, Taiwan and Europe, all of which are markets in which we
intend to be active.
From 1998 to 1999 we completed one production line for China Tianjin
Global Magnetic Card Co., Ltd. and one line for Beijing Aerospace Gold Card Co.,
each of which is located in China. Under our contracts with these parties, we
agreed to provide each of them with raw materials for the manufacture of cards.
We also have the exclusive right to buy the finished smart cards produced by
these manufacturers. However, because of a shortage in the supply of Mifare
microprocessors, we have been unable to provide the necessary raw materials, and
there is a risk that such parties may bring claims seeking to impose continuing
obligations upon us. (See "Risk Factors - We are Subject to Risks Associated
with Obligations Under our Capital Equipment Contracts.").
In late 2000 and early 2001 we completed the installation of three
production lines for two customers based in China. In addition, we have entered
into an agreement with another customer located in China covering the
installation of a double production line. We expect that the project will be
completed by the end of 2001. Under each of our production line contracts,
installation, testing, technical services and training are included in the cost
of the facilities. All of these contracts are governed under Chinese law and
provide for the arbitration of disputes in China.
The following summarizes the specific provisions of our current capital
equipment contracts:
China Card
In October 2000, we delivered and installed two production lines for
the Shandong Huang Tai Industrial Group in China. The equipment has been tested
and accepted by the customer and full-scale card production has begun. The
equipment was purchased by a joint venture company, China Card I.C. (Shanghai)
Co., Ltd., which is owned on a 50-50 basis by us and The Shandong Huang Tai
Industrial Group. Our capital contribution to the joint venture was in the form
of equipment; accordingly, a portion of the equipment sold to the joint venture
was deemed to be our capital contribution, and a proportionate deduction was
made from the cash amount payable to us under the equipment installation
contract. No revenue was recognized by us and no investment asset was recognized
on that portion of the equipment deemed to be capital contribution.
33
Under an equipment purchase agreement, we guarantee a manufacturing
capacity of 6 million cards per year and a reject rate of less than three
percent for each production line sold to China Card I.C. (Shanghai) Co., Ltd. We
also entered into a license agreement under which we provided technical
information and support services needed to operate the production lines. Under a
raw materials and product sale agreement, we have the right to buy contactless
cards from China Card over a three-year period at a fixed price per card.
Quantities are based on our forecasted requirements, and we must post letters of
credit to secure our purchases. In addition, this agreement requires us to
provide China Card with raw materials on an as-ordered basis over a three-year
period at a fixed price per card, subject to the issuance of letters of
credit securing China Card's payment obligation. We have agreed, however, that,
should we decide to buy finished cards, China Card will not pay us cash for raw
materials, but rather will deduct the appropriate amount from the price at
which they sell finished cards to us.
Shandong Huaguan
In February 2001, we delivered and installed one complete production
line for Shandong Huaguan Group General Company in China. The equipment has been
tested and accepted by the customer and full-scale card production has begun.
Under an equipment purchase agreement, we guarantee a manufacturing capacity of
6 million cards per year and a reject rate of less than 3 percent. We also
entered into a license agreement under which we provided technical information
and support services needed to operate the production lines. Under a raw
materials and product sale agreement, we have the right to purchase contactless
smart cards over a three-year period at a fixed price per card. Quantities are
based on our forecasted requirements, and we must post letters of credit to
secure our purchases. In addition, this agreement requires us to provide raw
materials over a three year period at a fixed price per card, subject to the
issuance of a letter of credit securing Shandong Huaguan's payment obligation.
Hainan Pacific
We have entered into an equipment purchase agreement with Hainan
Pacific New High Tech Co, Ltd., a Chinese company, covering the sale of a double
production line. Under this agreement, we guarantee a manufacturing capacity
of 1,500 cards per hour. Payments are to be made based on the progress of the
project. We also entered into a license agreement under which we provided
technical information and support services needed to operate the production
lines.
Research and Development
We conduct an ongoing analysis of available manufacturing technologies
and advancements in the automation industry, which we believe has enabled us to
procure modern, low-maintenance and cost-effective equipment. In 1999 we
completed modifications to our factory equipment that significantly
34
improved the efficiency and adaptability of our production lines. These
modifications included improving the mechanics and electronics of our coil
winding, process making the winding equipment more efficient and resulting in
higher output. We also enhanced the flexibility of our implanting machinery,
which can now implant the antenna into a variety of materials, including the
paper used in smart labels and new types of plastics. Our process for welding
the module to the antenna has been improved, resulting in an increase of
approximately 11% to 20% in the average stress that the card can withstand. From
1998 through 1999, we spent approximately $267,000 on both personnel and
equipment in connection with research and development.
During the 2000 fiscal year, we continued to evaluate new card and chip
technologies in order to ensure that our equipment fully utilizes these new
developments. By utilizing advances in materials and technology, we were able to
improve the efficiency of our processes, resulting in reduced raw material cost,
improved mechanical and electrical performance, and a higher quality product.
With rapid advances continually taking place in the plastics and semiconductor
industries, we view our research in this area as essential to establishing a
prominent role in the smart card market. In contrast to prior years, during 2000
research and development was conducted in the course of producing equipment for
customers, and not as a separate activity. Therefore, our research and
development costs for the year are not reflected as a separate line item in our
financial statements.
In response to the demonstrated needs of the market, we are developing
smart card systems solution software, including toll collection, door access,
and general communication applications for use by developers of custom software
during evaluation. This product is in the very early stages of development.
We anticipate that during the 2001 fiscal year, we will continue to
focus on improvements that can be implemented as part of our ongoing
installation work. We also intend, to a lesser extent, to allocate resources to
independent research and development projects, primarily for the further
development of new products. We believe that the ability to continue making
enhancements and improvements will be critical in positioning us to benefit from
the projected expansion of the smart card market.
Market Analysis
Market
The smart card markets in Europe, Asia and South America are well
established and have grown at a rapid rate. The smart card market is projected
to rise from $1.8 billion in worldwide sales in year 2000 to more than $6.5
billion by 2005 (Source: SJB Research). Our internal estimates place the size of
the worldwide smart card capital equipment market at approximately $500 million
for the 2001 fiscal year based on our assessment of current market activity
including contracts up for bid or being fulfilled.
In the U.S., the market for both smart cards and smart card capital
equipment remains relatively small. However, we believe that the U.S. is
currently undergoing a technological shift from magnetic stripe cards to smart
cards, and is at the onset of expansive growth in the smart card industry. It is
projected that the U.S. will account for up to 50 percent of worldwide growth in
smart card sales (source: Dataquest). Market data also suggest an increase in
capital equipment sales. The U.S. market for radio-frequency identification
equipment (which includes smart card reader/writers, contactless smart cards,
contact smart cards and smart labels) is projected to grow to $782 million by
the end of 2000, representing
35
a five-fold increase from 1994 (source: Frost & Sullivan). We believe that this
will also stimulate growth in the capital equipment market, as machinery will be
needed to meet the demand for these products.
Contactless smart cards are well suited for applications such as mass
transit or access control. In the U.S., we believe that applications such as
large corporate network access, public transportation, toll collection,
government ID cards, health cards, parking meters, gas stations, e-commerce and
keyless entry will all be viable applications. Contactless smart cards can also
be used with applications that make use of the SSL and SET protocols, which are
methods of insuring secure financial transactions over open networks like the
Internet.
Overall, we anticipate that demand for capital equipment and smart
cards will expand as a result of:
o The growth and diversity of smart card applications;
o The need for higher security in Internet e-commerce;
o The consumer desire for more convenient financial and personal
transactions;
o The progression of radio frequency applications to higher
frequencies; and
o The projected growth of the smart card market in South America and,
in the longer term, North America.
Our smart card equipment business has historically focused on the Asian
markets, particularly China. As a result of its economic growth over the last
decade, China has invested heavily in modernizing its electronics industry.
Initially, we took advantage of this modernization in the field of
electromagnetic products. Having transitioned into the smart card business, we
believe that our prior experience will allow us to continue competing
effectively in the Chinese market and other similar markets. Additionally, in
our smart card sales sector, we believe that our knowledge of the manufacturing
process provides a basis for understanding and meeting the needs of our smart
card customers. Overall, we believe that our company is well positioned to
compete in the smart card industry in China as a result of our knowledge of the
local market, our long-term experience in electromagnetic technologies, and the
quality of the equipment that we have produced and sold to customers in China.
We intend to use this as a basis for broadening our customer bases in Asia and
expanding into the North American, European and South American markets,
supported by an expansion of our sales force and the launch of an advertising
and promotional campaign.
Customer Profile
Our target market for smart card sales includes industrial concerns
wishing to expand into the field of smart cards and established card
manufacturer wishing to meet new market demand by offering contactless smart
cards.
A partial list of our current smart card customers includes:
o KD Electronics (South Korea)
o Motorola (USA)
o Korea Information & Communications Company (South Korea)
o Electronic Silicon Solutions (UK)
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Our current capital equipment customers are describe in this prospectus
under the heading "Business - Current Capital Equipment Contracts."
Competition
In the smart card capital equipment market, our competitors include
production line suppliers such as Mulhbauer (Germany), Melzer (Germany), Meinen
Ziegel & Co. (Germany), Ruhlamat (Germany), Essec (Switzerland), Sempac
(Switzerland), Sokymat (Switzerland) and Advanced Interconnection Technology
(United States).
Our competitors in the smart card sales market include
Aktiengesellschaft fur Chipkarten und Informationssysteme ("ACG") (Germany),
Giesecke & Devrient (Germany), Oberthur (France), Gemplus (France), Schlumberger
(France), and Amatech (Germany).
Key factors that have contributed to our competitive position in the
capital equipment industry include short lead times, technical know-how and
strong business relationships developed and maintained at the local level. In
addition, to our knowledge few competitors can match our ability to automate
every function within the production line. In the area of smart card sales, we
believe that we offer a competitive product in terms of both price and quality.
We have contracted with our capital equipment customers to purchase cards at
prices that we believe are very favorable. Since our suppliers will be using
equipment that we designed and manufactured, we are confident that we will
receive high quality product.
Our products are specifically engineered to meet the individual
requirements of our customers. In the case of smart card capital equipment,
every component built is fully tested and inspected before shipment to the
customer. We believe that this commitment to quality results in state of the art
product and high yield for our customers. In the case of smart card sales, the
product we purchase from manufacturers is extensively tested in order to ensure
that our customers receive high quality cards.
Marketing and Advertising
Our marketing strategy is to enhance, promote, and support the fact
that our products meet customers' stringent specifications, yet are priced
competitively. We intend to create a strategic marketing campaign delivering
this message along with the announcement of new sales offices and new products,
including our reader/writer for security systems and smart cards designed to
accommodate the new operating platforms that are now available. This marketing
campaign will include a public relations rollout, an advertising campaign in
trade publications, and direct mailings. We also intend to expand our web site,
URL:http://www.chipcards.com, to reflect our growing product line and include
e-commerce as a means of distributing our products.
Our overall advertising and promotional objectives are to position our
company as a recognized expert in the design of smart card manufacturing
facilities, and in the sale of contactless smart cards and related products and
services. Although we have not yet commenced any promotional activities, we have
budgeted $300,000 in fiscal 2001 for advertising and promotion (a portion of
which is expected to be funded from the proceeds of this offering). The budget
for advertising will be continuously updated to comprise approximately 3% of
total sales. For 2001, we intend to focus on press releases, sponsorship
programs and the Internet as publicity strategies. We appear at select trade
shows throughout the year and has co-sponsored industry events in China.
37
Distribution
We currently have sales offices located in Beijing, China and South
Korea. Currently, our Beijing office consists of four employees including one
sales employee and two engineers, and our South Korea office consists of four
employees including three sales employees. The Beijing office engages in the
sale of both capital equipment and smart cards. The South Korea office engages
primarily in the sale of smart cards but has begun to solicit potential
production line customers as well. In addition, we have six independent sales
representatives covering the United Kingdom, France, Italy, Japan, Germany and
Argentina. All of our sales representatives are dedicated solely to smart card
sales. They are not restricted from representing other parties, but have agreed
not to sell any products competitive with ours. In order to establish a greater
share of the international smart card market, we intend to expand the size of
our office in Beijing. We intend to hire our German sales representative as an
employee to open and manage a new sales office in Munich, Germany. In addition,
we are currently in negotiations to add independent sales representatives in the
Middle East.
In the market for contactless smart cards there exist only a few
companies with worldwide sales offices. We are determining, on a region by
region basis, if it will be more beneficial to compete head-to-head at the
retail level with these large distributors, or to become a wholesaler to them.
We are currently negotiating with several contactless smart card distributors to
explore the best strategy for each market. At present, one of our principal
smart card customers is a retailer which purchases from us on a wholesale basis.
Our web site has been instrumental as a promotional tool, and a means
of providing contact information. We also intend to add e-commerce capabilities
to enable the purchase of smart card products directly from our website.
Intellectual Property
We regard our factory automation designs and processes as proprietary
and will rely primarily on a combination of patent, copyright, trade secret and
confidential information laws, employee and third-party non-disclosure
agreements and other methods to protect such proprietary rights. The aspects of
our technology which we consider to be unique in the industry include the use of
robotics to achieve full automation, the integration of software based formats
in order to maximize flexibility, and the use of modular designs that enable
each workcell to function as a stand-alone unit. There can be no assurance that
these protections will be adequate to protect against infringement or
misappropriation of our recipes or formulations. We have filed three Provisional
Patent Applications with respect to certain designs and processes used in the
manufacture of our production lines. We intend to file corresponding
non-provisional patent applications in order to continue pursuing patent
protection for these inventions. There is no assurance, however, that we will be
successful in obtaining patents for any of the inventions claimed in these
applications. We currently do not have any issued patents, copyrights or
trademarks. We intend to enter into non-disclosure agreements with certain of
our employees and non-disclosure and assignment of invention agreements with
certain of our employees, consultants and subcontractors. However, there is no
assurance that such measures will be adequate to prevent competitors from
developing similar or superior products.
Legal Proceedings
38
From time to time, we may be involved in litigation relating to claims
arising out of our operations in the ordinary course of business. We are not
currently engaged in litigation or arbitration, the result of which would have a
material effect on our financial condition, results of operations or future
prospects.
Employees
We currently have eleven employees in the United States, four employees
in China and four employees in South Korea. All employees are full time except
for our Chief Financial Officer, who is serving on an as-needed basis. After the
completion of this offering, we intend either to secure the full-time services
of our current CFO or identify and hire another qualified candidate as a
full-time CFO.
In the area of sales, we use a combination of full time employee sales
personnel and independent sales representatives to optimize market potential and
geographic coverage. We have three employees directly engaged in the sale and
distribution of our technology products in the United States, one sales employee
in China and three sales employees in South Korea. After the completion of this
offering, we plan to expand both our employee and contract sales forces in the
U.S. and abroad to capitalize on the forecast demand for smart card products.
Our future performance depends in significant part upon the continued
service of our key technical and management personnel, and our continuing
ability to attract and retain highly qualified and motivated personnel in all
areas of our operations. Competition for qualified personnel is intense. We
provide no assurance that we can retain key managerial and technical employees
or that we can attract, assimilate or retain other highly qualified personnel in
the future. Our employees are not represented by a labor union. We have not
experienced any work stoppages and consider our employee relations to be good.
Properties and Equipment
Our headquarters are located in Citicorp Center at One Sansome Street,
19th Floor, San Francisco, California. We have entered into a one-year lease
with a term ending on June 30, 2001. The term will be automatically extended for
successive one-year periods unless either party elects not to renew at least 90
days prior to the expiration of the initial term or any renewal term. A 7% rent
increase will apply to each renewal term. The current rent is $4,638.00 per
month.
Our San Diego office is currently leased from Ampac Technology, LLC a
limited liability company owned by two of the principal stockholders of our
company. The property is located at 6827 Nancy Ridge Drive, San Diego,
California. The lease is for a term of twenty years ending on March 19, 2019, at
a base rent of $7,000.00 per month. Ampac has entered into an agreement to
transfer title to the San Diego property to us upon the completion of this
offering at a purchase price of $150,000 plus the assumption of the existing
mortgages with an outstanding balance of approximately $1,121,640.
Our China office is located at Huatong Building, A-19, West
Chegongzhuang Road, Beijing, China. We have entered into a one-year lease with a
term expiring April 30, 2002. The current base rent is approximately US $1,198
per month.
39
Our South Korea office is located at Samwon Building, 81-1, Karak-Dong,
Songpa-Ku, Seoul, South Korea. We share office space with Chunwoo Ind. Co. Ltd.,
a company controlled by one of our employees in South Korea, on a rent-free
basis.
MANAGEMENT
The Directors, Executive Officers and significant employees of our
company are as follows:
Name Age Position
Allen Yue(1) 43 President, Director
Eric Gravell(2) 41 Executive Vice President, Assistant Chief Financial Officer,
Director
Paul Amadeo 33 Chief Information Officer, Director*
Timothy Norman 33 Chief Technology Officer
Michael Recca 50 Chief Financial Officer
Fillian Lei 32 Controller
Ross Mandell 44 Director*
Scott A. Ziegler 40 Director*
(1) Member of Compensation Committee
(2) Member of Audit Committee
* Nominated as a director to serve upon the completion of this offering
Each of the above-listed directors will serve until the next annual
meeting of the shareholders and until his or her successor is elected and
qualified, or until his or her death, resignation or removal. Vacancies on the
Board of Directors are filled by a majority of the remaining directors.
Each of the above-listed officers and employees will serve until the
next annual meeting of the Board of Directors and until his or her successor is
elected and qualified, or until his or her death, resignation or removal,
subject to the employment agreements between our company and each such officer.
The board of directors is currently comprised of seven seats. At
present Allen Yue and Eric Gravell are serving as directors, and the remaining
five seats are vacant. Upon the completion of this
40
offering, Ross Mandell, Scott Ziegler and Paul Amadeo have been nominated to
serve on the board, and they have agreed to do so subject to our obtaining
acceptable directors and officers liability insurance. We intend to fill
the remaining two vacancies after the completion of this offering.
Business Experience
Allen Yue co-founded Chipcards in November 1993 and has served as its
President since then. Mr. Yue is directly responsible for the sales of all
Chipcards' machinery in Asia, and supervises its offices in Beijing and Seoul.
Prior to founding Chipcards, Mr. Yue co-founded Discount Air Brokers
International in 1988, and ran the Shanghai office of American Pacific
Development and Investment, a Boeing distributor, between 1991 and 1994. Mr. Yue
went to college at Beijing University and San Francisco State University.
Eric Gravell co-founded Chipcards in November 1993 and has served as
its Executive Vice President since then. He has also served as Assistant Chief
Financial Officer since January 2001. Prior to founding Chipcards, Mr. Gravell
was a Director at American Pacific Development and Investment, a Boeing
distributorship with offices in Hong Kong and Shanghai. In 1985, Mr. Gravell
co-founded Transoceanic Travel, the first agency in the United States to promote
international and around-the-world travel at wholesale prices. Mr. Gravell is
currently serving as an officer of TicketPlanet.com, Inc., an online supplier of
travel services. Mr. Gravell attended the University of Montreal and San
Francisco State University.
Paul Amadeo joined Chipcards in 1998 and serves as Chief Information
Officer. Prior to joining Chipcards, Mr. Amadeo conducted research and
development in Optical and RF components, managed a medium-scale LAN/WAN
network, and served as a project engineer/manager for RF components. Mr. Amadeo
earned a B.S. in Applied Physics from the California Institute of Technology,
and a M.S. in Electrical Engineering/Applied Physics from the University of
California, San Diego.
Timothy Norman joined Chipcards in 1997 to develop Chipcards' smart
card division. He currently serves as our Chief Technology Officer and has
served as a Director from October 1999 through January 2001. Prior to joining
Chipcards, Mr. Norman was involved with the research and development of
superconducting and composite materials. He served as a program manager for
composite material characterization on the F-22 project, and designed
experiments for the characterization of advanced plastic materials used in
commercial aircraft. Mr. Norman earned a B.S. in Physics from the University of
Nebraska.
Michael Recca was appointed Chief Financial Officer of Chipcards in May
2001. Mr. Recca serves in this capacity on an as-needed basis. Mr. Recca
currently serves as Chairman of the Board of Directors of Harvey Electronics,
Inc., a retailer of audio, video and home theater equipment. Since 1996, Mr.
Recca has served as the manager of Harvey Acquisition Company, LLC. From August
1995 through December 31, 1998, Mr. Recca was an employee of Taglich Brothers,
D'Amadeo, Wagner & Co., Inc., a NASD registered broker-dealer.
Fillian Lei joined Chipcards in 1994. She served as its Chief Financial
Officer between 1996 and 1998, and is now Controller. Prior to joining
Chipcards, Ms. Lei worked for American Savings Bank as a Senior Financial
Service Representative for seven years. Ms. Lei earned a B.S. degree in
accounting at San Francisco State University in 1994.
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Scott A. Ziegler has been the Senior Managing Partner at Ziegler,
Ziegler & Altman LLP in New York City since 1991, and has been a practicing
attorney since 1986. Mr. Ziegler specializes in international and domestic
corporate, securities, licensing and venture capital matters. Mr. Ziegler
attended Brown University (B.A., 1982) and the University of California School
of Law (J.D., 1985).
Ross H. Mandell is and has been a consultant to Chipcards since
March 2000. Mr. Mandell is also the President and Chief Executive Officer of
Sky Capital Ltd., a financial consulting and advisory company. He has been a
stockbroker since 1984. Mr. Mandell was employed by a number of stock brokerage
firms since that time, including E.F. Hutton and Oppenheimer & Co. In 1995,
Mr. Mandell founded (with two other individuals) Roan Capital Partners, L.P.,
a New York-based broker-dealer and investment banking firm. Mr. Mandell sold
his interests in Roan Capital in April 1997, and joined The Thornwater Company,
L.P., another New York-based brokerage firm, where he served as Senior Vice
President. Mr. Mandell resigned from Thornwater in January 2001, but continues
to serve that firm as a consultant pursuant to three-year consulting agreement.
Mr. Mandell is also a consultant to TicketPlanet.com Inc, a California based
online travel firm.
Mr. Mandell attained a Bachelor of Arts degree from the University of
Maryland in 1978. In 1999, Mr. Mandell was named in an arbitration proceeding
brought against Roan Capital. Mr. Mandell paid $75,000 in connection with the
settlement of that arbitration. In February 1995, Mr. Mandell settled
disciplinary charges brought by the New York Stock Exchange ("NYSE"). He
was suspended from the securities business for six weeks pursuant to that
settlement.
Employment Agreements
Eric Gravell has entered into a three-year employment agreement dated
January 1, 2001, which is renewable at our option. Mr. Gravell receives a salary
of $175,000 per year and is entitled to a discretionary bonus to be determined
by the board of directors.
Allen Yue has entered into a three-year employment agreement dated
January 1, 2001, which is renewable at our option. Mr. Yue receives a salary of
$175,000 per year and is entitled to a discretionary bonus to be determined by
the board of directors.
Each of Paul Amadeo, Timothy Norman and Fillian Lei has entered into a
three-year employment agreement dated November 1, 2000 providing for a salary of
$100,000 per year. Jose Flores has entered into a three-year employment
agreement dated November 1, 2000 providing for a salary of $70,000 per year and
an incentive bonus equal to ten percent of the gross profits from any sales
directly attributable to him.
COMPENSATION OF DIRECTORS AND OFFICERS
42
The following table sets forth the aggregate annual remuneration of our
President and the four most highly paid executive officers other than the
President who served as executive officers as of December 31, 2000:
Summary Compensation Table
---------------------------------------------------------------
ANNUAL COMPENSATION
- --------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e)
- --------------------------------------------------------------------------------------------------------
Other Annual
Name & Principal Position Year Salary ($) Bonus ($) Compensation($)
- --------------------------------------------------------------------------------------------------------
Allen Yue, President 2000 $125,000 -0- $20,000(1)
- --------------------------------------------------------------------------------------------------------
1999 $90,000 -0- $60,000(2)
- --------------------------------------------------------------------------------------------------------
1998 $57,600 $50,000 -0-
- --------------------------------------------------------------------------------------------------------
Eric Gravell, Executive Vice President 2000 $62,500 -0- -0-
- --------------------------------------------------------------------------------------------------------
1999 $78,750 -0- -0-
- --------------------------------------------------------------------------------------------------------
1998 $57,600 $100,000 -0-
- --------------------------------------------------------------------------------------------------------
Timothy Norman, Chief Technology Officer 2000 $66,667 $50,000 -0-
- --------------------------------------------------------------------------------------------------------
1999 $57,000 -0- -0-
- --------------------------------------------------------------------------------------------------------
1998 $40,092 $22,500 -0-
- --------------------------------------------------------------------------------------------------------
Paul Amadeo, Chief Information Officer 2000 $73,333 $40,000 -0-
- --------------------------------------------------------------------------------------------------------
1999 $68,000 -0- -0-
- --------------------------------------------------------------------------------------------------------
Fillian Lei, Controller 2000 $67,705 $50,000 -0-
- --------------------------------------------------------------------------------------------------------
1999 $35,750 -0- -0-
- --------------------------------------------------------------------------------------------------------
1998 $42,000 $22,500 -0-
- --------------------------------------------------------------------------------------------------------
(1) Represents cash commission paid in connection with the sale of equipment.
(2) Represents accrued commission in connection with the sale of equipment that
Mr. Yue elected to defer. This amount was paid during 2001.
43
Stock Compensation
In November 1999 we issued stock awards to the employees named in the
following table in connection with services provided to our company. All share
amounts have been retroactively restated to reflect a 2.65-for-one stock
dividend declared in May 2000. These shares had a nominal fair market value at
the time of issuance.
Name of Employee Amount of Award
- ---------------- ---------------
Fillian Lei 182,500 shares
- ----------------------------------------------------------------------------
Timothy Norman 182,500 shares
- ----------------------------------------------------------------------------
Paul Amadeo 182,500 shares
- ----------------------------------------------------------------------------
Jose Flores (engineer) 91,250 shares
- ----------------------------------------------------------------------------
Mo Jia (head of Beijing office) 182,500 shares
- ----------------------------------------------------------------------------
Stock Options
For the benefit of our employees, directors and consultants, we have
adopted the Chipcards, Inc. 2000 Equity Incentive Plan. The plan provides for
the issuance of options intended to qualify as incentive stock options for
federal income tax purposes to our employees and non-employees, including
employees who also serve as our directors. Qualification of the grant of options
under the plan as incentive stock options for federal income tax purposes is not
a condition of the grant and failure to so qualify does not affect the
exercisability of the stock options. The number of shares of common stock
authorized and reserved for issuance under the Plan is 2,500,000.
In May 2001 we issued 240,000 options to Michael Recca and 120,000
options to each of Allen Yue, Eric Gravell, Paul Amadeo, Timothy Norman, Fillian
Lei and Jose Flores. These options vest ratably over a period of three years. In
May 2000 we also issued 90,000 options to Ziegler, Ziegler & Altman LLP, and an
employee of such firm. Ziegler, Ziegler & Altman LLP is a law firm which we have
retained and will continue to retain in connection with certain legal matters
and which has given an opinion on the validity of the securities being offered.
These options were fully vested upon issuance. Scott Ziegler, who has been
nominated to serve as a director upon the completion of this offering, is a
partner of Ziegler, Ziegler & Altman, LLP. Mr. Ziegler has disclaimed any
interest in such 90,000 options. All of the 1,050,000 options described above
are exercisable at the lower of $8.00 per share or the initial public offering
price of the shares of common stock included in the units, provided that if an
initial public offering is not consummated prior to January 1, 2002, the option
exercise price will be adjusted to $5.00 per share. Upon the closing of this
offering, we also intend to issue 35,000 options to each director who is not an
officer or employee of our company. We anticipate that these options will be
fully-vested upon issuance and will be exercisable at the initial public
offering price of the shares of common stock included in the units.
44
Our board of directors administers and interprets the plan (unless
delegated to a committee) and has authority to grant options to all eligible
participants and determine the types of options granted, the terms, restrictions
and conditions of the options at the time of grant.
The exercise price of options may not be less than 85% of the fair
market value of our common stock on the date of grant of the option and to
qualify as an incentive stock options may not be less than the fair market value
of common stock on the date of the grant of the incentive stock options. Upon
the exercise of an option, the exercise price must be paid in full, in cash, in
our common stock (at the fair market value thereof) or a combination thereof.
Optionees are entitled to exercise for at least thirty days after the
optionee ceases to be an employee, a director, or non-employee service provider.
However, in the event of death or disability of the optionee, the options shall
be exercisable for at least six months following death or disability. In any
event options may not be exercised beyond the expiration date of the options,
which may not be more than one hundred twenty months from the date it is
granted. Options may be granted to our key management employees, directors, key
professional employees or key professional non-employee service providers,
although options granted non-employee directors do not qualify as incentive
stock options. No option may be granted after December 31, 2009. Options are not
transferable except by will or by the laws of descent and distribution.
All outstanding options granted under the Plan will become fully vested
and immediately exercisable if (i) within any 12-month period, we sell an amount
of common stock that exceeds 50% of the number of shares of common stock
outstanding immediately before the 12-month period or (ii) a "change of control"
occurs. For purposes of the plan, a "change of control" is defined as the
acquisition in a transaction or series of transactions by any person, entity or
group (two or more persons acting as a partnership, limited partnership,
syndicate or other group for the purpose of acquiring our securities) of
beneficial ownership, of 50% or more (or less than 50% as determined by a
majority of our directors) of either the then outstanding shares of our common
stock or the combined voting power of our then outstanding voting securities.
PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of our common
stock as of December 31, 2000, as adjusted to reflect the sale of the units
offered by this prospectus, by:
o each person who is known by us to beneficially own more than 5% of
our common stock
o each of the named executive officers and each of our directors; and
o all of our officers and directors as a group.
45
Unless otherwise indicated below, each stockholder named in the table
has sole or shared voting and investment power with respect to all shares
beneficially owned, subject to applicable community property laws.
Number of Shares Percentage Ownership
Name and Address of of Common Stock Before After
Beneficial Owner Beneficially Owned Offering(1) Offering(1)
- ------------------- ------------------ -------- --------
Eric Gravell 3,000,000 28.2% 25.8%
c/o Chipcards, Inc.
Citicorp Center
One Sansome Street, 19th Floor
San Francisco, California 94104
Xiao Qin Jiang 2,800,000 26.3% 24.1%
2885 Churchill Drive
Hillsborough, California 94010
Ross Mandell 2,495,000(2)(3) 23.4% 21.4%
110 Wall Street, Suite 15C
New York, New York 10005
Scott Ziegler [ ](3) [ ]% [ ]%
c/o Ziegler, Ziegler &
Altman, LLP
1330 Avenue of the Americas
New York, New York 10019
Allen Yue 500,000 4.7% 4.3%
c/o Chipcards, Inc.
Citicorp Center
One Sansome Street, 19th Floor
San Francisco, California 94104
Timothy Norman 182,500 1.7% 1.6%
c/o Chipcards, Inc.
6827 Nancy Ridge Dr.
San Diego, California
Paul Amadeo 182,500 1.7% 1.6%
c/o Chipcards, Inc.
6827 Nancy Ridge Dr.
San Diego, California
46
Number of Shares Percentage Ownership
Name and Address of of Common Stock Before After
Beneficial Owner Beneficially Owned Offering(1) Offering(1)
- ------------------- ------------------ -------- --------
Fillian Lei 182,500 1.7% 1.6%
c/o Chipcards, Inc.
Citicorp Center
One Sansome Street, 19th Floor
San Francisco, California 94104
All officers and directors
as a group (7 persons) [ ] [ %] [ %]
- --------------
(1) Percentage of ownership is based on 10,641,250 shares outstanding as of
December 31, 2000, and 11,641,250 outstanding after this offering, assuming no
exercise of the underwriters' over-allotment option. Shares issuable upon
exercise of warrants issued in the offering, or upon exercise of outstanding
options and contingent vesting rights, are not included in the number of shares
outstanding.
(2) Includes shares owned by Sky Capital Ltd., an entity controlled by
Mr. Mandell
(3) Includes options to purchase 35,000 shares of common stock anticipated to be
issued at the closing of this offering.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
On March 20, 2000, we entered into a three year Consulting Agreement
with Ross Mandell. Mr. Mandell is a principal stockholder of our company and has
been nominated to serve as a director upon the completion of this offering. Mr.
Mandell provides consulting and advisory services in connection with general
management consulting and financial advisory consulting. His compensation
included 3,000,000 shares of our common stock and a cash fee of $3,000 per month
for a period of 15 months or until such time as we consummate a public offering
or have raised at least $4,000,000 in net proceeds from a private offering of
our common stock. At such time as we have raised at least $4,000,000 in net
proceeds from a private or public offering, the cash fee will be increased to
$10,000 per month for a period of 24 months. Mr. Mandell sub-contracted a
portion of his consulting duties under this agreement to St. James Holdings, LLC
and has transferred 500,000 of his shares of common stock to St. James Holdings
LLC in payment for its services. The President of the Managing Member of St.
James Holdings, LLC is an Executive Vice President of The Thornwater Company,
L.P., the underwriter for this offering. Mr. Mandell was formerly registered as
a broker with the underwriter.
On March 20, 2000, we entered into a three year Consulting Agreement
with Scott Ziegler, whereby Mr. Ziegler provides consulting and advisory
services in connection with general management consulting and financial advisory
consulting in exchange for [ ] shares of our common stock. Mr. Ziegler is a
partner of Ziegler, Ziegler & Altman, LLP, a law firm which we have retained and
will continue to retain in connection with certain legal matters and which has
given an opinion on the validity of the securities being offered. Some of the
shares issued to Mr. Ziegler may be transferred to partners and/or employees of
Ziegler, Ziegler & Altman, LLP.
Our San Diego office is currently leased from Ampac Technology, LLC.
The members of Ampac Technology, LLC are Xiao Qin Jiang and Eric Gravell, each
of whom owns 50% of the membership interests. Xiao Qin Jiang is one of the
principal stockholders of our company. Eric Gravell is our Executive Vice
President and also a principal stockholder. Ampac Technology, LLC has entered
into
47
an agreement to transfer title to the San Diego property to us upon the
completion of this offering, at a consideration of $150,000 plus an assumption
of the outstanding indebtedness on the property. We believe that this price
represents the fair market value of the property, and that the terms of this
sale are no less favorable to us than could otherwise have been obtained from an
unaffiliated third party.
Eric Gravell, a principal stockholder, officer and director of our
company, periodically provided loans to us in between December 1997 and November
1999, in the aggregate principal amount of $60,000. All of these loans were
non-interest bearing and were repaid in full as of December 31, 2000.
In April 1999, Xiao Qin Jiang, a principal stockholder of our company,
provided us an interest-free loan in the amount of $110,876. This loan was
repaid in full as of December 31, 2000.
In January 2001, Xiao Qin Jiang was paid $90,000 representing an
accrued commission relating to her referral of business to us in 1999.
In August 1999, we entered into a settlement relating to an outstanding
loan that had been provided by us to TicketPlanet.com, Inc., a corporation in
which Eric Gravell is a principal stockholder, officer and director. At such
time, the amount of $75,000 remained unpaid under the loan. We accepted a
payment of $57,000 in full satisfaction of this debt.
DESCRIPTION OF SECURITIES
Common Stock
All shares of common stock have equal voting rights and, when validly
issued and outstanding, are entitled to one vote per share in all matters to be
voted on by shareholders, except that cumulative voting applies to the election
of directors. Cumulative voting permits each stockholder to vote the number of
shares owned by him or her multiplied by the number of directors to be elected,
and such cumulative number of votes may be cast for any one or more directors.
Holders of the common stock are entitled to share pro rata in dividends and
distributions with respect to the common stock, in such amounts and at such
times as may be declared by the Board of Directors out of funds legally
available. The shares of common stock have no preemptive, subscription or
conversion rights. In the event of a liquidation, each shareholder is entitled
to receive a proportionate share of our assets available for distribution to
shareholders after the payment of liabilities and after distribution in full of
preferential amounts, if any. All of the outstanding shares of common stock are,
and all of the shares of common stock to be issued in connection with this
offering will be, validly issued, fully paid and non-assessable.
Our Articles of Incorporation authorizes us to issue up to 25,000,000
shares of common stock, no par value. As of December 31, 2000, there were
10,641,250 shares of common stock issued and outstanding and 21 holders of
record of the common stock. Upon completion of this offering, assuming all of
the units being offered are sold (but not including any exercise of the
underwriter's overallotment
48
option), there will be 11,641,250 shares of common stock issued and outstanding
and 1,000,000 common stock purchase warrants outstanding.
Public Warrants
Each public warrant entitles the holder to purchase one share of our
common stock at an exercise price per share of 105% of the initial public
offering price of the shares included in the units. The exercise price is
subject to adjustment upon the occurrence of certain events as provided in the
public warrant certificate and summarized below. Our public warrants may be
exercised at any time during the period commencing 30 days after this offering
and ending on the fifth anniversary date of the closing of this offering, which
is the expiration date. Those of our public warrants which have not previously
been exercised will expire on the expiration date. A public warrant holder will
not be deemed to be a holder of the underlying common stock for any purpose
until the public warrant has been properly exercised.
Our common stock and public warrants will be offered as a unit and will
trade separately upon the closing of this offering. Accordingly, purchasers of
units in this offering receive separate certificates for the common stock and
public warrants included in the units.
We have the right to redeem the public warrants issued in this offering
at a redemption price of $0.10 per public warrant, after providing 30 days prior
written notice to the public warrant holders, if an appropriate registration
statement is then effective, and if the last reported sale price of our common
stock (if traded on a national securities exchange or on the Nasdaq National
Market or SmallCap Market) or the average of the last reported bid and asked
prices of our common stock (if traded on the over-the-counter market) has been
at least $9.60 for twenty trading days immediately preceding the date of the
notice.
A public warrant holder may exercise our public warrants only if an
appropriate registration statement is then in effect with the Securities and
Exchange Commission and if the shares of common stock underlying our public
warrants are qualified for sale under the securities laws of the state in which
the holder resides. Our public warrants may be exercised by delivering to our
transfer agent the applicable public warrant certificate on or prior to the
expiration date or the redemption date, as applicable, with the form on the
reverse side of the certificate executed as indicated, accompanied by payment of
the full exercise price for the whole number of public warrants being exercised.
The exercise price of the public warrants is subject to adjustment if
we declare any stock dividend to stockholders or effect any split or reverse
split with respect to our common stock. Therefore, if we effect any stock split
or reverse split with respect to our common stock, the exercise price in effect
immediately prior to such stock split or reverse split will be proportionately
reduced or increased, respectively. Any adjustment of the exercise price will
also result in an adjustment of the number of shares purchasable upon exercise
of a public warrant or, if we elect, an adjustment of the number of public
warrants outstanding.
SHARES ELIGIBLE FOR FUTURE SALE
If our stockholders sell substantial amounts of our common stock in the
public market following this offering, the market price of our common stock
could fall. Upon completion of this offering, we will have outstanding
11,641,250 shares of common stock, or 11,791,250 shares if the
49
underwriter's over-allotment option is exercised in full, not including the
exercise of warrants issued in this offering or the exercise of any outstanding
options or contingent vesting rights. Of these shares, up to 1,000,000 shares
sold in this offering, or 1,150,000 shares if the underwriter's option is
exercised in full, will be freely tradeable without restriction or further
registration under the Securities Act; provided, however, that if any of the
shares are purchased by "affiliates" as that term is defined in Rule 144 under
the Securities Act, their sales of shares would be subject to certain
limitations and restrictions under Rule 144, as described below. The remaining
10,641,250 shares of common stock held by our existing stockholders were issued
and sold by us in reliance on exemptions from the registration requirements of
the Securities Act. These shares may not be resold except pursuant to a
registration statement effective under the Securities Act or pursuant to an
exemption from registration, including the exemption provided by Rule 144. On
the effective date of this offering, all of these 10,641,250 shares will be
subject to "lock-up" agreements with the underwriter providing that they will
not offer or sell, pledge, contract to sell, grant any option for the sale of,
or otherwise dispose of, directly or indirectly, any of our securities for a
period of twelve months from the date of this prospectus without the prior
written consent of the underwriter.
Of the 10,641,250 shares held by our existing shareholders, 10,526,250
are currently eligible for resale pursuant to Rule 144, and the remaining
115,000 shares will be eligible for resale pursuant to Rule 144 as of May 18,
2001, in each case subject to the lock-up agreement. In general, under Rule 144,
beginning 90 days after the completion of this offering, a person or persons,
including an affiliate, whose shares are aggregated and who has satisfied a one
year holding period including the period of any prior owner who is not an
affiliate of ours, may sell, within any three month period, a number of shares
which does not exceed the greater of:
o 1% of the then outstanding shares of our common stock; or
o the average weekly trading volume during the four calendar weeks
preceding the sale
Sales under Rule 144 are also subject to manner of sale provisions,
notice requirements and to the availability of current public information about
us.
Rule 144(k) also permits the sale of shares, without any volume
limitations or manner of sale or public information requirements, by a person
who is not an affiliate of ours and who has not been an affiliate of ours for at
least the three months preceding the sale, and who has satisfied a two year
holding period.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our shares of common stock will be
Continental Stock Transfer & Trust Company. Its address is 2 Broadway, New York,
New York 10004 and its telephone number is (212) 509-4000.
50
UNDERWRITING
We have entered into an underwriting agreement with the underwriters
named below. Thornwater Company, L.P., or Thornwater, is acting as the
representative of the underwriters. The underwriting agreement provides for the
purchase of a specific number of units each of the underwriters. The
underwriters' obligations are several, which means that each underwriter is
required to purchase a specified number of units, but is not responsible for the
commitment of any other underwriter to purchase units. Subject to the terms and
conditions of the underwriting agreement, each underwriter has severally agreed
to purchase the number of units set forth opposite its name below:
UNDERWRITER NUMBER OF UNITS
----------- ---------------
The Thornwater Company, L.P..............
__________________________________........
__________________________________........
TOTAL 1,000,000
--------------------
This is a firm commitment underwriting. This means that the
underwriters have agreed to purchase all of the units offered by this prospectus
(other than those covered by the over-allotment option described below) if any
units are purchased. Under the underwriting agreement, if an underwriter
defaults in its commitment to purchase units, the commitments of non-defaulting
underwriters may be increased or the underwriting agreement may be terminated,
depending on the circumstances.
The representative has advised us that the underwriters propose to
offer the units directly to the public at the public offering price that
appears on the cover page of this prospectus. In addition, the representatives
may offer some of the units to certain securities dealers at such price less a
concession of $0.648 per unit. The underwriters may also allow, and such dealers
may reallow, a concession not in excess of $__________ per unit to certain
other dealers. After the units are released for sale to the public, the
representatives may change the offering price and other selling terms at various
times.
We have granted the representatives an over-allotment option. This
option, which is exercisable for up to 45 days after the date of this
prospectus, permits the representatives to purchase a maximum of 150,000
additional units from us to cover over-allotments. If the underwriters exercise
all or part of this option, they will purchase units covered by the option at
the public offering price that appears on the cover page of this prospectus,
less the underwriting discount. If this option is exercised in full, the total
price to the public will be $__________, the total proceeds to us will be
$__________.
The following table provides information regarding the amount of the
discount to be received by the underwriters.
TOTAL WITHOUT EXERCISE OF TOTAL WITH FULL EXERCISE OF
PER UNIT OVER-ALLOTMENT OPTION OVER-ALLOTMENT OPTION
- ------------- --------------------------- -------------------------------
$0.648 $ $
We will pay all of the total expenses of the offering, which we
estimate will be approximately $__________ ($__________ if the over-allotment is
exercised). In addition,
51
we will reimburse Thornwater $202,500 for its expenses ($232,875 if the
over-allotment is exercised).
We and Thornwater will enter into a financial consulting agreement
providing for Thornwater to act as financial consultant to us for a 36 month
period for a fee of of $3,333 per month, with the total fee of $120,000 payable
in advance at the closing of this offering. We have also entered into a
consulting agreement with Ross Mandell, one of our principal shareholders.
Mr. Mandell is also a consultant to Thornwater.
We have agreed to indemnify the underwriters against certain
liabilities, including liabilities under the Securities Act.
Our shareholders have agreed that they will not, without the prior
written consent of Thornwater, directly or indirectly sell any of our common
stock owned by them during the first year following the closing of this
offering; During this period and for an additional period of two years, any
public sale of our securities by these stockholders will be effected through the
facilities of Thornwater.
We and our principal stockholders, officers and directors will grant to
Thornwater a three year right of first refusal to have Thornwater sell
securities under future public and private offerings of any non bank debt or
equity securities of us or our subsidiaries, by us, our subsidiaries, our
affiliates, and/or principal stockholders, officers and directors, except for
issuances or sales to employees pursuant to our stock option plan.
We have granted Thornwater for a period ending on the third anniversary
of the closing of this offering, the right to have Thornwater's designee present
at meetings of the Board and each of its committees subject to our right to
exclude such designee under certain circumstances. The designee will be entitled
to the same notices and communications sent by us as we gave to our directors
and will attend directors' and committees' meetings, but will not be entitled to
vote thereat. Such designee will also be entitled to receive the same
compensation payable to directors as members of the Board and its committees and
all reasonable expenses in attending such meetings. As of the date of this
prospectus no designee has been selected.
In connection with this offering, we have agreed to sell to Thornwater,
for nominal consideration, warrants to purchase up to an aggregate of 100,000
units exercisable initially at $9.72 per unit for a period of four years
beginning one year from the date hereof. These warrants contain antidilution
provisions providing for adjustment of the exercise price upon the occurrence
of certain events, including any recapitalization, reclassification, stock
dividend, stock split, stock combination or similar transaction. In addition,
the warrants grant to the holders rights commencing one year from the date of
this prospectus to have common stock issued upon exercise of the warrants
registered under the Securities Act. These rights include the right to require
us to register these shares for a four year period and the right to include
these shares underlying the units for a six year period in a registration
statement filed by us.
Rules of the Commission may limit the ability of the underwriters to
bid for or purchase shares before the distribution of the shares is completed.
However, the underwriters may engage in the following activities in accordance
with the following rules:
- Stabilizing transactions -- The representatives may make bids or
purchases for the purpose of pegging, fixing or maintaining the
price of shares, so long as stabilizing bids do not exceed a
specified maximum.
- Over-allotments and syndicate covering transactions -- The
underwriters may create a short position in the shares by selling
more shares than are set forth on the cover page of this
prospectus. If a short position is created in connection with the
offering, the representatives may engage in syndicate covering
transactions by purchasing shares in the open market. The
representatives may also elect to reduce any short position by
exercising all or part of the over-allotment option.
52
LEGAL MATTERS
The validity of the issuance of the securities offered hereby will be
passed upon for us by Ziegler, Ziegler & Altman LLP, 1330 Avenue of the
Americas, New York, New York 10019. Members of Ziegler, Ziegler & Altman, LLP
collectively own [ ] shares of our common stock. In addition, Ziegler,
Ziegler & Altman LLP and one of its employees have been granted options to
purchase 90,000 shares of common stock. Scott Ziegler, a partner of Ziegler,
Ziegler & Altman LLP, has disclaimed any ownership interest on these 90,000
options. Upon the closing of this offering, to the extent Scott Ziegler becomes
a director, he will be issued 35,000 options. Ziegler, Ziegler & Altman LLP
regularly represents the underwriter in regulatory and other matters, although
not for purposes of this offering. Particular legal matters that arise in
connection with the offering will be passed upon for the Underwriter by its
counsel, Parker Duryee Rosoff & Haft.
EXPERTS
The financial statements included in this prospectus and in the
registration statement have been audited by BDO Seidman, LLP, independent
certified public accountants, to the extent and for the periods set forth in
their reports appearing elsewhere herein and in the registration statement, and
are included in reliance upon such reports given upon the authority of said firm
as experts in auditing and accounting.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We intend to furnish our stockholders annual reports, which will
include financial statements audited by independent accountants, and all other
periodic reports as we may determine to furnish or as may be required by law,
including Sections 13(a) and 15(d) of the Exchange Act. We have filed with the
SEC a registration statement on Form SB-2 under the Securities Act with respect
to the securities offered by this prospectus. This prospectus does not contain
all the information set forth in the registration statement and the accompanying
exhibits, as permitted by the rules and regulations of the SEC. For further
information, please see the registration statement and accompanying exhibits.
Statements contained in this
53
prospectus regarding any contract or other document which has been filed as an
exhibit to the registration statement are qualified in their entirety by
reference to these exhibits for a complete statement of their terms and
conditions. The registration statement and the accompanying exhibits may be
inspected without charge at the offices of the SEC and copies may be obtained
from the SEC's principal office at 450 Fifth Street, N.W., Washington, D.C.
20549 or at either of its regional offices, located at 7 World Trade Center,
13th Floor, New York, New York 10048 and 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661, upon payment of the fees prescribed by the SEC.
Electronic reports and other information filed through the Electronic Data
Gathering, Analysis, and Retrieval System, known as EDGAR, are publicly
available on the SEC's website, http://www.sec.gov.
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Our underwriting agreement requires us to indemnify Thornwater against
any costs or liability incurred by it by reason of misstatement or omissions to
state material facts in connection with the offering.
To the extent the provisions of our underwriting agreement with
Thornwater purports to provide exculpation from possible liabilities arising
from the federal securities laws, in the opinion of the Securities and Exchange
Commission, these indemnification provisions are contrary to public policy and
therefore unenforceable.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling persons pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
54
INDEX TO FINANCIAL STATEMENTS
Page
Financial Statements filed as a part of this Annual Report
(i) Report of Independent Certified Public Accountants F-2
(ii) Consolidated Balance Sheet as at F-3
December 31, 2000
(iii) Consolidated Statements of Operations F-5
for the years ended December 31, 2000
and December 31, 2000
(iv) Consolidated Statements of Stockholders' Deficit F-6
(v) Consolidated Statements of Cash Flows F-7
for the years ended December 31, 2000
and December 31, 1999
(vi) Summary of Accounting Policies F-8
(vii) Notes to Financial Statements F-12
F-1
Report of Independent Certified Public Accountants
To the Board of Directors
Chipcards, Inc.
fka: American Pacific Technology Corporation
San Francisco, California
We have audited the accompanying consolidated balance sheet of Chipcards, Inc.,
fka: American Pacific Technology Corporation as of December 31, 2000, and the
related consolidated statements of operations, stockholders' deficit, and cash
flows for the years ended December 31, 2000 and 1999. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 Chipcards, Inc.,
fka: American Pacific Technology Corporation at December 31, 2000, and the
results of its operations and its cash flows for the years ended December 31,
2000 and 1999 in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 12, the Company restated its accumulated deficit balance
as of January 1, 1999.
/s/ BDO Seidman, LLP
San Francisco, California
February 9, 2001, except for Note 13
which is as of May 11, 2001
F-2
===========================================================================================
December 31, 2000
- -------------------------------------------------------------------------------------------
Assets (Note 3)
Current
Cash and cash equivalents $ 294,806
Trade receivables 28,461
Inventory 286,634
Costs and estimated earnings on uncompleted contracts in excess of
billings (Note 1) 1,011,977
Prepaid expenses and other current assets 56,021
- -------------------------------------------------------------------------------------------
Total Current Assets 1,677,899
- -------------------------------------------------------------------------------------------
Property and Equipment:
Buildings and improvements (Note 4) 1,215,816
Office equipment 137,423
- -------------------------------------------------------------------------------------------
1,353,239
Less accumulated depreciation 110,257
- -------------------------------------------------------------------------------------------
Net property and equipment 1,242,982
- -------------------------------------------------------------------------------------------
$2,920,881
===========================================================================================
F-3
Chipcards, Inc.
fka: American Pacific Technology Corporation
Consolidated Balance Sheet
===========================================================================================
December 31, 2000
- -------------------------------------------------------------------------------------------
Liabilities and Stockholders' Deficit
Current
Checks issued against future deposits $ 74,356
Short-term borrowings (Note 3) 14,500
Accounts payable 1,484,308
Current portion of long-term debt (Note 4) 28,070
Accrued compensation and commissions (Note 2) 288,910
Income taxes payable (Note 5) 66,000
Other accrued liabilities 64,903
Billings in excess of costs and estimated earnings on uncompleted
contracts (Note 1) 30,621
Deferred profit on production line contracts 1,515,344
- ------------------------------------------------------------------------------------------
Total Current Liabilities 3,567,012
Long-term debt, less current portion (Note 4) 1,101,163
- ------------------------------------------------------------------------------------------
Total Liabilities 4,668,175
- ------------------------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
Stockholders' Deficit (Note 6)
Common stock, no par; 25,000,000 shares authorized; 10,641,250 shares
issued and outstanding 685,100
Accumulated deficit (2,432,394)
- ------------------------------------------------------------------------------------------
Total Stockholders' Deficit (1,747,294)
- ------------------------------------------------------------------------------------------
$ 2,920,881
==========================================================================================
See accompanying summary of accounting policies and
notes to financial statements.
F-4
Chipcards, Inc.
fka: American Pacific Technology Corporation
Consolidated Statements of Operations
=====================================================================================================
Years ended December 31, 2000 1999
- -----------------------------------------------------------------------------------------------------
Revenues
Production line sales $5,359,063 $ 1,520,108
Finished smart card sales 956,851 1,293,096
Smart card component and other sales 137,825 1,526,952
- -----------------------------------------------------------------------------------------------------
Total Revenue 6,453,739 4,340,156
- -----------------------------------------------------------------------------------------------------
Cost of Sales
Production line costs 3,779,619 546,700
Finished smart cards costs 1,119,979 1,419,279
Smart card component and other costs 88,160 1,264,875
- -----------------------------------------------------------------------------------------------------
Total Costs of Sales 4,987,758 3,230,854
- -----------------------------------------------------------------------------------------------------
Gross Profit 1,465,981 1,109,302
Selling Expenses 122,946 759,352
General and Administrative Expenses 1,688,262 1,072,919
Research and Development - 99,324
- -----------------------------------------------------------------------------------------------------
Operating Loss (345,227) (822,293)
- -----------------------------------------------------------------------------------------------------
Other Income (Expense)
Other income (including $181,000 on recovery of previously
written-off accounts receivable) 256,489 75,890
Other expense (9,054) (114,188)
Interest expense, net (160,045) (139,473)
- -----------------------------------------------------------------------------------------------------
Total Other Income (Expense) 87,390 (177,771)
- -----------------------------------------------------------------------------------------------------
Loss Before Income Taxes and Extraordinary Gain (257,827) (1,000,064)
Income tax expense (benefit) (Note 5) 67,600 (169,800)
- -----------------------------------------------------------------------------------------------------
Net Loss Before Extraordinary Gain (325,437) (830,264)
Extraordinary gain, net of $171,400 tax expense (Note 9) - 258,957
- -----------------------------------------------------------------------------------------------------
Net Loss $ (325,437) $ (571,307)
=====================================================================================================
Basic and Diluted Net Loss Before Extraordinary Gain
Per Common Share $ (0.03) $ (0.13)
Extraordinary Gain Net of Tax, per common share - 0.04
- -----------------------------------------------------------------------------------------------------
Basic and Diluted Net Loss, per common share $ (0.03) $ (0.09)
- -----------------------------------------------------------------------------------------------------
Shares Used in Per Common Share Calculations, Basic and Diluted 9,710,000 6,037,000
=====================================================================================================
See accompanying summary of accounting policies and
notes to financial statements.
F-5
Chipcards, Inc.
fka: American Pacific Technology Corporation
Consolidated Statements of Stockholders' Deficit
============================================================================================================
Common Stock
--------------------------- Accumulated
Shares Amount Deficit Total
- ------------------------------------------------------------------------------------------------------------
Balance, January 1, 1999, (Note 12) 5,840,000 $ 100 $ (1,535,650) $ (1,535,550)
Stock-based compensation (Note 6) 1,186,250 6,500 - 6,500
Net loss - - (571,307) (571,307)
- ------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 7,026,250 6,600 (2,106,957) (2,100,357)
Issuance of common stock for consulting
services (Note 6) 3,500,000 103,500 - 103,500
Sale of common stock 115,000 575,000 - 575,000
Net loss - - (325,437) (325,437)
- ------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 10,641,250 $685,100 $ (2,432,394) $(1,747,294)
============================================================================================================
See accompanying summary of accounting policies and
notes to financial statements.
F-6
Chipcards, Inc.
fka: American Pacific Technology Corporation
Consolidated Statements of Cash Flows
===========================================================================================================
December 31, 2000 1999
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net loss $ (325,437) $ (571,307)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Extraordinary gain - (258,957)
Loss on investment in Chinese businesses - 420,000
Depreciation 52,040 51,581
Stock-based compensation 103,500 6,500
Loss on disposal of property and equipment 19,550 6,792
Changes in operating assets and liabilities:
Trade receivables 37,727 228,276
Inventory 695,952 (764,584)
Related party receivable 71,887 113,116
Receivable from insurance provider 430,357 -
Prepaid expenses and other current assets (45,291) 10,551
Costs and estimated earnings on uncompleted contracts in
excess of billings (538,020) (299,917)
Accounts payable and accrued expenses (12,949) (93,102)
Accrued compensation and commissions (19,433) 294,600
Income taxes payable 66,000 (291,400)
Billings in excess of costs and estimated earnings on
uncompleted contracts 30,621 -
Deferred revenue (397,707) (639,566)
- -----------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Operating Activities 168,797 (1,787,417)
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Partial refund of investment in Chinese businesses - 230,000
Acquisitions of property and equipment (28,822) (1,221,857)
- -----------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (28,822) (991,857)
- -----------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Checks issued in excess of future deposits (8,339) 82,695
Net proceeds from the sale of common stock 575,000 -
Net borrowings (repayments) under bank credit agreements
and line of credit (520,163) 515,663
Proceeds from notes payable 506,339 650,000
Proceeds from shareholder loans 9,700 591,797
Principal payments on shareholder loans (525,324) (76,173)
Principal payments on long-term debt (24,516) (2,590)
- -----------------------------------------------------------------------------------------------------------
Net Cash Provided by Financing Activities 12,697 1,761,392
- -----------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 152,672 (1,017,882)
Cash and Cash Equivalents, beginning of year 142,134 1,160,016
- -----------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, end of year $ 294,806 $ 142,134
===========================================================================================================
Supplemental disclosures of cash flow information
Cash paid for interest $ 98,922 $ 78,674
Cash paid for income taxes 1,600 112,927
===========================================================================================================
See accompanying summary of accounting policies and
notes to financial statements.
F-7
Chipcards, Inc.
fka: American Pacific Technology Corporation
Summary of Accounting Policies
================================================================================
Nature of Business Chipcards, Inc. fka: American Pacific Technology
Corporation ("the Company") is a California
corporation, established in 1993 and primarily engaged
in the construction and installation of turnkey
factories in China that produce contactless smart
cards. Smart cards are plastic cards that can store
encrypted data that can be integrated with a variety of
systems including automated bank teller machines,
subway turnstiles, and security systems. The Company
also sells the raw materials used to produce smart
cards to the organizations that acquire the factories
constructed by the Company. Furthermore, the Company
may purchase finished smart cards from these
organizations for resale to end-use customers. The
Company is currently headquartered in San Francisco,
California.
The consolidated financial statements include the
accounts of the Company and Ampac Technology, LLC
("Ampac"). In 1999, the Company's principal
shareholders formed Ampac to acquire an engineering
facility in San Diego, California. The facility is
leased to the Company. All intercompany accounts and
transactions have been eliminated. The Company and Ampac
have entered into an agreement whereby the Company will
buy the building from those shareholders for $150,000
plus the assumption of outstanding borrowings of
approximately $1.1 million.
Cash and Cash Cash and cash equivalents include cash on hand and in
Equivalents banks, and all highly liquid investments with a
maturity of three months or less at the time of
purchase.
Revenue and Cost Revenues from long-term contracts for the construction
Recognition of smart card production lines are recognized on the
percentage-of-completion method, measured by the
percentage of actual costs incurred to date to current
estimated total costs to be incurred on each contract.
Changes in job performance, job conditions and
estimated profitability may result in revisions to
costs and income and are recognized in the period in
which the revisions are determined. At the time a loss
on a contract becomes known, the entire amount of the
estimated ultimate loss is accrued.
In certain contracts, the Company received ownership
interests in Chinese joint venture entities in lieu of
cash consideration. The Chinese joint venture entities
are the entities formally acquiring the equipment.
These joint venture equity interests are not recorded
on the financial statements as the Company is unable to
reasonably estimate fair market value. Because the cash
payment of the entire amount of the contract is
uncertain, the Company uses a zero estimate of gross
profit until the actual payment is received. Therefore,
equal amounts of revenue
F-8
Chipcards, Inc.
fka: American Pacific Technology Corporation
Summary of Accounting Policies
================================================================================
and costs are recognized until contract revenue can be
estimated more precisely. Changes from a zero estimate
of profit to a more precise estimate are accounted for
as changes in accounting estimates. Gross profit on
sales of equipment to entities in which the Company has
an equity interest are deferred to the extent of the
Company's equity interest. This amount is amortized to
revenue over the term of the joint venture.
Some contracts contain provisions requiring the Company
to purchase substantially all of the finished smart
cards manufactured by the purchaser of the production
line over a three-year period. For these contracts,
risk of ownership in the production line is not deemed
to have transferred to the purchaser until the purchase
commitment terminates. Accordingly, gross profit resulting
from the sale of these production lines is deferred and
recognized ratably over the three-year commitment period.
Contract costs include all direct labor, material and
subcontractor costs and those indirect costs related to
contract performance, such as indirect labor,
supervision, supplies, tools, repairs and maintenance.
General and administrative costs are charged to expense
as incurred.
Revenues from the sale of smart card raw materials and
finished smart cards are recognized when shipped to
customers.
Inventory Inventory, consisting of smart card components, is
valued at the lower of cost (first in, first out) or
market.
Property, Equipment Property and equipment are stated at cost. Major
and Depreciation additions and improvements are capitalized; maintenance
and repairs are charged to operations as incurred. Upon
the retirement or disposal of assets, the cost and
related accumulated depreciation are removed from the
accounts and gain or loss, if any, is reflected in
operations in the year of retirement or disposal.
Depreciation of property and equipment is generally
computed using the straight-line method over the
following estimated useful lives:
-------------------------------------------------------
F-9
Chipcards, Inc.
fka: American Pacific Technology Corporation
Summary of Accounting Policies
================================================================================
Buildings and improvements 39 years
Office furniture and equipment 3 to 7 years
-------------------------------------------------------
Research and The Company expenses the costs associated with the
Development research and development of new products as incurred.
Income Taxes Income taxes are calculated using the asset and
liability method specified by Statement of Financial
Accounting Standards No. 109, Accounting for Income
Taxes, and consist of taxes currently payable plus the
change in deferred income taxes resulting from timing
differences between the tax basis of certain assets and
liabilities and the basis used for financial reporting
purposes.
Use of Estimates The preparation of financial statements in conformity
with generally accepted accounting principles 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. Significant estimates used in preparing these
financial statements include those assumed in computing
profit percentages under the percentage-of-completion
revenue recognition method, and those used in recording
receivables for outstanding construction claims. Due to
a certain degree of uncertainty involved with
estimating these amounts, it is at least reasonably
possible that the significant estimates used will
change within the next year.
New Accounting In June 1998, the FASB issued Statement of Financial
Pronouncement Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No.
133 requires companies to recognize all derivatives
contracts as either assets or liabilities in the
balance sheet and to measure them at fair value. If
certain conditions are met, a derivative may be
specifically designated as a hedge, the objective of
which is to match the timing of gain or loss
recognition on the hedging derivative with the
recognition of (i) the changes in the fair value of the
hedged assets or liability that are attributable to the
hedged risk, or (ii) the earnings' effect of the hedged
forecasted transaction.
For a derivative not designated as a hedging
instrument, the gain and loss is recognized in income
in the period of change. SFAS No. 133, amended by SFAS
No. 137, is effective for all fiscal quarters of fiscal
years beginning after
F-10
Chipcards, Inc.
fka: American Pacific Technology Corporation
Summary of Accounting Policies
================================================================================
June 15, 2000.
Historically, the Company has not entered into
derivative contracts either to hedge existing risks or
for speculative purposes. Accordingly, the adoption of
the new standard on January 1, 2001 had no effect on
the Company's financial statements.
Net Loss Per Share The Company has adopted the provisions of SFAS No. 128,
Earnings Per Share. SFAS No.128 provides for the
calculation of basic and diluted earnings per share.
Basic earnings per share includes no dilution and is
computed by dividing income available to common
stockholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per
share reflect the potential dilution of securities that
could share in the earnings of an entity.
Reclassification Certain prior year amounts have been reclassified to
conform to the current year presentation.
F-11
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
1. Costs and Details of costs and estimated earnings on uncompleted
Estimated contracts are summarized as follows:
Earnings on
Uncompleted December 31, 2000
Contracts -----------------------------------------------------------------
Gross Expected Billings on Uncompleted Contracts $4,990,000
=================================================================
Costs incurred on uncompleted contracts $1,831,356
Estimated earnings recognized -
-----------------------------------------------------------------
Revenues earned to date 1,831,356
Less billings to date 850,000
-----------------------------------------------------------------
$ 981,356
=================================================================
Costs and estimated earnings on uncompleted
contracts in excess of billings $1,011,977
Billings in excess of costs and estimated
earnings on uncompleted contracts (30,621)
-----------------------------------------------------------------
$ 981,356
=================================================================
2. Related Party During 2000 and 1999, the Company's principal stockholders
Transactions loaned the Company $9,700 and $591,797 and the Company
made payments of $525,324 and $76,173 on these loans.
These loans did not bear any interest, were due on
demand and fully repaid by December 31, 2000.
The Company provides in the normal course of business,
sales commission on new business in the range of 10%
to 25%. At December 31, 2000 and 1999 approximately
$90,000 and $237,000 in commissions were directly or
indirectly payable to an officer and certain
shareholders of the Company.
3. Short-Term The Company has a $1,950,000 credit facility, bearing
Borrowings interest at prime rate plus 1.5% (11% at December 31,
2000), and maturing in September 2001. The credit
facility is guaranteed by the primary stockholders of
the Company and is collateralized by substantially all
assets. Borrowings cannot exceed 90% of the value of
letters of credits posted by customers to secure
payment to the Company. The facility was unused at
December 31, 2000.
F-12
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
The Company obtains short-term advances from its bank
to enable the Company to post letters of credit which
are drawn upon by its smart card suppliers. During the
year ended December 31, 2000, the Company received
various short-term advances ranging from $14,500 to
$130,500 all bearing interest of 11.5%. At December 31,
2000, outstanding short term advances total $14,500
which were paid in full in January 2001.
The Company has a revolving line of credit of $150,000
for purchase order financing. It bears interest at
prime rate plus 2% (11.5% at December 31, 2000) and
matures in January 2001. The line is guaranteed by
primary stockholders of the Company and collateralized
by substantially all assets. At December 31, 2000, the
line of credit was unused.
The Company also has an unsecured revolving
line-of-credit agreement with a bank guaranteed by a
principal stockholder allowing maximum borrowings of
$100,000 at December 31, 2000. Interest on such
advances is calculated at the bank's reference rate
plus 3.625% (or 13.125% at December 31, 2000) and
expires in February 2001 and was subsequently
renewed under the same terms.
The Company also has an unsecured $25,000 line of
credit bearing interest at prime plus 1.75% (11.25% at
December 31, 2000) that matures in September 2001 and a
$15,000 unsecured line of credit bearing interest at
prime plus 3% that matures in November 2001. Both lines
of credit were unused at December 31, 2000.
4. Long-Term Debt Long-term debt consists of:
December 31, 2000
-----------------------------------------------------------------
Note payable, secured by real property, guaranteed by
two of the Company's principal stockholders, principal
and interest due in monthly installments of $4,910 with
a balloon payment due upon maturity in August 2014. The
note bears interest at the weekly average yield on U.S.
Treasury Securities plus 2.46% (8.06% at December 31,
2000). $ 639,229
Note payable, secured by real property, guaranteed by
the Company's principal stockholders, bearing interest
at 8.12%,
F-13
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
December 31, 2000
-----------------------------------------------------------------
principal and interest due in monthly installments of
approximately $4,500 through May 2020. 482,411
Other 7,593
-----------------------------------------------------------------
1,129,233
Less current portion 28,070
-----------------------------------------------------------------
$1,101,163
=================================================================
Future minimum principal payments under the long-term
debt agreements are as follows:
Year ending December 31, Amount
-----------------------------------------------------------------
2001 $ 28,070
2002 22,164
2003 23,991
2004 25,968
2005 28,108
Thereafter 1,000,932
-----------------------------------------------------------------
$ 1,129,233
=================================================================
5. Taxes on Income The significant components of income tax expense (benefit) are
as follows:
December 31, 2000 1999
---------------------------------------------------------------------------
Current
Federal $ 33,000 $ -
State 34,600 1,600
-
---------------------------------------------------------------------------
$ 67,600 $ 1,600
===========================================================================
Income tax (benefit) from continuing operations $ 67,600 $ (169,800)
Income tax from extraordinary items - 171,400
---------------------------------------------------------------------------
-
Total $ 67,600 $ 1,600
===========================================================================
Deferred tax assets are comprised of the following:
December 31, 2000
---------------------------------------------------------------------------
F-14
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
Deferred revenue on construction contracts $ 1,145,000
Accrued commission 74,000
Inventory reserve 34,000
Organization costs 17,000
Other 13,000
-----------------------------------------------------------------
1,283,000
Less valuation allowance (1,283,000)
-----------------------------------------------------------------
Total $ -
=================================================================
At December 31, 2000 and 1999, the Company established
a 100% valuation allowance for its gross deferred tax
assets as it could not determine that it was more
likely than not that the deferred tax asset could be
realized. Following increases in deferred tax assets,
the valuation allowance was increased by $107,000 and
$22,000 during 2000 and 1999.
The following is a reconciliation of income taxes
determined by applying statutory rates to income taxes
reported:
Years ended December 31, 2000 1999
-----------------------------------------------------------------
Federal taxes 34% 34%
State taxes, net of federal tax benefit 6 6
Change in valuation allowance and other (66) (40)
-----------------------------------------------------------------
Total (26)% -
=================================================================
6. Stockholders' On February 25, 1999, the stockholders approved and the
Equity Company effected a 1,600 for 1 stock split of the
Company's outstanding common stock. On May 19, 2000 the
Board of Directors declared a 265% stock dividend to
effect a 3.65-for-1 stock split of the Company's
outstanding common stock. All common share amounts have
been restated to reflect the stock split and
distribution in all periods presented.
In October 1999, the Company entered into an agreement
with an employee to grant him 25,000 shares of the
Company's common stock upon completion of two years of
service. The Company also granted this individual
warrants to purchase 25,000 shares of Company stock at
a price of $2 per share. 12,500
F-15
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
warrants are exercisable upon completion of two years
of service and 12,500 warrants are exercisable upon
completion of three years of service. Expense
associated with these awards was insignificant. As this
employee was terminated in 2001, these awards were
effectively canceled.
In November 1999, the Company issued 325,000 shares
(1,186,250 post-split) of common stock valued at
$0.02 per share as a bonus to employees.
In May 2000, the Company issued 3,500,000 shares of
common stock valued at approximately $103,500 by an
independent appraiser to two of its consultants in
exchange for on-going financial advisory services.
In June 2000, the Company entered into an agreement
with an employee to grant him 10,000 shares of the
Company's common stock upon completion of 18 months of
service.
7. Commitments Production Line Contracts
and
Contingencies In connection with its sale of two smart card
production lines, the Company entered into commitments
with the production line purchaser (Party A). First,
the Company promises to sell raw materials needed for
the production of smart cards at a fixed price per
unit. Second, Party A promises to sell, and the Company
is required to buy, an agreed-upon amount of finished
smart cards to the Company at a fixed price per unit.
The Company is also required to post a letter of credit
in favor of Party A for the entire purchase price of
finished smart cards. In the event, the price of smart
card raw materials exceeds the fixed purchase price or
the Company is unable to resell the finished smart
cards it is obligated to purchase, these commitments
would have a material adverse impact on the Company's
financial position or results of operations. Subsequent
to year-end, as a result of an arbitration, commitments
for material purchases and sales were eliminated for
one of the contracts.
At December 31, 2000, the Company had entered into a
letter of credit agreement amounting to $163,500 to
guarantee its commitments to purchase finished smart
cards. The letter of credit was amended in January 2001
to increase this amount to $193,500.
F-16
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
8. Concentration of The Company derives substantially all of its revenue
Risk from the construction of smart card production lines in
China. While the Company requires customers to post
letters of credit as collateral for construction
contracts, enforcing payment on contracted amounts is
not assured given the Chinese economic infrastructure.
The Company uses a single supplier to manufacture smart
card producing equipment. Therefore, the company's
ability to supply equipment is substantially dependent
on the availability and quality of this supplier. The
loss of this supplier could have material adverse effect
on the Company's results of operations and financial
position.
Since the third quarter of 1999, there has been a
worldwide shortage in the supply of Mifare
microprocessors, which is the predominant type of
microprocessor for smart card systems. This has had a
material impact on the Company's sole source of
finished cards. The Company is obligated to provide
these customers with the components needed to
manufacture cards, including microprocessors. Because
of the Mifare shortage, the Company has been unable to
obtain adequate microprocessors for its customers,
which in turn has restricted our supply of cards and
exposes the Company to claims for damages. As a result,
the Company has been forced to substantially curtail
fulfillment of orders beginning in January 2000. This
has caused cancelled orders and impaired the Company's ability to
expand smart card sales. Approximately $80,000 of card
orders were cancelled during the year ended December 31,
1999 and approximately $443,000 of orders were cancelled
during the year ended December 31, 2000.
9. Extraordinary In 1999, uncertainty regarding the proceeds to be
Item recovered by the Company from the warehouse's insurer
was resolved and settled. The claim was the result of
a fire in the Company's warehouse in 1998. As a result,
the Company recorded an extraordinary gain of $258,957
net of tax expense of $171,400. The full amount was
received in 2000.
10. Loss Per Warrants to purchase 25,000 shares of the Company's
Share common stock and 35,000 contingently issuable shares of
common stock were outstanding at December 31, 2000 and
1999. Because their effect would be anti-dilutive, they
were not included in the computation of diluted net
loss per common share.
11. Segment The Company, from its headquarters in San Francisco and
Reporting engineering facility in Southern California, is engaged
primarily in the construction and sale of smart card
production lines to customers in China. Therefore, the
Company has only one business segment. Substantially
all of the Company's revenue is derived from foreign
customers.
Revenue from customers exceeding 10% of total revenue:
December 31, 2000 1999
--------------------------------------------------------------------
Customer A $ 2,554,000 $ -
Customer B 1,211,000 -
Customer C - 1,864,000
Customer D - 839,000
Customer E - 474,000
====================================================================
F-17
Chipcards, Inc.
fka: American Pacific Technology Corporation
Notes to Consolidated Financial Statements
================================================================================
12. Restatement The Company restated gross profit recognized in 1998 in
connection with production line contracts containing
performance conditions under which the Company retained
risk of loss. The restatement resulted in a reduction
in gross margin and net income of approximately $2.4
million which amount was adjusted through the Company's
beginning accumulated deficit and deferred profit
balances as of January 1, 1999.
In May 2001, the Company's stockholders approved its
stock option plan. 2,500,000 shares of the Company's
common stock are reserved for issuance under the plan.
13. Subsequent In May 2001, the Company granted 1,015,000 stock
Event options to employees and consultants at a price to be
determined.
F-18
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SECURITIES ONLY IN THOSE JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF OUR SECURITIES.
UNTIL , 2001 (25 DAYS AFTER COMMENCEMENT OF THE OFFERING), ALL DEALERS EFFECTING
TRANSACTIONS IN OUR COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THE OFFERING,
MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN
ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
1,000,000 UNITS
EACH CONSISTING OF
ONE SHARE OF COMMON STOCK
AND ONE COMMON STOCK PURCHASE WARRANT
OF CHIPCARDS, INC.
----------------------
PROSPECTUS
----------------------
THE THORNWATER COMPANY, L.P.
99 Wall Street
New York, New York 10005
, 2001
PART II
INDEMNIFICATION OF OFFICERS AND DIRECTORS
Director and Officer Liability and Indemnification
California law provides that directors of a corporation will not be
personally liable for monetary damages for breach of their fiduciary duties as
directors, except liability (i) for acts or omissions that involve intentional
misconduct or a knowing and culpable violation of law, (ii) for acts or
omissions that a director believes to be contrary to the best interests of the
corporation or its shareholders or that involve the absence of good faith on the
part of the director, (iii) for any transaction from which a director derived an
improper personal benefit, (iv) for acts or omissions that show a reckless
disregard for the director's duty to the corporation or its shareholders in
circumstances in which the director was aware, or should have been aware, in the
ordinary course of performing a director's duties, of a risk of serious injury
to the corporation or its shareholders, (v) for acts or omissions that
constitute an unexcused pattern of inattention that amounts to an abdication of
the director's duty to the corporation or its shareholders, (vi) for unlawful
distributions of assets, unlawful payments of dividends or unlawful stock
repurchases or redemptions, (vii)for any act or omission occurring prior to the
date when the provision becomes effective, and (viii) for any act or omission as
an officer, notwithstanding that the officer is also a director or that his or
her actions, if negligent or improper, have been ratified by the directors. Such
limitation of liability does not apply to liabilities arising under the federal
securities laws and does not affect the availability of equitable remedies such
as injunctive relief or rescission.
Our Bylaws authorize us to indemnify any director or officer who is a
party, or is threatened to be made a party, to any proceeding (including a
derivative lawsuit by or in the right of our corporation) by reason of the fact
that such person served as a director or officer of our company, or served as an
officer, director or other agent for any other company or enterprise at our
request, against expenses (including without limitation attorneys' fees),
judgments, fines, settlements and other amounts actually and reasonably incurred
in connection with such proceeding if such person acted in good faith and in a
manner reasonably believed to be in the best interests of our corporation and,
in the case of a criminal proceeding, had no reasonable cause to believe the
conduct was unlawful. However, in the case of a derivative lawsuit, no
indemnification will be provided for the following: (i) any claim as to which
the officer or director is adjudged to be liable to our corporation in the
performance of his or her duty to the corporation and its shareholders (except
to the extent that the court otherwise determines that the person is fairly and
reasonably entitled to indemnity for expenses), (ii) any amounts paid in
settling or otherwise disposing of a pending action without court approval, or
(iii) any expenses incurred in defending a pending action which is settled or
otherwise disposed of without court approval.
If an officer or director is successful on the merits in defending any
action, such person shall be indemnified against all expenses actually and
reasonably incurred in connection with such action. Otherwise, indemnification
will be provided only if authorized in accordance with California law based on a
determination that the officer or director has met the applicable standard of
conduct.
II-1
Expenses incurred by an officer or director in defending any action will
be advanced prior to the final disposition of the action upon receipt of an
undertaking to repay the amount advanced if such person is ultimately determined
not to be entitled to indemnification.
We believe that these provisions are necessary to attract and retain
qualified persons as directors and executive officers. Insofar as
indemnification for liabilities arising under the Securities Act of 1933, as
amended, may be permitted to directors, officers and controlling persons of our
company pursuant to the provisions of our charter documents or California law,
we have been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933, as amended, and is, therefore, unenforceable.
We intend to purchase and maintain insurance on behalf of our officers and
directors for any liability arising out of their actions in such capacities. It
is expected that such insurance will cover all potential liabilities, whether or
not we would be authorized to provide indemnification under our Bylaws or
California law.
II-2
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following sets forth the estimated expenses in connection with the
issuance and distribution of the securities offered hereby:
Registration Fees - $ 5,197
NASD Listing Fee $ 5,000
Boston Stock Exchange Listing Fee $ 15,250
Printing and Engraving - (estimated) $ 50,000
Legal - (estimated) $150,000
Accounting - (estimated) $250,000
Blue Sky fees and expenses - (estimated) $ 25,000
Financial advisory fee $120,000
Miscellaneous Expenses - (estimated) $ 10,000
--------
Total $630,447
========
RECENT SALES OF UNREGISTERED SECURITIES
Since inception, we have sold the following securities without registering such
securities under the Securities Act:
Title and Amount Person or Class Total Offering Price of
Date of Securities of Persons Type of Consideration
---- ------------- ---------- ---------------------
12/5/93 500 shares of Eric Gravell $50
Common Stock
12/5/93 500 shares of Alan Yue $50
Common Stock
10/29/99 50,000 shares of Fillian Lei Services rendered
Common Stock
10/29/99 50,000 shares of Timothy Norman Services rendered
Common Stock
10/29/99 50,000 shares of Paul Amadeo Services rendered
Common Stock
10/29/99 50,000 shares of Mo Jia Services rendered
Common Stock
10/29/99 25,000 shares of Jose Flores Services rendered
Common Stock
II-3
Title and Amount Person or Class Total Offering Price of
Date of Securities of Persons Type of Consideration
---- ------------- ---------- ---------------------
10/30/99 100,000 shares of Allen Yue Services rendered
Common Stock
3/20/00 3,000,000 shares of Ross Mandell Consulting services
Common Stock
3/20/00 500,000 shares of Scott Ziegler Consulting services
Common Stock
5/18/00 115,000 shares of Private placement $575,000
Common Stock investors
All of the foregoing securities were sold in transactions not involving a
public offering in reliance on the exemption from registration set forth in
Section 4(2) of the Securities Act of 1933.
II-4
INDEX TO EXHIBITS
Exhibits filed as part of this Registration Statement
- --------------------------------------------------------------------------------
Exhibit Exhibit
Number
- --------------------------------------------------------------------------------
1.0 Form of Underwriting Agreement
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Registrant as filed
on November 3, 1993 with the Secretary of State of
the State of California
- --------------------------------------------------------------------------------
3.2 Amendment to the Articles of Incorporation of the
Registrant as filed on August 31, 1998 with the
Secretary of State of the State of California
- --------------------------------------------------------------------------------
3.3 Amendment to the Articles of Incorporation of the
Registrant as filed on April 1, 1999 with the
Secretary of State of the State of California
- --------------------------------------------------------------------------------
3.4 Amendment to the Articles of Incorporation of the
Registrant as filed on April 27, 2000 with the
Secretary of State of the State of California
- --------------------------------------------------------------------------------
3.5 Amendment to the Articles of Incorporation of the
Registrant as filed on August 7, 2000 with the
Secretary of State of the State of California
- --------------------------------------------------------------------------------
3.6 Amended and Restated By-laws of the Registrant
- --------------------------------------------------------------------------------
4.1* Form of warrant for the purchase of one share of
Common Stock of the Registrant
- --------------------------------------------------------------------------------
4.2* Form of Underwriter's Warrant to be issued by the
Registrant to The Thornwater Company, L.P.
- --------------------------------------------------------------------------------
5.1* Opinion of Ziegler, Ziegler & Altman LLP regarding
the legality of the securities covered by this
Registration Statement
- --------------------------------------------------------------------------------
10.1 Employment Agreement, dated as of January 1, 2001,
between the Registrant and Eric Gravell
- --------------------------------------------------------------------------------
10.2 Employment Agreement, dated as of January 1, 2001,
between the Registrant and Allen Yue
- --------------------------------------------------------------------------------
10.3* Employment Agreement, dated as of November 1, 2000,
between the Registrant and Fillian Lei
- --------------------------------------------------------------------------------
10.4* Employment Agreement, dated as of November 1, 2000,
between the Registrant and Paul Amadeo
- --------------------------------------------------------------------------------
10.5* Employment Agreement, dated as of November 1, 2000,
between the Registrant and Timothy Norman
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Exhibit Exhibit
Number
- --------------------------------------------------------------------------------
10.6 2000 Equity Incentive Plan
- --------------------------------------------------------------------------------
10.7 Lease of Space, dated March 18, 1999, between the
Registrant and AMPAC Technology LLC
- --------------------------------------------------------------------------------
10.8 Office Service Agreement, dated April 10, 2000
between the Registrant and Vantas Corporate Centers
- --------------------------------------------------------------------------------
10.9* Sino Foreign Joint Venture Agreement, dated February
18, 2000, between the Registrant and Shandong Huang
Tai Industrial Group
- --------------------------------------------------------------------------------
10.10* Agreement for Extending the Deadline of Foreign
Investment Contribution, dated August 12, 2000
between the Registrant and Shandong Huang Tai
Industrial Group of China.
- --------------------------------------------------------------------------------
10.11* Agreement of Purchase of Equipment, dated February
18, 2000, between the Registrant and China Card I.C.
(Shanghai) Co., Ltd.
- --------------------------------------------------------------------------------
10.12* Supplemental Agreement amending the Agreement of
Purchase of Equipment, the Agreement of Raw
Materials and Sales and the Technical Services and
Patent Technology Licensing Agreement, between the
Registrant and China Card I.C. (Shanghai) Co., Ltd.
- --------------------------------------------------------------------------------
10.13* Addendum to the Agreement for Purchase of Equipment,
between the Registrant and China Card, I.C. (Shanghai)
Co., Ltd.
- --------------------------------------------------------------------------------
10.14* Addendum to the Agreement for Purchase of Equipment,
dated November 10, 2000, between the Registrant and
China Card, I.C. (Shanghai) Co., Ltd.
- --------------------------------------------------------------------------------
10.15* Agreement of Raw Materials and Sales, dated February
18, 2000, between the Registrant and China Card, I.C.
(Shanghai) Co., Ltd.
- --------------------------------------------------------------------------------
10.16* Technical Support Agreement, dated February 18, 2000
between the Registrant and China Card I.C. (Shanghai)
Co., Ltd.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Exhibit Exhibit
Number
- --------------------------------------------------------------------------------
10.17* Technical Services and Patent Technology Licensing
Agreement, dated February 18, 2000, between the
Registrant and China Card I.C. (Shanghai) Co. Ltd.
- --------------------------------------------------------------------------------
10.18* Materials Processing Agreement between the Registrant
and China Card I.C. (Shanghai) Co. Ltd.
- --------------------------------------------------------------------------------
10.19* Agreement of Purchase of Equipment, dated April 1,
2000, between the Registrant and Shandong Huaguan
Group General Company.
- --------------------------------------------------------------------------------
10.20* Agreement for Purchase of Raw Materials, dated April
1, 2000, between the Registrant and Shandong Huaguan
Group General Company
- --------------------------------------------------------------------------------
10.21* Technical Services and Licensing Agreement dated
April 1, 2000 between the Registrant and Shandong
Huaguan Group General Company.
- --------------------------------------------------------------------------------
10.22* Supplemental Agreement amending the Agreement of
Purchase of Equipment, the Agreement for Purchase of
Raw Materials and Sales and the Technical Services
and Patent Technology Licensing Agreement, between
the Registrant and Shandong Huaguan Group General
Company
- --------------------------------------------------------------------------------
10.23* Agreement for Purchase of Equipment dated May 8,
2001, between Hainan Pacific New High Tech Company
and the Registrant
- --------------------------------------------------------------------------------
10.24* Technical Services and Licensing Agreement dated
May 8, 2001, between Hainan Pacific New High Tech
Company and the Registrant
- --------------------------------------------------------------------------------
10.25* Letter of the President of the Registrant, dated
May , 2001, representing that Exhibits 10.9
through 10.24 are fairly and accurately translated
- --------------------------------------------------------------------------------
10.26* Consulting Agreement dated March 20, 2000, between
Ross Mandell and the Registrant
- --------------------------------------------------------------------------------
10.27* Consulting Agreement dated March 20, 2000 between
Scott Ziegler and the Registrants
- --------------------------------------------------------------------------------
23.1* Consent of Ziegler, Ziegler & Altman LLP (to be
included in Exhibit 5.1)
- --------------------------------------------------------------------------------
23.2 Consent of BDO Seidman, LLP
- --------------------------------------------------------------------------------
UNDERTAKINGS
--------------------------------------------------------------------
(A) RULE 415 OFFERING.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement to:
(i) Include any prospectus required by section 10(a)(3) of
the Securities Act of 1933;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the Registration Statement; and
(iii) Include any material information with respect to the
plan of distribution not previously disclosed in the Registration
Statement or any material change to such information.
(2) For determining liability under the Securities Act, treat
each post-effective amendment as a new registration statement of the
securities offered, and the offering of the securities at that time
to be the initial bona fide offering.
(3) File a post-effective amendment to remove from
registration any of the securities that remain unsold at the end of
the end of the offering.
(d) EQUITY OFFERINGS OF NONREPORTING SMALL BUSINESS ISSUERS.
The Registrant will provide to the underwriter at the closing
specified in the underwriting agreement the certificates in such
denominations and registered in such names as required by the
underwriter to permit prompt delivery to each purchaser.
--------------------------------------------------------------------
SIGNATURES
In accordance with the requirements of the Securities Act of
1933, the registrant certifies that it has reasonable grounds to believe that it
meets all the requirements for filing on Form SB-2 and authorized this
registration statement to be signed on its behalf by the undersigned, in the
city of San Francisco, California, on May 11, 2001.
By: /s/ Allen Yue
--------------------------------------
Name: Allen Yue
Title: President
In accordance with the requirements of the Securities Act of
1933, as amended, this Registration Statement has been signed by the following
persons in the capacities and on the dates stated.
SIGNATURE NAME AND TITLE DATE
/s/ Allen Yue Allen Yue, May 11, 2001
- ---------------------------- President and Director
/s/ Eric Gravell Eric Gravell, May 11, 2001
- ---------------------------- Executive Vice President and
Director
/s/ Michael Recca Michael Recca, May 11, 2001
- ---------------------------- Chief Financial Officer
/s/ Fillian Lei Fillian Lei, May 11, 2001
- ---------------------------- Controller