<Page>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 15, 2002
REGISTRATION NO. 333-60896
________________________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
PRE-EFFECTIVE
AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-------------------
CHIPCARDS, INC.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
-------------------
<Table>
CALIFORNIA 3612 94-3191805
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
OF INCORPORATION OR CLASSIFICATION IDENTIFICATION NO.)
ORGANIZATION) OR CODE NUMBER)
</Table>
-------------------
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:
<Table>
STEVEN ALTMAN, ESQ. MICHAEL D. DIGIOVANNA, ESQ.
ZIEGLER, ZIEGLER & ALTMAN LLP REED SMITH LLP
555 MADISON AVENUE, ELEVENTH FLOOR 529 FIFTH AVENUE
NEW YORK, NEW YORK 10022 NEW YORK, NEW YORK 10017
(212) 319-7600 (212) 599-0500
</Table>
-------------------
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. [ ]
(continued on following page)
-------------------
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.
________________________________________________________________________________
<Page>
CALCULATION OF REGISTRATION FEE
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
PROPOSED
AMOUNT MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES TO BE OFFERED PRICE AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED PER SHARE OFFERING PRICE(1) FEE(5)
- -------------------------------------------------------------------------------------------------------------------
Units, each consisting of:. 1,150,000(2) $8.10 $9,315,000 $2,328.85
(i) one share of common stock, no par value,
and
(ii) one redeemable 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
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
</Table>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) 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. The Company is registering the common stock
underlying the units and the warrants underlying the units.
(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(g) of the Securities Act of 1933, as amended.
(5) The full amount of the registration fee was previously paid.
<Page>
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 , 2002
PROSPECTUS
1,000,000 UNITS CONSISTING OF
1,000,000 SHARES OF COMMON STOCK AND
1,000,000 REDEEMABLE COMMON STOCK
PURCHASE WARRANTS
[CHIPCARDS LOGO]
-------------------
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 'CHIP' and 'CCD'. We
currently estimated that the initial public offering price per unit will be
$8.10.
-------------------
<Table>
<Caption>
PER UNIT TOTAL
-------- -----
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
</Table>
-------------------
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 our behalf by The Thornwater Company,
L.P. as representative of the underwriters. The underwriters have committed to
purchase all of the securities being offered. The Thornwater Company, L.P.
expects to deliver the shares against payment on or about , 2002.
-------------------
THESE SECURITIES ARE SPECULATIVE. INVESTING IN OUR COMMON STOCK INVOLVES A
HIGH DEGREE OF RISK. SEE 'RISK FACTORS' BEGINNING ON PAGE 7.
-------------------
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.
-------------------
THE THORNWATER COMPANY, L.P.
DIRKS & COMPANY, INC.
May , 2002
<Page>
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
Prospectus Summary.......................................... 3
Risk Factors................................................ 7
Cautionary Note Regarding Forward Looking Statements........ 17
Use of Proceeds............................................. 18
Dividend Policy............................................. 19
Dilution.................................................... 19
Capitalization.............................................. 20
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 21
Description of Business..................................... 28
Management.................................................. 45
Compensation of Directors and Officers...................... 47
Principal Stockholders...................................... 49
Certain Relationships and Related Party Transactions........ 50
Nasdaq Listing Application and Approval..................... 52
Description of Securities................................... 53
Shares Eligible for Future Sale............................. 56
Transfer Agent and Registrar................................ 56
Underwriting................................................ 57
Legal Matters............................................... 59
Experts..................................................... 59
Where You Can Find Additional Information................... 59
Indemnification for Securities Act Liabilities.............. 60
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 60
Index to Financial Statements............................... F-1
</Table>
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 , 2002, 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.
2
<Page>
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.
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. A provisional patent application is a
simplified filing that may be submitted without a formal patent claim or prior
art, and it must be followed with a complete non-provisional application within
12 months. We have also marketed finished smart cards since 1998. We have made
arrangements with certain 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 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, 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
3
<Page>
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.
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:
access to restricted areas (replacing keys and identification cards);
public transportation fare collection (replacing tokens and tickets);
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;
public telephones;
industrial applications such as quality control, warehousing, inventory
control, distribution and warranty;
health care (replacing patients' paper files in hospitals and HMOs); and
cellular phones.
We were incorporated in California in November 1993 under the name American
Pacific Technology, 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.
4
<Page>
THE OFFERING
<Table>
Securities offered:.......................... 1,000,000 units, each consisting of one share of
common stock and one redeemable common stock purchase
warrant per share. Upon the closing of this offering,
the shares of common stock and the warrants included
in the units will be separately traded.
Terms of Warrants:........................... Each warrant entitles the holder to purchase one
share of common stock at an exercise price of $8.40
per share, and may be exercised at any time
commencing 30 days after the closing of this offering
and ending five years after the closing. We have the
right to redeem the warrant at a price of $0.10 per
warrant if the price of our common stock is at least
$9.60 for twenty trading days and a registration
statement is then effective with respect to the
shares subject to the warrants.
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 for the common stock, CHIPW for the warrants.
Proposed Boston Stock Exchange Symbol:....... CCD for the common stock, CCDW for the warrants.
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.
</Table>
- ---------
(1) Based on shares outstanding as of May 1, 2002. Does not include shares
issuable upon exercise of options or any contingent rights.
(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.
5
<Page>
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 as of and for the years ended December 31, 2001 and
December 31, 2000 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 combined 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 and related debt is included 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.'
<Table>
<Caption>
AS OF AND FOR THE YEAR ENDED
----------------------------
DECEMBER 31, DECEMBER 31,
2001 2000
---- ----
Revenues................................................... $15,678,123 $4,622,383
Net income (Loss).......................................... 441,680 (325,437)
Basic and diluted net income (loss) per common share....... 0.04 (0.03)
Total assets............................................... 2,783,723 2,920,881
Long-term debt (excluding current portion)................. 1,079,809 1,101,163
</Table>
6
<Page>
RISK FACTORS
As used in this prospectus, unless the context otherwise indicates, the
terms 'we,' 'us,' or 'our' refer to Chipcards, Inc., the term 'common stock'
refers to our common stock, no par value, and the term 'units' refers to the
units offered by this prospectus. In addition, we refer to prospective investors
as 'you' or the 'investors.'
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 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 $571,307 for the years ended
December 31, 2000 and 1999. As of December 31, 2000 we had a working capital
deficit of $1,510,113, an accumulated deficit of $2,432,394 and a stockholders'
deficit of $1,747,294. As of December 31, 2001 we had a working capital deficit
of $1,109,114, an accumulated deficit of $1,990,714 and a stockholders'
deficit of $1,002,614. Although we recorded operating income of $442,376 and net
income of $441,680 for the year ended December 31, 2001, we may not be able to
continue growing our sales and may not be able to maintain profitability in the
future.
We have historically had negative gross margins on the sale of smart cards.
That has been caused by competitive market conditions and high rate of damaged
or defective cards we have. We intend to establish our own manufacturing
facility in the United States following the offering where we believe we can
manage costs in production, particularly quality control, much more efficiently.
We expect it will take four months to establish the manufacturing facility
during which time no revenues will be generated. We expect that sales of smart
cards manufactured at such a U.S. facility will be at positive gross margins,
but there is no guarantee that will occur.
A SIGNIFICANT INCREASE IN OUR BUSINESS MAY REQUIRE ADDITIONAL CAPITAL, AND WE
MAY NOT BE ABLE TO OBTAIN THE NECESSARY FUNDS
We will need the proceeds of this offering in order to implement our
business plan, including the planned expansion of our manufacturing
capabilities. In addition, even if this offering is successful, we may need to
obtain additional funding if we receive a significantly higher volume of
production line orders than in past periods. 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.
IF WE DO NOT IMPROVE OUR MANAGEMENT AND ACCOUNTING CONTROLS, WE MAY NOT BE ABLE
TO MANAGE OUR BUSINESS EFFECTIVELY
Due to our limited size and resources in the early stages of our operations,
we did not employ a Chief Financial Officer. To address this issue, in January
2002, we promoted Fillian Lei to the position of Chief Financial Officer. To
address increased management and accounting controls the company is planning to
hire a new Chief Financial Officer. We also plan to hire additional personnel
in this area in order to provide the necessary management supervision with
respect to financial and accounting matters. However, if we should fail to hire
such personnel it could have a material adverse effect on our business and on
our ability to execute our business strategy successfully.
7
<Page>
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 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:
countries in which we do business may have political, social and economic
systems that are unstable, which could result in nationalization and other
risks;
the impact of possible recessions in economies outside the U.S.,
particularly in Asian markets which have experienced volatility and in
which growth has been uneven across geographic and economic sectors;
difficulties in and costs of staffing and managing foreign operations due
to the fact that a substantial portion of our business and a significant
number of our employees are located outside and at a far distance from our
U.S. operations;
lack of complete business experience in foreign markets, which may create
difficulties in understanding and complying with local laws, regulations,
business practices and customs;
difficulty in enforcing intellectual property rights outside the U.S. due
to the lack of assurance that we will be the first to file any patent
application and the risk that laws of certain foreign countries do not
provide the protection to intellectual property provided in the United
States;
the impact of changes in United States and foreign regulatory requirements
resulting in, imposition of or increases in customs' duties, other tariffs,
export controls and other trade barriers;
potentially adverse tax consequences resulting from the imposition of or
increases in foreign revenue, income, revenue or earnings taxes and
withholding or other taxes on remittances; and
language and cultural barriers.
Any one or more of the foregoing factors could limit our ability to sustain
or increase international revenues, which could 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
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.
8
<Page>
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. Moreover, in the past we have been
required to re-negotiate material contract terms with production line customers
in China. In fiscal 2000, a material contract was renegotiated reducing the
purchase price for the sale of two production lines by 40 percent. The
renegotiated sales price is included in our financial statements for the period
ended December 31, 2000. Although this situation has not arisen in any of our
current contracts, if any customer should in the future seek to re-negotiate a
contract, we may have limited alternatives given the uncertainties in enforcing
our legal rights in China.
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. Production Line sales to
Chinese governmental entities in 2001 were $2,810,000, which represented
approximately 24% of total equipment sales. There were no smart card sales in
2001 to Chinese governmental agencies. To our knowledge, the only production
line customers that are governmental entities are the Chinese Ministry of Public
Security and the China Motor Vehicle Safety Inspection Center. We estimate that
in 2002, 35% of our production line sales and none of our smart card sales will
be to Chinese governmental agencies. However, certain Chinese customers
are majority owned by governmental entities, which is believed to be the case
with substantially all Chinese public companies. We intend to continue to pursue
further government contracts in connection with a broad-based project by the
Chinese Ministry of Public Security to provide each citizen with smart cards for
identification and other purposes. Accordingly, to the extent that a significant
portion of our future business may be with governmental entities, we could face
greater exposure to sovereign immunity risks.
WE HAVE NO EXPERIENCE IN SELLING OUR PRODUCTION LINES IN MARKETS OTHER THAN
CHINA
To date, our production line sales have been limited to customers located in
mainland China and Hong Kong. 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 products
will depend upon emerging communications and commerce networks, such as the
Internet. If growth in the domestic market
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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 10 installations at any one time.
Each production line takes from three to six months to complete, including
assembly, delivery, installation and testing. Until we can add internal capacity
with the proceeds of this offering, our capital equipment business will remain
dependent on a limited number of customers at any given time.
OUR ABILITY TO SUPPLY PRODUCTION LINES TO OUR CUSTOMERS COULD BE DISRUPTED BY
PROBLEMS AFFECTING OUR 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, in February 2001 we replaced our previous contractor
with a new company which we believe has provided better service. However, if
this manufacturer fails to continue performing 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 current 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
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, 2001, 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:
manufacture of products similar to ours by competitors; or
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.
In addition, an inability to retain major
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customers would hurt our efforts to expand our customer base and grow our smart
card sales business.
OUR ABILITY TO MANUFACTURE PRODUCTION LINES IS CONTINGENT ON THE SUPPLY OF
COMPONENTS FROM THIRD PARTY VENDORS
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.
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.
OUR ABILITY TO SELL SMART CARDS IS RESTRICTED BY OUR RELIANCE ON OUTSIDE SOURCES
OF SUPPLY, WHICH
COULD ADVERSELY AFFECT OUR REVENUES AND CASH FLOW
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 sources of supply are customers to which we have sold
production lines. We are able to buy smart cards from these customers at
commercially reasonable prices. We expect to fill our needs for finished smart
cards from Hainan Pacific and the Ministry of Public Security. Our agreements
with these institutions are set forth in the 'Description of Business' section
of this prospectus under the headings 'Production Line Contracts -- Hainan
Pacific' and 'Production Line Contracts -- Ministry of Public Security.'
Quantities of cards purchased 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 will obtain will be competitive under current market
conditions. There is, however, no assurance that the manufacturers will have a
sufficient supply of cards at any given time to meet our needs. There is also a
risk that the manufacturers may not be willing to sell us cards under these
arrangements at prices acceptable to us or at all. 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, which
would adversely affect our revenues and cash flows. However, if we are
successful in establishing an in-house production line, our dependence on
third-party suppliers will be reduced.
WE HAVE EXPERIENCED SHORTAGES IN SUPPLY OF SMART CARDS BECAUSE OF A WORLDWIDE
SHORTAGE OF
MICROPROCESSORS, AND WE MAY EXPERIENCE SHORTAGES IN THE FUTURE
From the third quarter of 1999 through the end of 2000, there was a
worldwide shortage in the supply of Mifare microprocessors. Mifare is the
predominant type of microprocessor for smart card systems and is manufactured by
only two companies worldwide, Siemens and Philips Semiconductor. This
microprocessor is specifically designed to operate the Mifare smart card
platform, which is the leading operating system in the smart card industry.
Other types of microprocessors are generally incompatible with the Mifare
platform and, therefore, are not interchangeable with Mifare chips. The Mifare
shortage had a material impact on our smart card sales. We depended, and
presently depend, on our production line customers as our sole source of
finished cards. We were obligated to provide these customers with the components
needed to manufacture cards, including microprocessors. Because of the Mifare
shortage, we were unable to obtain adequate microprocessors for our customers,
which in turn restricted our supply of cards. As a result, we were forced to
substantially curtail fulfillment of orders beginning in January 2000. This
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. During the six months ended June 30,
2001, approximately $328,000 of smart card orders were cancelled, which was
caused by continuing shortages in early 2001. At present the Mifare shortage has
abated and we have sufficient access to microprocessors. There are no open
contracts for the supply of
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smart cards. However, if similar shortages should occur in the future, we may
again be unable to meet the requirements of our customers. There is no guarantee
that we will be able to maintain sufficient inventory to hedge against possible
future shortages.
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 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 AND WE MAY NOT HAVE THE NECESSARY
RESOURCES
TO COMPETE EFFECTIVELY AGAINST OTHER COMPANIES
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 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, particularly in the area of finished smart card sales, 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, though we have secured
non-disclosure and invention assignment agreements covering our principal
employees and technologies.
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.
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OUR PRODUCTS UTILIZE TECHNOLOGIES OWNED BY THIRD PARTIES, WHICH COULD SEEK TO
RESTRICT OUR USE
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.
WE ARE DEPENDENT ON CURRENT MANAGEMENT AND THE LOSS OF ANY OF OUR KEY PERSONNEL
COULD WEAKEN OUR ABILITY TO COMPETE
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 twenty-one employees in
the U.S. and abroad, including five 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 employees or the inability of any of them to devote
sufficient time to their duties could weaken our ability to compete and would
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.
OUR PRODUCTS CONTAIN TECHNOLOGICALLY COMPLEX COMPONENTS, WHICH MAY MAKE IT
DIFFICULT FOR US
TO DETECT 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. Defects can also occur in the microprocessors and
other 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.
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WE MAY BE SUBJECT TO LIABILITY RESULTING FROM OUR PAST INABILITY TO MEET
CONTRACTUAL OBLIGATIONS TO PROVIDE RAW MATERIALS
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 were unable to obtain the required raw materials for
these customers. One of these customers brought an arbitration proceeding in
China seeking $2.8 million in damages for alleged breach of contract. This
action was dismissed, because the petitioner's claim was found to be based on an
invalid contract containing a falsified signature of Chipcards. Since the claim
was brought under the arbitration provision of the purported contract, the
arbitration commission determined that it did not have jurisdiction over the
matter. Despite this dismissal, the same party could attempt to bring additional
claims against us in the future though it has not done so to date. 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. Any potential litigation, whether or not
ultimately found to be meritorious, could consume significant resources and
affect our ability to carry on normal operations.
WE PLAN TO EXPAND OUR BUSINESS WHICH COULD STRAIN OUR RESOURCES
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, WHICH MAY
CAUSE OUR STOCK PRICES TO DECLINE
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 revenues on our installation contracts
until the project is complete and 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.
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
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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
THERE IS NO PUBLIC MARKET FOR OUR SECURITIES AND WE CANNOT PREDICT THE EXTENT TO
WHICH A TRADING MARKET WILL DEVELOP
There is no public market for our common stock. Although we expect that our
common stock will be traded on the Nasdaq market and the Boston Stock Exchange,
we cannot assure you that an active public market for our common stock will
develop or be sustained after this offering.
THE MARKET PRICE OF OUR COMMON STOCK MAY FLUCTUATE SIGNIFICANTLY
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:
fluctuations in our financial results;
general conditions or developments in the technology and smart card
products industries and the worldwide economy;
sales of our common stock into the marketplace;
the number of market makers for our common stock;
announcements of technological innovations or new or enhanced products by
us or our competitors or customers;
announcements of major contracts by us or our competitors;
a shortfall in revenue, gross margin, earnings or other financial results
from operations; and
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.
AN INVESTMENT IN THIS OFFERING IS SUBJECT TO IMMEDIATE AND SUBSTANTIAL DILUTION
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.'
WE CAN REDEEM THE WARRANTS ON SHORT NOTICE
We can redeem your warrants at a price of $.10 per warrant upon 30 days'
written notice, if the last reported sale price of our common stock has been at
least $9.60 for the twenty consecutive trading days immediately preceding the
date of notice of redemption. Investors will not be able to control the timing
of any redemption of the warrants, and thus will not be in a position to
necessarily maximize their tax benefits in connection with receiving the
consideration for that redemption. In addition, warrants may only be exercised
by an investor if, among other things, the common stock underlying the warrants
are qualified for sale under the securities laws of the state in which the
warrant holder resides. If we redeem the warrants you will be forced to sell or
exercise the warrants or accept the redemption price. If you do not exercise
your warrants prior to their expiration or redemption, you will not be able to
purchase the securities underlying your warrants. If we redeem the warrants, you
will have to:
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exercise the warrants and pay the exercise price at a time when it may be
disadvantageous for you to do so,
sell the warrants at the current market price for the warrants when you
might otherwise wish to hold the warrants for possible additional
appreciation, or
accept the redemption price, which will in all likelihood be substantially
less than the market value of the warrants at the time of redemption.
We will not be able to redeem your warrants unless a registration statement
covering the exercise of the warrants is in effect, which would enable you to
exercise before any redemption, and we may not be required at all times to
maintain a current registration statement.
OUR PRINCIPAL SHAREHOLDERS, OFFICERS AND DIRECTORS WILL BE ABLE TO CONTROL OUR
COMPANY
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 greater than 5% stockholders and affiliates. Those persons as a
group own and control 38% of its common stock before the offering and 34.9%
after the offering. As a result, upon completion of this offering, you may not
be able to (i) elect, or defeat the 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.
OUR MANAGEMENT WILL HAVE BROAD DISCRETION IN ALLOCATING THE PROCEEDS OF THIS
OFFERING
Our management has no obligation to make any specific use of the proceeds of
this offering and have broad discretion as to the manner in which such funds
will be utilized. We currently intend to use the net proceeds that we receive
from this offering in the manner described in this prospectus under 'Use of
Proceeds.' However, we reserve the right to reallocate the proceeds to different
uses, including ways which differ from the specific proposed uses described in
this prospectus, if management determines the needs of our business so require.
In addition, a larger portion of the net proceeds is allocated to discretionary
purposes.
FUTURE SALES OF OUR COMMON STOCK BY OUR EXISTING STOCKHOLDERS COULD HAVE ADVERSE
EFFECTS ON
THE MARKET PRICE OF OUR COMMON STOCK
All of the 10,641,250 shares of our common stock currently issued and
outstanding are 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.
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THE OFFERING PRICE OF THE UNITS DOES NOT NECESSARILY REFLECT THE VALUE OF OUR
COMPANY OR OUR
SECURITIES
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 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:
discuss our future expectations;
contain projections of our future operating results or of our future
financial condition; or
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.
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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:
<Table>
<Caption>
APPROXIMATE DOLLAR APPROXIMATE
AMOUNT OF NET PROCEEDS PERCENTAGE
---------------------- ----------
Capital Equipment(1)............................... $2,750,000 40.7%
Project Financing(2)............................... 2,200,000 32.5
Machinery & Equipment(3)........................... 500,000 7.4
Product Development................................ 250,000 3.7
Advertising & Marketing............................ 200,000 3.0
Purchase of Real Property(4)....................... 150,000 2.2
General working capital............................ 714,000 10.5
---------- ----
Total.......................................... $6,764,000 100%
---------- ----
---------- ----
</Table>
- ---------
(1) Installation of a smart card production line at our San Diego facility,
which is expected to take approximately four months to complete. This
equipment will be designed to produce 2,000 contactless cards per hour, with
complete magnetic striping and printing capabilities. Our expansion plans
for manufacturing are limited to San Diego.
(2) Represents cash requirements associated with the manufacture of production
lines for sale to current customers.
(3) Expansion of in-house capabilities for manufacture of capital equipment.
(4) Represents the cash amount required to purchase the San Diego facility from
an entity owned by Eric Gravell and Xiao Qin Jiang, two of our principal
shareholders. The cost is based on the amount of equity initially invested
in the property by the owner, plus closing costs and improvements. This
facility and related debt are included in the consolidated financial
statements as of December 31, 2000 and December 31, 2001. It is contemplated
that the $1.1. million mortgage secured by that property will be assumed or
refinanced by us on substantially similar terms.
The working capital amounts will be dedicated to general corporate purposes,
including salaries and general and administrative expenses. We do plan to expand
our sales and administrative offices in San Francisco and Beijing. Those
expansion plans will be funded with proceeds from the offering. 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.
The Use of Proceeds was determined without taking into account the potential
receipt of proceeds from the exercise of the warrants included in the Units
being offered. We cannot predict the extent to which warrants will be exercised,
if at all. In addition, since the warrants are exercisable over a five-year
period, we cannot predict the timing of any proceeds that might be received upon
exercise. Therefore, for purposes of disclosing its intended use of proceeds, we
believe that the most conservative approach is not to assume any additional
proceeds from exercise of the warrants. To the extent we do receive any such
proceeds, it is anticipated that they will be used for working capital.
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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. After the completion of this offering (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, 2001, we had a negative net tangible book value of
$1,002,614 and a negative net tangible book value per share of $0.09. '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
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 combined 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 of common stock (which are part of the units) offered
hereby, and deducting the underwriter's commission and associated estimated
offering expenses, 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, 2001
would have been approximately $5,761,386 or $0.53 per share. This represents an
immediate increase in net tangible book value per share of $0.57 to existing
stockholders and an immediate dilution of $7.51 per share to the investors
purchasing shares of
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common stock at the initial public offering price. The following table
illustrates this dilution in net tangible book value to new investors:
<Table>
Initial public offering price per share of common stock..... $ 8.00
Net tangible book value per share before offering........... (0.09)
Increase per share attributable to new investors............ 0.58
------
Pro forma tangible book value per share after offering...... 0.49
------
Dilution to new investors................................... $ 7.51
------
------
</Table>
The following table sets forth, as of December 31, 2001, 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 per unit.
<Table>
<Caption>
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
---------- ---- ---------- ---- -----
---------- ---- ---------- ---- -----
</Table>
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, 2001, 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.
<Table>
<Caption>
AS OF DECEMBER 2001
-------------------------
ACTUAL AS ADJUSTED
------ -----------
Debt:
Long-Term Debt (including current maturities)........... $ 1,105,010 $ 1,105,010
Short Term Advances..................................... 0 0
----------- -----------
Total debt.......................................... 1,105,010 1,105,010
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 $ 7,449,100
Additional Paid-In Capital.............................. 303,000 303,000
Accumulated Deficit(2).................................. (1,990,714) (2,140,714)
----------- -----------
Total stockholders' equity (deficit)................ (1,002,614) 5,611,386
----------- -----------
Total capitalization................................ $ 102,396 $ 6,716,396
----------- -----------
----------- -----------
</Table>
- ---------
(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.
(2) Accumulated deficit on an as-adjusted basis has been increased by $150,000
to reflect the cash payment to be made to Ampac Technology, LLC for the
purchase of the San Diego facility. Ampac intends to distribute such payment
of $150,000 to its members.
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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 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 microprocessors and other smart card components 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 smart card components only
at our customers' request.
Cost of sales for our production line business consists primarily of
internal engineering personnel costs and outsourced engineering and construction
costs. Smart card cost of sales consists of our cost of purchasing finished
smart cards from third-party manufacturers. Our cost of sales for smart card
components represents the cost of purchasing raw materials from third-party
suppliers.
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 three to six months to complete, including assembly, delivery,
installation and customer testing. At present, we can only undertake
approximately ten 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 testing equipment and other machinery used in the production
process.
We recognize revenues from long-term installation contracts on the
completed contract method. This means that, revenue recognition occurs only
when a contract is completed or substantially completed. Accordingly, cost of
contracts in process and current billings are accumulated, but there are no
interim charges or credits to income prior to completion other than provisional
losses.
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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.
We generally receive payments on our contracts as follows: (i) upon the
commencement of work we receive 10% of the contract price, (ii) upon conditional
acceptance at installation, we received 80% of our contract price, (iii) within
one to three months after the customer's acceptance, we receive the last 10% of
the contract price.
One of our production line customers in 2000 was a joint venture company in
which we held a 50% ownership interest. Sales to this customer represented
approximately 48% of production line revenues for 2000. Under the terms of this
joint venture, we were required to make an initial capital contribution in the
form of equipment. In September 2001 we divested our entire interest in this
joint venture, and we have no further obligations relating to our investment
therein.
With respect to our sales of finished smart cards, we began receiving
revenues during 1999. This revenue stream has been adversely affected by a
shortage of cards. Our sole sources of smart cards from 1999 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 smart card 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. During the
year ended December 31, 2001, approximately $1,694,000 of smart card orders were
cancelled, which was caused by continuing shortages through the first quarter
of 2001.
During the period of limited smart card supply, we gave first priority to
orders for which we received cash payment. Other orders were prioritized based
on the size of the order and the price per card. Should shortages recur in the
future, we do not anticipate changing our allocation policies, even if we are
successful in adding an internal smart card production line.
With the recent abatement of the Mifare shortage, we have been able to
eliminate our deficit of chips and smart cards. We now have a surplus of Mifare
microprocessors, having purchased approximately 4.6 million chips in 2001, which
was written down to its net realizable value. In addition, 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 to the extent non-Mifare platforms gain acceptance by operators of
smart card systems, the risk of future microprocessor shortages may be
alleviated by allowing us to seek alternate sources of supply. This could
ultimately reduce our dependence on Mifare microprocessors by giving us the
flexibility to supply non-Mifare smart cards for such alternate systems.
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 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
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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.
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.
Key developments during fiscal 2001 include entering into installation
contracts for a total of fourteen production lines. One double line was
delivered to a customer in mainland China for installation and testing. One
triple line was sold to the China Ministry of Public Security, and another
triple line was sold to the Chinese Motor Vehicle Safety Inspection Center. Both
of these are governmental authorities taking part in a broad-based national
project to provide citizens with smart cards for identification and other
purposes. In addition, one double line and one single line were sold to a
customer in Hong Kong, and a triple line was sold to a customer in mainland
China. During 2001 we also divested our holdings in a Chinese joint venture
company in which we owned a 50% equity interest. The joint venture did not
commence operations, nor did the Company contribute funds or services to the
joint venture. Thus, the divesture in the joint venture had no financial impact
on the Company. Subsequent to December 31, 2001, we have entered into agreements
to install five double production lines to two customers, and completed the
installation of five production lines to two customers.
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
combined 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.'
Critical Accounting Policies
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout management's Discussion and Analysis of Financial Condition and
Results of Operations where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see Note 1 in the Notes to the Combined Financial
Statements in this document beginning on page F-15. Note that our preparation of
this fling requires us to make estimates and assumptions that affect the
reported amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our financial statements, and the reported amounts of
revenue and expenses during the reporting period. There can be no assurance that
actual results will not differ from those estimates.
Revenue Recognition: Revenues from long-term contracts for the construction of
smart card production lines are recognized under the completed-contract method,
recognizing revenue only when the contract is completed or substantially
completed. Accordingly, costs of contracts in process and current billings are
accumulated, but there are no interim charges or credits to income prior to
completion, other than provisions for losses, upon signed customer acceptance.
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. The Company offers a
one-year warranty to its production line customers. During this period the
Company is responsible for repairing or replacing any defective components. The
Company accrues for warranty costs based on its experience and expectation of
future costs.
Inventory: Inventory, consisting of finished smart cards, modules and other
materials, is valued at the lower of cost (first in, first out) or market. The
Company writes down its inventory for known defected or damaged inventory,
estimated obsolescence or other unmarketable inventory equal to the difference
between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual future demand
or market conditions are less favorable than those projected by management,
additional inventory write-downs may be required.
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000
Total revenues for year ended December 31, 2001 were approximately $15.7
million, an increase of 234 percent from $4.6 million in 2000. This included
approximately $11.7 million of production line sales in 2001, compared to $3.5
million in 2000, and revenues from the sale of smart card components of
approximately $1.8 million for 2001, compared to $138,000 in 2000. We also
recorded revenues of approximately $2.2 million from the sale of finished smart
cards in 2001, compared to $957,000 in 2000.
The increase in production line sales was due to increased completion of
production lines; seven lines were completed in 2001 in comparison to two
production lines in 2000 recognized from production line projects commenced in
2000 and completed in 2001 and to a lesser extent the recognition of deferred
revenues related to the termination of purchase obligations and the joint
venture in China Cards. Sales of production line components increased due to
an increase in our installed base of production lines. We only sell components
to our production line customers. Our finished smart card sales increased in
2001 because we were able to rebuild our inventory of cards containing Mifare
microprocessors, as the worldwide shortage of these microprocessors began to
abate. Those sales were principally in the first six months of 2001. In the
prior year, we did not have adequate inventory to fulfill our customers'
orders as a result of the shortage. However, by the second quarter of 2001 we
were able to replenish our supply and increase sales of finished cards.
Historically, a material portion of our smart card business has depended on
our ability to purchase cards on favorable terms from our production line
customers, who often did not have well developed distribution channels for
their output. These manufacturers have now begun to establish a broader
customer base and, as a result, they may not have sufficient supplies of cards
to meet our needs. In addition, we do not have any contractual right to buy
cards under the new production line contracts we entered into in 2001.
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Our cost of sales for the year ended December 31, 2001 was approximately
$10.4 million, representing an increase of 225 percent from $3.2 million for the
same period in the prior year. This included production line costs of
approximately $6 million in 2001 compared to $1.9 million in 2000. The total
production line costs increased as a result of increased production line sales.
Our cost per production line decreased in 2001 primarily because we were able to
obtain more favorable pricing terms from our new contract manufacturer. Finished
smart card costs were approximately $3 million in 2001 compared to $1.1 million
in 2000. This increase in costs was a function of the increased sales and the
$1 million write off of defective inventory purchased from a certain supplier as
the microprocessor shortage abated. Our cost per card did not materially change
from 2000 to 2001. Smart card component costs increased to approximately
$1.4 million in 2001 compared to $88,000 in 2000. This was due primarily to an
increase in the volume of raw materials sold. Our cost per unit of raw materials
did not materially change from 2000 to 2001.
Our gross profit for the year ended December 31, 2001 was approximately $5.3
million, an increase of 253 percent from a gross profit of approximately $1.5
million the prior year. Our overall gross margin for 2001 was 34 percent
compared to a gross margin of 32 percent in 2000. These increases are mainly the
result of an increase in profit margins on our production line sales. Gross
profits on production lines increased from 45 percent for 2000 to 49 percent in
2001. This increase was primarily due to cost savings, which are largely
attributable to more favorable pricing obtained from the new contract
manufacturer we retained in 2001. In addition a portion of the increase was due
to the accelerated recognition of gross profit on a prior production line
contract as a result of our finished card purchase commitment under that
contract having been effectively terminated in February 2001. More particularly,
gross profit of $284,000 related to our Beijing contract was accelerated during
2001 because the obligation to purchase output from the machine was effectively
terminated. Gross profit was being recognized ratably over the three year period
of the purchase commitment, which, absent the early termination, was to expire
in January 2002. Due to termination of the purchase commitment, we have no
further obligation to perform under the terms of this contract. Therefore,
accelerated revenue recognition during 2001 was deemed to be appropriate.
Furthermore, the deferred margin on the China Card contract, completed in 2000,
was recognized due to the termination of the joint venture. (See Financial
Statements -- Summary of Accounting Policies). Margins on smart card sales
declined from a negative gross margin of 17 percent for the year ended
December 31, 2000 to a negative gross margin of 33 percent in 2001. As a result
of the reduction in the shortage of smart card microprocessors, the worldwide
supply of smart cards increased in 2001. This resulted in a more competitive
environment for selling smart cards, causing us to reduce our pricing. At
December 31, 2001, we had defective cards in inventory obtained from the
manufacture of the cards. We are seeking recourse from that party for costs of
replacement and damages. It is uncertain whether collection is probable and
should our claim be denied, we will bear the costs of replacement. We expensed
approximately $1,441,000 in defective inventory of which $360,000 is retained
on our books as a reserve for defective cards in excess of their salvage value.
(See Financial Statements -- Notes to Combined Financial Statements; Legal
Proceedings and Claims). However, based on current orders, we believe that we
will be able to sell the remainder of our current inventory above its net book
value. Gross margins on component sales also decreased, going from 36 percent
for 2000 to 19 percent in 2001. Because component sales were very low in 2000
due to the microprocessor shortage, in our view the resulting margins were
inflated and not characteristic for our business. We believe that component
sales and gross margins in 2001 provide a more representative figure. The
margins achieved in 2001 reflect a favorable market for components, as we were
able to keep our price of acquiring raw materials below the fixed prices at
which we were obligated to provide such raw materials to our customers.
Operating expenses for the year ended December 31, 2001 were approximately
$4.9 million. This represents an increase of 168 percent from selling, general
and administrative expenses of approximately $1.8 million for 2000. Selling
expenses consist primarily of commissions payable to sales employees. Selling
expenses increased by approximately $746,000 from December 31, 2001 compared to
December 31, 2000. This is attributable mainly to commissions paid to sales
employees in our China and Korea offices. Other operating expenses consist
primarily of payroll and related expenditures and legal and professional fees
including legal and accounting charges. Compensation increased from $685,000
in 2000 to
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approximately $1.9 million in 2001, an increase of 177 percent. This increase
resulted principally from bonuses and other compensation paid to employees
involved in sales efforts and those supporting them. Legal and professional fees
increased from $326,000 in 2000 to approximately $1.1 million in 2001, an
increase of 237 percent. This increase resulted principally from expenses
incurred in connection with our Nasdaq listing request, which was initially
denied and later conditionally approved. The details of the listing application
process is described in this prospectus under the heading 'Nasdaq Listing
Application and Approval.'
LIQUIDITY AND CAPITAL RESOURCES
We rely on a combination of equity capital, short-term bank financing and
internally-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 friends and family in 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 at December 31, 2001, we had a working capital deficit of approximately
$1.1 million. Cash flow from operating activities in 2001 was approximately
$536,000 compared to approximately 168,000 in 2000. This additional cash flow
from operations contributed to the reduction in the working capital deficit
from $1,510,000 at December 31, 2000.
We currently have no material outstanding long-term indebtedness other than
purchase property mortgages on our San Diego property in the amount of
approximately $1.1 million.
As of December 31, 2001 we had an accounts payable balance of approximately
$1.8 million. This relates primarily to subcontractor costs of manufacturing
production lines, finders fees of third parties which assisted in securing
production line contracts, professional fees in connection with this offering,
and subcontractor costs of processing smart cards. Generally, production line
subcontractor costs and finders fees are paid upon completion of the relevant
production line contract, at which time we receive the majority of our payment
under the contract. Professional fees and smart card subcontractor costs are
also expected to be paid as and when funds become available upon receipt of
payment under our production line contracts. We made payments of approximately
$600,000 to our accounting firm and legal counsel in 2001.
In 2000, we received insurance proceeds of approximately $259,000 ($171,000
net of tax expense) as a result of a prior claim. This provided additional
operating cash flow for these periods, but as a non-recurring item it will not
have any effect on current or future liquidity.
Operating cashflows were a source of cash in 2000 of approximately $170,000
and a further source of cash in 2001 of approximately $536,000. This increase is
the result principally of increased production line sales in 2001.
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. However, we expect to fund a portion of these costs by drawing on
credit facilities secured by the letters of credit we typically obtain from
equipment purchasers. We currently have commitments to install five double
production lines in 2002, which will require estimated capital expenditures of
$4.9 million.
In order to meet our short-term 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 have also obtained a secured line
of credit from Trans Pacific National Bank, supported by a Small Business
Administration guaranty, for borrowings of up to $1,100,000 through September
2002. In addition, Bank of America has provided us with an
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unsecured line of credit for borrowings of up to $100,000 and has required, as a
condition of extending the credit, that one of our principal stockholders
guarantee all advances under this loan. We also have unsecured lines of credit
in the amounts of $25,000 and $15,000. As of May 1, 2002 we had no outstanding
borrowings under these lines of credit.
We believe that we will be able to meet our present commitments through a
combination of utilizing existing lines of credit and increasing our credit
line. We expect to be able to access such credit because, among other reasons,
we have completed installation of the three triple production lines, one double
line and single that we had been committed to install in 2001 and 2002. We also
expect to continue to finance future installations of production lines, as we
have in the past, through cash deposits and financing secured by letters of
credit issued by the purchasers. In addition we intend to allocate a portion of
the proceeds from this offering to fund production line assembly costs.
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
$2.75 million, as well as the expansion of our in-house manufacturing capability
and the diversification of our capital equipment product line to produce cards
for use in GSM cellular phones and other technologies, which is projected to
cost approximately $500,000. 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 to fund the $150,000 cash
payment.
At present we do not have any financing in place to cover longer-term
liquidity needs for future periods beyond a 12-month horizon. We do not have any
current plans to seek long-term financing. To the extent long-term liquidity
requirements arise as a result of future installation projects or raw material
sourcing obligations, we intend to increase existing lines of credit or seek
additional lines of credit to provide cash flow. If we are unable to secure
additional short-term financing to fund future operating needs, or if the
planned expansion of our business creates unanticipated cash flow shortfalls, we
may be required to seek additional debt or equity financing.
From time to time in the past, we obtained interest-free loans from
shareholders in order to address cash flow shortages that arose because we had
incurred expenses to perform installation projects, while the majority of our
compensation was not payable until the work was substantially completed. The
aggregate amount of these loans was $170,876, and we have repaid all of this
indebtedness in full. We do not anticipate further shareholder loans, as we
intend to obtain any required project financing by increasing our lines of
credit or accessing the capital markets.
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.
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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.
In June 2001, the Financial Accounting Standards Board finalized FASB
Statements No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and
Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The company has not entered into any business combinations. Therefore, the
Company does no expect that the implementation of these standards will have an
effect on its financial statements.
SFAS 143, Accounting for Asset Retirement Obligations, was issued in
June 2001 and is effective for fiscal years beginning after June 15, 2002.
SFAS 143 requires that any legal obligation related to the retirement of
long-lived assets be quantified and recorded as a liability with the associated
asset retirement cost capitalized on the balance sheet in the period it is
incurred when a reasonable estimate of the fair value of the liability can be
made.
SFAS 144, Accounting for the Impairment or Disposal of Long-Loved Assets,
was issued in August 2001 and is effective for fiscal years beginning after
December 15, 2001. SFAS 144 provides a single, comprehensive accounting model
for impairment and disposal of long-lived assets and discontinued operations.
SFAS 143 and SFAS 144 will be adopted on their effective dates, and adoption
is not expected to result in any material effects on the Company's financial
statements.
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DESCRIPTION OF BUSINESS
INTRODUCTION
Chipcards, Inc. (formerly known as American Pacific Technology, 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 production
line customers to sell us 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:
expanding our international distribution network;
promoting new applications for our capital equipment such as smart labels;
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;
replacing vendors with internal equipment-making capability, thus reducing
delivery time to customers and costs borne by us;
bringing our own factory automation to market by creating in-house capacity
to manufacture smart cards; and
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.
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 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. 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. However, there is no assurance
that the proceeds of this offering will be sufficient for us to successfully
implement any of these plans.
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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:
access to restricted areas (replacing keys and identification cards);
public transportation fare collection (replacing tokens and tickets);
point of sale purchases (replacing cash or credit cards at cafeterias,
newsstands, vending machines and other point of sale locations where speed
of purchase is important);
public telephones;
industrial applications such as quality control, warehousing, inventory
control, distribution and warranty;
health care (replacing patients' paper files in hospitals and HMOs); and
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 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 2.5
billion in 2001, and by 2003 it is projected that 3.25 billion smart cards will
be in use. By financial worth, the smart card market is projected to rise to
more than $6.5 billion in 2005. To date, smart card usage has
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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
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 integrated smart card support directly into their Windows
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.
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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 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.
In 2000 and 2001 we completed a total of nine production line installations
for five customers in China. All these lines have been tested and accepted by
the customer and full-scale production has commenced. We currently have
contracts in place to install five double production lines in 2002. 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
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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
completed contract 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:
Hole Punching Workcell. This workcell has optical sensors that are used to
register the placement of the modules for punching 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. Our equipment
precisely delivers the module to the targeted location so that no fillers are
required to eliminate gaps between the module and the sheet.
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. In addition, our high frequency system
consumes less power, can implant into a wider range of materials and can implant
a full antenna in less time than in older version untrasonic equipment.
Bonding Workcell. This system is used to form the bond between the module
and the wire antenna, using thermo-compression welding techniques. A computer
interface provides the operator with feedback on welding parameters and
automatically prevents faulting welds.
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. We have no written agreement with
our contract manufacturer, and all assembly work is done on a purchase order
basis. The contract manufacturer recently completed the assembly of a double
production line, and currently has accepted orders for and commenced work on the
assembly of antenna embedding, pick and place and bonding workcells for the five
double production lines that we are scheduled to deliver by year end 2002.
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.
One full production line consists of each of the six workcells described
above. However, we can also design combination lines, such as double lines or
triple lines, that use fewer components by taking advantage of the greater
production rates achievable by certain workcells. For example, the embedding
workcell is faster than both the module pick and place and the bonding
workcells. Therefore, we can design a triple line in which three pick and place
machines feed into two embedding machines, which in turn feed into three bonding
machines. This combination production line has the capacity of three single
lines while using only two embedding workcells. This makes our production line
products more cost effective for customers requiring high levels of output. Our
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combination production lines allow for the customer to customize its process
flows in order to maximize efficiency based on its particular needs and uses.
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. 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 and Siemens.
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. 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 in 1998 and 1999. In 2000 and 2001
we installed three new production lines from which we have the ability to
purchase finished cards. 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.
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 anticipate that the need for dual-interface cards will
expand to other markets as demand for secure applications increases.
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.
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
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verification. This distinguishes GSM phones from conventional cellphones,
which have an electronic identification number programmed into each
individual cellphone. The smart card gives GSM phones greater flexibility
because the card is detachable and interchangeable with any other GSM
phone. GSM is a standardized technology produced by all major cellphone
manufacturers. It 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 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.
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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. We do not have written agreements with our agents or
sub-agents.
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 were
obligated to provide each of them with raw materials for the manufacture of
cards. We also had the exclusive right to buy finished smart cards produced by
these manufacturers. However, because of a shortage in the supply of Mifare
microprocessors, we were unable to provide the necessary raw materials. These
commitments ended in 2001 through expiration of the commitment period or
successful arbitration. (See 'Risk Factors -- We are Subject to Risks Associated
with Obligations Under our Capital Equipment Contracts.').
In 2000 and 2001 we completed the installation of nine production lines for
five customers based in China. In addition, in 2001 we entered into new
installation agreements with five customers including a company in mainland
China to which we recently delivered a double production line, as well as two
Chinese governmental agencies, each of which ordered a triple line, a company in
Hong Kong which ordered one double line and one single line, and a company in
mainland China which has ordered a triple line. We expect that all of these
projects will be completed by the end of 2002. Under each of our production line
contracts, installation, testing, technical services and training are included
in the cost of the facilities as of the date of this filing we have not incurred
significant costs related to technical services and training. All of these
contracts are governed under Chinese law and provide for the arbitration of
disputes in China. Our equipment purchase contracts and license agreements do
not contain any termination provisions. Under the license agreements, we provide
technical and other services for one year following completion.
In addition, in 2002 we secured two new production line contracts. In April
2002, we secured a contract for the sale and installation of four double
production lines to the Ministry of Public Security. Gross Sales contracted to
be $6 million. In April 2002, we also secured a contract with Shandong
Huaguan for the sale and installation of an additional double production line.
Gross Sales from that contract should be are $1,736,000.
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 was initially 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. In September
2001, we transferred our entire interest in the China Card joint venture to
three companies based in China. As a result of this transfer, we are released
from any liability in connection with the joint venture.
Under an equipment purchase agreement, for each production line sold to
China Card I.C. (Shanghai) Co., Ltd. we guarantee a manufacturing capacity of
6 million cards per year and a
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reject rate of less than three percent. The warranty period for the equipment
was 12 months from the customer's receipt and acceptance. During this period, we
were responsible for repairing or replacing any defective components. We did not
incur any significant costs as a result of this warranty. We also entered into a
license agreement and a technical support agreement under which we provided
technical information and support services needed to operate the production
lines.
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. The warranty
period for the equipment is 12 months from the customer's receipt and
acceptance. During this period, we were responsible for repairing or replacing
any defective components. We did not incur any significant costs as a result of
this warranty. 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. We are not obligated to purchase any
minimum amount of cards. 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.
Our undertaking to source raw material does not give us priority over other
parties who may seek to purchase finished smart cards from Shandong Huaguan.
In April 2002, we secured a new contract with Shandong Huaguan for the sale
and installation of an additional double production line. Gross revenues from
that contract are $1,736,000.
HAINAN PACIFIC
In May 2001 we entered into an equipment purchase agreement with Hainan
Pacific New High Tech Co, Ltd., a Chinese company, covering the sale of a
combination production line that will have the capacity of two full lines. The
equipment has been tested and accepted by the customer and full-scale card
production has begun. Under this agreement, we guarantee a manufacturing
capacity of 1,500 cards per hour and a reject rate of less than 3 percent. The
warranty period for the equipment is 12 months from the customer's receipt and
acceptance. During this period, we were responsible for repairing or replacing
any defective components. We also entered into a license agreement under which
we provided technical information and support services needed to operate the
production lines. We have used and intend to continue to use Hainan Pacific as a
source for finished smart cards.
MINISTRY OF PUBLIC SECURITY
In June 2001 we entered into an equipment purchase agreement with the
Beijing Zhongdun Security Technology Development Company, acting as agent for
the Chinese Ministry of Public Security. The equipment has been tested and
accepted by the customer and full-scale card production has begun. Pursuant to
this agreement, we agreed to sell a combination production line capable of
achieving the equivalent output of three full lines. By taking advantage of the
greater speed of certain workcells, we have designed this unit to use fewer
components than would be required for three separate production lines. We
guarantee a manufacturing capacity of 2,500 cards per hour, a reject rate of
less than two percent for each separate workcell and an overall reject rate of
less than three percent for the entire unit. The warranty period for the
equipment is 12 months from the customer's receipt and acceptance. During this
period we are responsible for repairing or replacing any defective components.
We have also entered into a technical services and licensing agreement under
which we must provide technical information and support services needed to
operate the production lines.
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We have used and intend to continue to use the Ministry of Public Security
as a source for finished smart cards. In April 2002, we secured a new contract
for the sale and installation of four double production lines to the Ministry of
Public Security. Gross revenues for that contract are $6 million.
CHINA MOTOR VEHICLE SAFETY INSPECTION CENTER
In June 2001 we entered into an equipment purchase agreement with the
Beijing Bu Lu Dun High Tech Company Limited, acting as agent for the China Motor
Vehicle Safety Inspection Center. The equipment has been tested and accepted by
the customer and full-scale card production has begun. Pursuant to this
agreement, we agreed to sell a combination production line that will have the
capacity of three full lines. We guarantee a manufacturing capacity of 2,500
cards per hour, a reject rate of less than two percent for each separate
workcell and an overall reject rate of less than three percent for the entire
unit. The warranty period for the equipment is 12 months from the customer's
receipt and acceptance. During this period we are responsible for repairing or
replacing any defective components. We have also entered into a technical
services and licensing agreement under which we must provide technical
information and support services needed to operate the production lines.
TRANCO LTD.
In August 2001 we entered into two equipment purchase agreements with Tranco
Ltd., a company based in Hong Kong. The equipment has been tested and accepted
by the customer and full-scale card production has begun. Pursuant to these
agreements, we agreed to sell one single production line and one combination
production line that will have the capacity of two full lines. We guarantee a
manufacturing capacity of 2,500 cards per hour for the triple line and a
manufacturing capacity of 750-850 cards per hour for the single line, with an
overall reject rate of less than three percent for each of these production
lines. The warranty period for each production line is 12 months from the
customer's receipt and acceptance. During this period we are responsible for
repairing or replacing any defective components. We have also entered into a
separate technical services and licensing agreement for each production line
under which we must provide technical information and support services needed to
operate the equipment.
SHANDONG LU NENG HUANG TAI INDUSTRIAL GROUP LIMITED
In September 2001 we entered into an equipment purchase agreement with the
Shandong Lu Neng Huang Tai Industrial Group Limited, acting as agent for a
company tentatively named Shanghai Lu Neng China Card Smartcard Company Limited.
Shandong Lu Neng Huang Tai Industrial Group Limited owns an interest in a joint
venture company in which we previously held a 50% interest. Pursuant to this
agreement, we agreed to sell a combination production line that will have the
capacity of three full lines. We guarantee a manufacturing capacity of 2,500
cards per hour, and an overall reject rate of less than three percent for the
entire unit. The warranty period for the equipment is 12 months from the
customer's receipt and acceptance. During this period we are responsible for
repairing or replacing any defective components. We have also entered into a
technical services and licensing agreement under which we must provide technical
information and support services needed to operate the production lines. The
contract was in progress as of December 31, 2001.
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 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
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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.
During the 2001 fiscal year and into 2002, we have continued to focus on
improvements that can be implemented as part of our ongoing installation work.
In the future we intend 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. 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. 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 a five-fold increase from 1994. 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:
The growth and diversity of smart card applications;
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The need for higher security in Internet e-commerce;
The consumer desire for more convenient financial and personal
transactions;
The progression of radio frequency applications to higher frequencies; and
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 list of our five largest smart card customers during 2001 follows:
Cricon International Business (USA)
Printoplast Inc. Korea
KD Electronics (South Korea)
Electronic Silicon Solutions (UK)
KBC (Korea)
Our current capital equipment customers are described in this prospectus
under the heading 'Production Line Contracts.'
COMPETITION
In the smart card capital equipment market, our competitors include
production line suppliers such as Mulhbauer (Germany), Melzer (Germany), Amatech
(Germany), Ruhlamat (Germany), Essec (Switzerland), Sempac (Switzerland),
Sokymat (Switzerland) and Advanced Interconnection Technology (United States).
We believe that we have positioned ourselves as an emerging company within
the smart card production line industry. The leading competitors are large, well
established companies and have developed a strong worldwide reputation. However,
we have been able to offer a competitive product because of the speed and
flexibility of our equipment. An important step in the development of our
reputation was securing installation contracts from the Chinese Ministry of
Public Security and the China Motor Vehicle Safety Inspection Center. These
government agencies are participating in a highly publicized project seeking to
provide each citizen in China with smart cards for identification and other
purposes. The Ministry of Public Security awarded us the first production line
contract in connection with this project, after soliciting bids from all of the
leading production line suppliers. We believe this has greatly enhanced our
competitive position and will enable us to capture significant market share for
smart card equipment sales in China.
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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).
We believe that in the smart card sales industry we have also positioned
ourselves as an emerging competitor. Since our marketing resources are limited,
the leading competitors have better worldwide market coverage. However, we are
focusing our efforts on smaller customers to which we can offer fast turnaround
and competitive pricing.
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. Automated key-processes give our equipment
greater flexibility to utilize a variety of raw materials and to accommodate
alternate operating platforms. Switching raw materials, such as different types
of plastic, or using chips containing different operating platforms requires
only a simple change in machine operation parameters. These paramaters are
stored within the machine's computer system and can be quickly retrieved by the
user through a menu choice. Automation also reduces the need for skilled
employees to operate the machinery, reducing training and labor expense for our
customers. Our production line products face a competitive disadvantage,
however, in terms of price. This is partly due to the fact that we require
payment in U.S. dollars, whereas most of our competitors are paid in
lower-valued currencies.
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 favorable.
This has enabled us to decrease our pricing in response to recent competitive
pressures. In addition, 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. We are not incorporating the
information on our website into this prospectus, and we do not intend to make
our website a part of this prospectus.
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 2002 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. At the outset, 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 have co-sponsored industry events in China.
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DISTRIBUTION
We currently have sales offices located in Beijing, China and South Korea.
Currently, our Beijing office consists of five 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 order to establish a greater share of the
international smart card market, we intend to expand the size of our office in
Beijing.
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. 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. These features
enable customers to conveniently make any adjustments needed to meet their
specific product requirements. Most changes to the production line can be done
with simple and often pre-loaded operation settings. Mechanical adaptations
typically include only minor and inexpensive changes to the robot mechanism.
These are the principal areas in which we apply our proprietary technologies to
the basic components that make up our production lines. We 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. 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 within 12 months of the initial filings 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 and/or non-disclosure and assignment of invention agreements with
certain 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 AND CLAIMS
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.
In 2000 and 2001, we purchased chip modules from International Semiconductor
Technology, Ltd. We experienced a very high rate of defective product among
those modules. As a result of failures and defects in those products, we have
incurred substantial costs in replacing defective product. Those costs exceed
$322,020 for 2001 to date. We thus determined to hold back payments claimed to
be due and owing by us to that supplier of approximately $503,000. However, the
amount is fully accrued at December 31, 2001.
EMPLOYEES
We currently have twelve employees in the United States, five employees in
China and four employees in South Korea. All employees are full time. Prior to
the completion of this offering, we intend to hire another qualified candidate
as a full-time CFO.
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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 one employee 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
With the proceeds of the Offering, we expect to build equipment to produce
smart cards. However, we believe our current real property is adequate to meet
the Company's operating needs for the foreseeable future. Our facilities are as
below.
Our headquarters are located in Citicorp Center at One Sansome Street,
19th Floor, San Francisco, California where we lease 672 square feet of space.
We have entered into a one-year lease with a term ending on June 30, 2002. 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 and consists of 13,850 square feet of space, half of which we sublet
to an unrelated third party. 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 $1,100,000 at
December 31, 2001.
Our China office consists of 930 square feet of space 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, 2003. The current base rent is
approximately US $1,198 per month.
Our South Korea office consists of 1,500 square feet of space 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.
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MANAGEMENT
The Directors, Executive Officers and significant employees of our company
are as follows:
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
Allen Yue(1).......................... 43 President, Director
Eric Gravell(2)....................... 42 Executive Vice President, Assistant
Chief Financial Officer, Director
Paul Amadeo........................... 33 Chief Information Officer, Director*
Timothy Norman........................ 33 Chief Technology Officer
Fillian Lei........................... 32 Chief Financial Officer
Francis Christian..................... 59 Director*
Jerry B. Collum....................... 56 Director*
</Table>
- ---------
(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 offering, Francis Christian, Jerry
Collum 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. We also intend to obtain officers' and directors'
insurance coverage at 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 was a
co-founder and in 2000 was employed by 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. In 1997, Mr. Amadeo served as an electrical engineer for Remec. Prior
to joining Chipcards, Mr. Amadeo also 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
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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. In 1995, Mr. Norman founded a
business that engineered lightweight watercraft. Prior thereto, Mr. Norman
co-owned Highpoint Presents, a multimedia production company. During that same
period, he also served as a financial specialist for the State of Washington.
Prior to joining Chipcards, Mr. Norman was also 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.
Fillian Lei joined Chipcards in 1994. She served as its Chief Financial
Officer between 1996 and 1998, and is again our Chief Financial Officer. 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.
Francis Christian is a consultant with more than 36 years of technical
experience in the electronic industry and has become an expert in the field of
contactless smart card technology. He has served on the United States National
Committee for Information Technology Standards (NCITS) as the chairman for the
contactless smart card group. He is also the Head of Delegation from the United
States to the ISO/IEC JTC1 SC17 WG8 International Contactless Smart Card
Standards Group. He for many years was employed by Motorola in its Government
Electronics group. Mr. Christian holds a B.S. in Science from Kansas State
University and a M.S. in Electrical Engineering from Arizona State University.
He has no prior business relationship with us.
Jerry B. Collum retired from REMEC, a San Diego area-based engineering firm,
in February 2001, where he held several positions, most recently Senior Vice
President and President of its Metal Fab Center. From 1968 through 1984, Mr.
Collum was employed in various positions at Texas Instruments. He holds a B.S.
in Mechanical Engineering from Lamar University. He has no prior business
relationship with us.
Mr. Christian and Mr. Collum are replacing Ross Mandell and Scott Ziegler
who had previously been appointed to be directors upon completion of the
offering. (See Nasdaq Listing Application and Approval)
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 beginning in 2001 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 beginning in 2001 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 $70,000 per year and
an incentive bonus equal to ten percent of the gross profits from any sales
directly attributable to him.
Each of the above employment agreements grants the employee a severance
payment equal to base salary for a period of three months or, if shorter, the
balance of the term, should the employee be terminated without cause. The
employee is also entitled to three months of base salary in the event of his
death or disability.
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COMPENSATION OF DIRECTORS AND OFFICERS
The following table sets forth the aggregate annual remuneration of our
President and the four most highly paid executive officers other than the
President who served as executive officers as of December 31, 2001:
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
ANNUAL COMPENSATION
-----------------------------------------------
(A) (B) (C) (D) (E)
- --- --- --- --- ---
OTHER ANNUAL
NAME & PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION($)
- ------------------------- ---- ---------- --------- ---------------
Allen Yue, President............................ 2001 $185,417 $591,900(4) -0-
2000 125,000 -0- $20,000(1)
1999 90,000 -0- 60,000(2)
Eric Gravell, Executive Vice President.......... 2001 $179,167 $ 54,000 -0-
2000 62,500 -0- -0-
1999 78,750 -0- -0-
Timothy Norman, Chief Technology Officer........ 2001 $100,000 $100,000(4) $ 230(1)
2000 66,667 50,000 -0-
1999 57,000 -0- $ 1,000(3)
Paul Amadeo, Chief Information Officer.......... 2001 $100,000 $ 95,000(4) -0-
2000 73,333 40,000 -0-
1999 68,000 -0- $ 1,000(3)
Fillian Lei, Controller......................... 2001 $100,000 $100,000(4) -0-
2000 67,705 50,000 -0-
1999 35,750 -0- $ 1,000(3)
</Table>
- ---------
(1) Represents cash commission paid in connection with the sale of equipment or
smart cards.
(2) Represents accrued commission in connection with the sale of equipment that
Mr. Yue elected to defer. This amount was paid during 2001.
(3) Represents value of stock grant.
(4) Represents bonus paid to reflect business performance in 2001.
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 on each share of common stock held of record as of March 18, 2000.
These shares had a nominal fair market value at the time of issuance.
<Table>
<Caption>
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
</Table>
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.
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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. All but 120,000 of the 1,050,000
options described above are exercisable at $5.00 per share and have a term of
ten years. The remaining 120,000 options have a term of five years and are
exercisable at a price equal to the Power of $8.80 or 110% of the initial public
offering price. In December 2001, 240,000 options were canceled upon the
termination of one of the Company's officers. 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.
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.
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PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of our common stock
as of December 31, 2001, as adjusted to reflect the sale of the units offered by
this prospectus, by:
each person who is known by us to beneficially own more than 5% of our
common stock
each of the named executive officers and each of our directors; and
all of our officers and directors as a group.
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.
<Table>
<Caption>
PERCENTAGE OWNERSHIP
NUMBER OF SHARES -------------------------
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 ............................ 2,460,000(2) 23.4% 21.4%
110 Wall Street, Suite 15C
New York, New York 10005
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
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)................. 4,047,500 38% 34.9%
</Table>
- ---------
(1) Percentage of ownership is based on 10,641,250 shares outstanding as of
May 1, 2002, 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. These shares will be subject to a voting trust.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
On March 20, 2000, we entered into a three year Consulting Agreement with
Ross Mandell. a principal stockholder of our company. That agreement was
terminated in January 2002. See Nasdaq Listing Application and Approval. Mr.
Mandell provided 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 was to be increased to
$10,000 per month for a period of 24 months. Aggregate fees of $54,000 have been
paid to Mr. Mandell through December 31, 2001. Mr. Mandell sub-contracted a
portion of his consulting duties under this agreement to St. James Holdings LLC
in April 2000, and transferred 500,000 of his shares of common stock to St.
James Holdings LLC in payment for its services. The President and the Managing
Member of St. James Holdings, LLC is President and Chief Executive Officer of
The Thornwater Company, L.P., the co-underwriter for this offering. Mr. Mandell
was formerly registered as a broker with the underwriter. St. James Holdings LLC
secured services that were rendered in consideration for the services it
provided from an individual based in Germany who has extensive personal
experience in and knowledge of the smart card industry.
For over one year prior to the execution of the consulting agreement, Mr.
Mandell performed substantial services on behalf of the Company including
numerous trips for meetings with our executive officers concerning business
matters, trips to London and Paris, including attendance at a smart card show,
and review of our business and industry. During this period, Mr. Mandell met
with numerous customers and suppliers and rendered significant advice concerning
our business and prospects, including diversification by marketing smart cards
and seeking to do business in countries other than China. Mr. Mandell also was
instrumental in restructuring and strengthening the present management team and
devising sales strategy. After the execution of the consulting agreement,
Mr. Mandell has continued to provide services including introductions to
suppliers and analysis of potential acquisitions. We believe these services were
obtained on terms no less favorable than could otherwise have been obtained from
an unaffiliated third party.
Mr. Mandell is 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, and until
January 2002 served as a consultant to that 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. The claimants in that arbitration sought damages of $700,000
against Mr. Mandell based on allegations that certain transactions that were
effected over a period of years in their securities brokerage accounts were
unauthorized and were unsuitable investments for them. The claimants also
asserted that Mr. Mandell was liable to them for an additional $350,000, which
they invested in a limited partnership that owned and controlled Roan Capital.
This arbitration was settled in November 1999. Pursuant to the written
settlement agreement, all claims against Mr. Mandell were dismissed with
prejudice, the claimants executed general releases in Mr. Mandell's favor, and
they covenanted not to sue him with respect to any matter. Mr. Mandell paid the
sum of $75,000 in consideration for that settlement.
Mr. Mandell was the subject of a New York Stock Exchange Hearing Panel
Decision dated January 17, 1995. The matters that were the subject of that
decision all occurred during the period beginning in 1986 and ending in 1990.
Pursuant to the decision, Mr. Mandell consented to findings that he effected
certain transactions without customer knowledge or authorization and accepted
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<Page>
orders for customers from a person other than the customer without written
authorization. He was censured and served a six week suspension in accordance
with the decision.
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.
Mr. Ziegler was issued 500,000 shares of our common stock in compensation for
his services. 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 or to
other third parties. Mr. Ziegler was instrumental in restructuring and
strengthening the present management team and devising financial strategy. We
believe these services were obtained on terms no less favorable than could
otherwise have been obtained from an unaffiliated third party.
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 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. The $150,000 payment is based
on the amount of equity initially invested in the property by Ampac Technology,
LLC, plus closing costs and improvements. 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. We believe the terms of
these loans were no less favorable than those which could have been obtained
from unaffiliated third parties.
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. We believe the terms of this loan were
no less favorable than those which could have been obtained from an unaffiliated
third party.
In January 2000, Xiao Qin Jiang was paid $90,000 representing an accrued
commission relating to her referral of business to us in 1999.
In August 2000, 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 was formerly a principal stockholder, officer and director. The
original principal amount of the loan was $180,000 bearing interest at a rate of
six percent per annum. The initial term of the loan was the sooner of one year
or an initial public offering of Ticket Planet. We believe the terms of this
loan were no less favorable than could otherwise have been obtained from an
unaffiliated third-party borrower. At the time of the settlement, the amount of
$75,000 remained outstanding and was repayable within one week of an initial
public offering by TicketPlanet. We accepted a payment of $57,000 in full
satisfaction of this debt, based on our assessment that TicketPlanet would be
unlikely to conduct an initial public offering in the foreseeable future.
All material facts with respect to the transactions described above, and the
related party's interest in the transaction, were fully disclosed to the board
of directors and, after consultation with counsel at our expense, were approved
or ratified by all of the directors who did not have an interest in the
transaction. All future material transactions with related parties will require
approval of a majority of independent directors who do not have an interest in
the transaction and who have access at our expense to company counsel or
independent legal counsel.
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We anticipate that all future material transactions with related parties
will be on terms no less favorable to us than can otherwise be obtained from
unaffiliated third parties.
NASDAQ LISTING APPLICATION AND APPROVAL
Initially, NASDAQ Listing Qualifications staff determined that it could
not approve our application to list our common stock on the NASDAQ SmallCap
Market.
After a hearing the NASDAQ qualification listing panel approved our
application subject to conditions, including meeting all quantitative and
quantitative requirements for new issuers. The finding as amended is subject to
approval by the panel of the voting trust agreement and acceptability of the
trustee as well as execution of a suitable lock-up agreement. The lock-up
agreement will provide that the subject shares may not be sold, transferred,
pledged or hypothecated for 365 days following the public offering except to
the extent other insiders sell their shares. We are also required to notify
NASDAQ of our release of the underwriter's lockup. The panel decision is now
subject to review by the Listing and Hearing Review Council. A decision is
anticipated by June.
The panel decision was based on the involvement of Ross Mandell with
us and the panel's view of the nature and extent of Mr. Mandell's
regulatory history in the securities industry which is substantially described
in this prospectus. To satisfy the panel we and Mr. Mandell took several
steps to reduce his involvement with the Company.
Those steps included the termination of Mr. Mandell's consulting
agreement, his agreement not to serve as an officer, director, employee or
consultant and the placement of all of his shares in a voting trust. In
accordance with the terms of the termination agreement with Mr. Mandell, we are
no longer obligated to pay him any money on a monthly basis. He is due, however,
the sum of $200,000 upon the successful completion of this offering.
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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 November 1, 2001, 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 option), there will be 11,641,250 shares of common stock issued
and outstanding and 1,000,000 common stock purchase warrants outstanding.
REDEEMABLE WARRANTS
Each redeemable 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
redeemable warrant certificate and summarized below. Our redeemable 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 redeemable warrants which
have not previously been exercised will expire on the expiration date. A
redeemable warrant holder will not be deemed to be a holder of the underlying
common stock for any purpose until the redeemable warrant has been properly
exercised.
Our common stock and redeemable 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
redeemable warrants included in the units. The amount of $0.10 is being
allocated to each warrant included in the units.
We have the right to redeem all (but not less than all) of the redeemable
warrants issued in this offering at a redemption price of $0.10 per redeemable
warrant, after providing 30 days prior written notice to the redeemable 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 consecutive trading
days immediately preceding the date of the notice.
A redeemable warrant holder may exercise our redeemable 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 redeemable
warrants are qualified for sale under the securities laws of the state in which
the holder resides. We are not under any obligation to maintain an effective
current registration statement. Our redeemable warrants may be exercised by
delivering to our transfer agent the applicable redeemable warrant certificate
on or prior to the expiration date or the redemption date, as applicable, with
the form on the reverse side of the
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<Page>
certificate executed as indicated, accompanied by payment of the full exercise
price for the whole number of redeemable warrants being exercised.
The exercise price of the redeemable 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 dividend,
stock split or reverse split with respect to our common stock, the exercise
price in effect immediately prior to such event will be proportionately reduced
or increased, as appropriate. Any adjustment of the exercise price will also
result in an adjustment of the number of shares purchasable upon exercise of a
redeemable warrant or, if we elect, an adjustment of the number of redeemable
warrants outstanding. These adjustments are intended to protect the interests of
the warrant holders from being diluted.
Notice of redemption will be provided by first class mail to all registered
holders of common stock and to all brokerage firms and other institutions who
hold stock in street name for others at the addresses on file with our transfer
agent. Investors who choose to hold warrants in 'street name' or other form of
indirect ownership will be provided notice from their respective broker or
financial institution. We will provide a form notice of exercise to the transfer
agent who will be directed to deliver notices to each street name holder. The
notice will provide the street name holders sufficient additional time to
receive and return their exercise forms to the transfer agent.
U.S. FEDERAL INCOME TAX CONSEQUENCES
The following discussion is a summary of the material U.S. federal tax
consequences relevant to the purchase, ownership, and disposition of the
redeemable warrants by persons who hold the warrants as capital assets
(generally, property held for investment within the meaning of Section 1221 of
the Internal Revenue Code). This discussion is based upon the Internal Revenue
Code, Treasury Regulations, Internal Revenue Service rulings and pronouncements,
and judicial decisions now in effect, all of which are subject to change at any
time by legislative, administrative, or judicial action, possibly with
retroactive effect. This discussion does not discuss every aspect of U.S.
federal taxation that may be relevant to a particular taxpayer in light of their
personal circumstances or to persons who are otherwise subject to special tax
treatment (including, without limitation, banks, broker-dealers, insurance
companies, pension and other employee benefit plans, tax exempt organizations
and entities, investors in pass-through entities, persons who acquire warrants
in connection with the performance of services, certain U.S. expatriates,
persons holding warrants as a part of a hedging or conversion transaction or a
straddle, certain hybrid entities and owners of interests therein, holders whose
functional currency is not the U.S. dollar, and persons who are not U.S. holders
(as defined below)), and it does not discuss the effect of any applicable U.S.
state and local or non-U.S. tax laws or U.S. tax laws other than U.S. income tax
law. We have not sought and will not seek any rulings from the Internal Revenue
Service concerning the tax consequences of the purchase, ownership or
disposition of the warrants and, accordingly, we cannot assure you that the
Internal Revenue Service will not successfully challenge the tax consequences
described below. EACH PROSPECTIVE PURCHASER IS URGED TO CONSULT THEIR OWN TAX
ADVISOR WITH RESPECT TO THE U.S. FEDERAL INCOME TAX CONSEQUENCES OF HOLDING AND
DISPOSING OF WARRANTS, AS WELL AS ANY TAX CONSEQUENCES APPLICABLE UNDER THE LAWS
OF ANY U.S. STATE, LOCAL, OR NON-U.S. TAXING JURISDICTION.
This section summarizes the material U.S. federal income tax consequences of
the ownership and disposition of warrants by 'U.S. holders.' The term 'U.S.
holder' refers to a person that is classified for U.S. federal tax purposes as a
United States person. For this purpose, a United States person includes
a citizen or resident of the United States,
a corporation created or organized in the United States or under the laws
of the United States or of any state or political subdivision thereof,
an estate the income of which is subject to U.S. federal income taxation
regardless of its source, or
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a trust whose administration is subject to the primary supervision of a
United States court and which has one or more United States persons who
have the authority to control all substantial decisions of the trust.
Notwithstanding the preceding sentence, to the extent provided in Treasury
Regulations, certain trusts in existence on August 20, 1996, and treated as
United States persons prior to such date that elect to continue to be treated as
United States persons, shall also be considered U.S. holders.
Issue Price of the Warrants. For U.S. federal income tax purposes, the
common stock and warrants included in the units being sold in this offering are
treated as an investment unit. The issue price of $8.10 per unit is required to
be allocated between the common stock and warrants based upon their relative
fair market values. Based on an estimate of the relative fair market values of
the common stock and warrants, we have allocated the amount of $8.00 to the
common stock and $0.10 to the warrants. Our allocation is not binding on the
Internal Revenue Service, which may challenge such allocation.
Tax Treatment of Warrants. A U.S. holder will generally not recognize gain
or loss upon exercise of warrants for cash (except with respect to any cash
received in lieu of a fractional share). A U.S. holder will have a tax basis in
the common stock received on exercise of a warrant equal to the sum of its tax
basis in the warrant and the aggregate cash exercise price paid in respect of
such exercise. The holding period of common stock received upon the exercise of
a warrant will commence on the day after the warrant is exercised.
The holder of a warrant may, at his or her choosing, exercise the warrant
through a broker to effect a 'cashless exercise' (whereby the underlying stock
is sold immediately by a broker to raise funds for the holder to pay the
exercise price). The tax consequences of a cashless exercise of a warrant are
not clear. Such an exercise may be tax-free, either because the exercise is not
a gain realization event or because it qualifies as a tax-free recapitalization.
In the former case, a U.S. holder's tax basis in the common stock received would
equal the tax basis in the surrendered warrants and the holding period of such
common stock would commence on the day after the warrant is exercised. In the
latter case, a U.S. holder's tax basis in the common stock received would equal
the tax basis in the surrendered warrants, and the holding period of such common
stock would include the holding period of the surrendered warrants. It is also
possible that the cashless exercise of a warrant could be treated as a taxable
exchange in which gain or loss should be recognized.
If a warrant expires without being exercised, a U.S. holder will recognize a
capital loss in an amount equal to its tax basis in the warrant. The
deductibility of capital losses is subject to limitation. Upon the sale,
exchange or redemption of a warrant, a U.S. holder will generally recognize a
capital gain or loss equal to the difference, if any, between the amount
realized on such sale, exchange or redemption and the U.S. holder's tax basis in
such warrant. Such capital gain or loss will be long-term capital gain or loss
if, at the time of such sale, exchange or redemption, the warrant has been held
for more than one year.
Under Section 305 of the Internal Revenue Code, a U.S. holder of a warrant
may be deemed to have received a constructive distribution from the issuer,
which may result in the inclusion of ordinary dividend income, in the event of
certain adjustments to the number of shares of common stock to be issued on
exercise of a warrant.
Backup Withholding. A U.S. holder may be subject to backup withholding with
respect to proceeds received from a disposition of the warrants. Certain holders
(including, among others, corporations and certain tax-exempt organizations) are
generally not subject to backup withholding. A U.S. holder will be subject to
backup withholding if such holder is not otherwise exempt and such holder:
fails to furnish its taxpayer identification number, which, for an
individual is ordinarily his or her social security number;
furnishes an incorrect taxpayer identification number;
53
<Page>
is notified by the Internal Revenue Service that it has failed to properly
report payments of interest or dividends; or
fails to certify, under penalties of perjury, that it has furnished a
correct taxpayer identification number and that the Internal Revenue
Service has not notified the U.S. holder that it is subject to backup
withholding.
Backup withholding is not an additional tax but, rather, is a method of tax
collection. U.S. holders will be entitled to credit any amounts withheld under
the backup withholding rules against their actual tax liabilities provided the
required information is furnished to the Internal Revenue Service.
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 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.
All of the 10,641,250 shares held by our existing shareholders, are
currently eligible for resale pursuant to Rule 144 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:
1% of the then outstanding shares of our common stock; or
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.
54
<Page>
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 by 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:
<Table>
<Caption>
UNDERWRITER NUMBER OF UNITS
----------- ---------------
The Thornwater Company, L.P.................................
Dirks & Company, Inc........................................
Total................................................... 1,000,000
---------
---------
</Table>
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 representative 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 representative may change the
offering price and other selling terms at various times.
We have granted the representative an over-allotment option. This option,
which is exercisable for up to 45 days after the date of this prospectus,
permits the representative 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.
<Table>
<Caption>
TOTAL WITHOUT TOTAL WITH FULL
EXERCISE OF EXERCISE OF
PER UNIT OVER-ALLOTMENT OPTION OVER-ALLOTMENT OPTION
-------- --------------------- ---------------------
$0.648....................................... $ $
</Table>
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, 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 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
55
<Page>
years, any public sale of our securities by these stockholders will be effected
through the facilities of Thornwater.
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. The
warrants may not be transferred except to partners of any underwriter that is a
partnership, or if an underwriter is a corporation, to officers and employees of
the underwriter who are also shareholders, or by will, the laws of descent and
distribution, or by the operation of law.
No underwriting syndicate has been formed as yet. Thornwater and Dirks &
Company, Inc. have agreed to co-underwrite the offering. Neither presently
intends to engage in the electronic offer, sale or distribution of the shares.
Nor do they presently intend to enter into an arrangement with a third party to
host or access the preliminary prospectus on the Internet.
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 stabilizing transactions by making 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.
In connection with this offering, the underwriters may make short sales of
our shares and may purchase our shares on the open market to cover positions
created by short sales. Short sales involve the sale by the underwriters of a
greater number of shares than they are required to purchase in the offering.
There are generally two types of short sales, 'covered' short sales and 'naked'
short sales.
'Covered' short sales are sales made in an amount not greater than the
underwriters' overallotment option to purchase additional shares in the
offering. The underwriters may close out any covered short position by either
exercising their overallotment option or purchasing shares in the open market.
In determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the overallotment option.
'Naked' short sales are sales in excess of the overallotment option. The
underwriters must close out any naked short position by purchasing shares in the
open market. A naked short position is more likely to be created if the
underwriters are concerned that there may be downward pressure on the price of
the shares in the open market after pricing that could adversely affect
investors who purchase in the offering.
Similar to other purchase transactions, the underwriters' purchases to cover
the syndicate short sales may have the effect of raising or maintaining the
market price of our stock or preventing or retarding a decline in the market
price of our stock. As a result, the price of our stock may be higher than the
price that might otherwise exist in the open market.
56
<Page>
We are not aware of any activities by Ross Mandell related to the
distribution of units and other securities. Mr. Mandell has executed an
agreement of non-involvement with us. Mr. Mandell did introduce our principals
to the principal of Thornwater. The decision to engage Thornwater, however, was
solely that of our principals. We understand that Mr. Mandell will have no role
in identifying persons who may purchase units from the underwriters, and have no
role in the negotiation, marketing or solicitation-related activities in
connection with the distribution of units or other securities. Mr. Mandell's
consulting agreement with us has been terminated. His consulting agreement with
Thornwater has also been terminated and he has similarly entered into an
agreement of non-involvement with Thornwater.
Mr. Mandell is currently registered as a broker with Sky Capital, LLC, which
has applied for membership with the NASD. We do not intend to have Sky Capital
serve as an underwriter of the units, or otherwise participate in the
distribution of the public offering of the units or their component securities.
We do not know whether Sky Capital or any affiliate of it intends to make a
market in the units or their component securities.
Robert J. Grabowski is the President and Chief Executive Officer of
Thornwater. He is also the Managing Member of St. James Holdings. Mr.
Grabowski's activities related to the distribution of units or other securities
will be limited to his capacities at Thornwater. We believe that St. James
Holdings LLC will not perform any activities on behalf of it or Mr. Mandell
related to the distribution of units or other securities.
LEGAL MATTERS
The validity of the issuance of the securities offered hereby will be passed
upon for us by Ziegler, Ziegler & Altman LLP, 555 Madison Avenue, New York, New
York 10022. Members of Ziegler, Ziegler & Altman, LLP collectively own 500,000
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 in these 90,000 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, Reed Smith LLP.
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 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 233
Broadway, 16th
57
<Page>
Floor, New York, New York 10279 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.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
We have not had any changes in or disagreements with our principal
independent accountants during the two most recent fiscal years or any later
interim period.
58
Chipcards, Inc.
------------------------------------------
Combined Financial Statements
Years Ended December 31, 2001 and 2000
Chipcards, Inc.
Contents
- --------------------------------------------------------------------------------
Independent Auditors' Report F-2
Financial Statements
Combined balance sheets F-3
Combined statements of operations F-5 - F-6
Combined statements of stockholders' deficit F-7
Combined statements of cash flows F-8 - F-9
Summary of accounting policies F-10 - F-14
Notes to combined financial statements F-15 - F-24
F-1
Independent Auditors' Report
To the Board of Directors
Chipcards, Inc.
San Francisco, California
We have audited the accompanying combined balance sheets of Chipcards, Inc., as
of December 31, 2001 and 2000, and the related combined statements of
operations, stockholders' deficit, and cash flows for the years then ended.
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 combined financial statements referred to above present
fairly, in all material respects, the financial position of Chipcards, Inc. at
December 31, 2001 and 2000, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
As indicated in Note 11, the Company restated its 2000 financial statements.
February 6, 2002
F-2
Chipcards, Inc.
Combined Balance Sheets
- --------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Assets (Note 3)
Current
Cash and cash equivalents $ 667,963 $ 294,806
Trade receivables 2,884 28,461
Inventory (Note 2) 875,148 286,634
Costs of uncompleted contracts in excess of related billings (Note 11) - 1,011,977
Prepaid expenses and other current assets 51,419 56,021
- --------------------------------------------------------------------------------------------------------------------
Total Current Assets 1,597,414 1,677,899
- --------------------------------------------------------------------------------------------------------------------
Property and Equipment:
Buildings and improvements 1,199,122 1,215,816
Office equipment 144,502 137,423
- --------------------------------------------------------------------------------------------------------------------
1,343,624 1,353,239
Less accumulated depreciation (157,315) (110,257)
- --------------------------------------------------------------------------------------------------------------------
Net property and equipment 1,186,309 1,242,982
- --------------------------------------------------------------------------------------------------------------------
$2,783,723 $2,920,881
====================================================================================================================
F-3
Chipcards, Inc.
Combined Balance Sheets
- --------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Deficit
Current
Checks issued against future deposits $ - $ 74,356
Short-term borrowings (Note 3) - 14,500
Accounts payable 1,775,443 1,484,308
Accrued compensation 62,239 105,003
Accrued commissions (Note 1) 480,000 183,907
Income taxes payable (Note 5) - 66,000
Other accrued liabilities 303,475 64,903
Billings on uncompleted contracts in excess of related costs 60,170 30,621
Deferred revenue - 1,136,344
Current portion of long-term debt (Note 4) 25,201 28,070
- --------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 2,706,528 3,188,012
- --------------------------------------------------------------------------------------------------------------------
Deferred revenue, net of current portion - 379,000
Long-term debt, less current portion (Note 4) 1,079,809 1,101,163
- --------------------------------------------------------------------------------------------------------------------
Total Liabilities 3,786,337 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 685,100 685,100
Additional paid-in capital 303,000 -
Accumulated deficit (1,990,714) (2,432,394)
- --------------------------------------------------------------------------------------------------------------------
Total Stockholders' Deficit (1,002,614) (1,747,294)
- --------------------------------------------------------------------------------------------------------------------
$ 2,783,723 $ 2,920,881
====================================================================================================================
See accompanying summary of accounting policies and notes to financial statements.
F-4
Chipcards, Inc.
Combined Statements of Operations
- -------------------------------------------------------------------------------------------------
Years ended December 31, 2001 2000
- -------------------------------------------------------------------------------------------------
Revenues
Production line sales $11,685,344 $3,527,707
Finished smart card sales 2,220,454 956,851
Smart card component sales and other sales 1,772,325 137,825
- -------------------------------------------------------------------------------------------------
Total Revenue 15,678,123 4,622,383
- -------------------------------------------------------------------------------------------------
Cost of Sales
Production line costs 5,984,200 1,948,263
Finished smart cards costs 2,957,928 1,119,979
Smart card component costs and other costs 1,434,953 88,160
- -------------------------------------------------------------------------------------------------
Total Costs of Sales 10,377,081 3,156,402
- -------------------------------------------------------------------------------------------------
Gross Profit 5,301,042 1,465,981
- -------------------------------------------------------------------------------------------------
Operating Expenses
Selling expenses 888,792 142,946
Compensation 1,879,772 684,989
Other general and administrative 2,090,102 983,270
- -------------------------------------------------------------------------------------------------
Total Operating Expenses 4,858,666 1,811,208
- -------------------------------------------------------------------------------------------------
Operating Income (Loss) 442,376 (345,227)
- -------------------------------------------------------------------------------------------------
Other (Expense) Income
Other income (including $181,000 in 2000 on recovery of
previously written-off amounts receivable) 141,744 256,489
Other expense (34,101) (9,054)
Interest expense, net (186,472) (160,045)
- -------------------------------------------------------------------------------------------------
Total Other (Expense) Income (78,829) 87,390
- -------------------------------------------------------------------------------------------------
Income (Loss) from Before Taxes 363,547 (257,837)
Income tax (benefit) expense (Note 5) (78,133) 67,600
- -------------------------------------------------------------------------------------------------
Net Income (Loss) $ 441,680 $ (325,437)
==================================================================================================
F-5
Chipcards, Inc.
Combined Statements of Operations
- -------------------------------------------------------------------------------------------------
Years ended December 31, 2001 2000
- -------------------------------------------------------------------------------------------------
Basic Net Income (Loss), per common share $0.04 $(0.03)
- -------------------------------------------------------------------------------------------------
Diluted Net Income (Loss), per common share $0.04 $(0.03)
- -------------------------------------------------------------------------------------------------
Shares Used in Per Common Share Calculations, basic 10,641,250 9,710,000
- -------------------------------------------------------------------------------------------------
Shares Used in Per Common Share Calculations, diluted 10,651,250 9,710,000
=================================================================================================
See accompanying summary of accounting policies and notes to financial statements.
F-6
Chipcards, Inc.
Combined Statements of Stockholders' Deficit
- --------------------------------------------------------------------------------------------------------------------------
Common Stock Additional
-------------------------- Paid-in Retained
Shares Amount Capital Earnings Total
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 7,026,250 $ 6,600 $ - $(2,106,957) $(2,100,357)
Sale of common stock 115,000 575,000 - - 575,000
Issuance of common stock for
consulting
services (Note 6) 3,500,000 103,500 - - 103,500
Net loss - - - (325,437) (325,437)
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 10,641,250 685,100 - (2,432,394) (1,747,294)
Stock-based compensation - - 303,000 - 303,000
Net income - - - 441,680 441,680
- --------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 10,641,250 $685,100 $ 303,000 $(1,990,714) $(1,002,614)
==========================================================================================================================
See accompanying summary of accounting policies and notes to financial statements.
F-7
Chipcards, Inc.
Combined Statements of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income (loss) $ 441,680 $(325,437)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation 74,915 52,040
Write-off of defective inventory 1,074,146 -
Write-down of inventory 366,500 44,600
Stock-based compensation 303,000 103,500
Loss on disposal of property and equipment 31,923 19,550
Changes in operating assets and liabilities:
Trade receivables 25,577 37,727
Inventory (2,029,160) (166,718)
Costs of uncompleted contracts in excess of related billings 1,011,977 280,050
Related party receivable - 71,887
Receivable from insurance provider - 430,357
Prepaid expenses and other current assets 4,602 (45,291)
Accounts payable and accrued expenses 529,707 (12,949)
Accrued compensation and commissions 253,329 (19,433)
Income taxes payable (66,000) 66,000
Billings on uncompleted contracts in excess of related costs 29,549 30,621
Deferred revenue (1,515,344) (397,707)
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 536,401 168,797
- ---------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Proceeds from disposal of property and equipment 5,735 -
Acquisitions of property and equipment (55,900) (28,822)
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (50,165) (28,822)
- ---------------------------------------------------------------------------------------------------------------------------
F-8
Chipcards, Inc.
Combined Statements of Cash Flows
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Checks issued in excess of future deposits $ (74,356) $ (8,339)
Net proceeds from the sale of common stock - 575,000
Borrowings under bank credit agreements and line of credit 6,141,411 523,120
Repayments under bank credit agreements and line of credit (6,155,911) (1,043,283)
Proceeds from notes payable - 506,339
Proceeds from shareholder loans - 9,700
Principal payments on shareholder loans - (525,324)
Principal payments on long-term debt (24,223) (24,516)
- ---------------------------------------------------------------------------------------------------------------------------
Net Cash (Used in) Provided by Financing Activities (113,079) 12,697
- ---------------------------------------------------------------------------------------------------------------------------
Net Increase in Cash and Cash Equivalents 373,157 152,672
Cash and Cash Equivalents, beginning of year 294,806 142,134
- ---------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents, end of year $ 667,963 $ 294,806
===========================================================================================================================
Supplemental disclosures of cash flow information
Cash paid for interest $ 106,163 $ 98,922
Cash paid for income taxes 153,947 1,600
===========================================================================================================================
See accompanying summary of accounting policies and notes to financial statements.
F-9
Chipcards, Inc.
Summary of Accounting Policies
- --------------------------------------------------------------------------------
Nature of Business Chipcards, Inc. ("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.
Basis of Presentation The combined 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.
Cash and Cash Cash and cash equivalents include cash on hand
Equivalents and in 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
Recognition construction of smart card production lines are
recognized under the completed-contract method,
recognizing revenue only when the contract is
completed or substantially completed.
Accordingly, costs of contracts in process and
current billings are accumulated, but there are
no interim charges or credits to income prior to
completion, other than provisions for losses,
upon signed customer acceptance.
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
acquiring the equipment. These joint venture
equity interests are not recorded on the
financial statements, as the Company is unable to
reasonably estimate their fair market value.
Gross profit on sales of equipment to entities in
which the Company has an equity interest is
deferred for the contracted life of the joint
venture to the extent of the Company's equity
interest. As of December 31, 2000, the Company
was a partner in one joint
F-10
Chipcards, Inc.
Summary of Accounting Policies
- --------------------------------------------------------------------------------
venture but did not contribute funds or services
to the joint venture. Further, the joint venture
did not commence operations. Thus, the joint
venture had no financial impact on the Company.
The joint venture was terminated in 2001.
Accordingly, the remaining deferred revenue of
$545,000 relating to the contract was recognized.
Two 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, which commenced in 1998. For
these contracts, risk is not deemed to have been
transferred to the purchaser until the purchase
commitment terminates. Accordingly, gross profit
resulting from the sale of these production lines
was deferred and recognized ratably over the
three-year commitment period. Both commitments
ended in 2001 through expiration of the
commitment period or successful arbitration. No
revenue was deferred at December 31, 2001.
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.
The Company offers a one-year warranty to its
production line customers. During this period the
Company is responsible for repairing or replacing
any defective components. The Company accrues for
warranty costs based on its experience and
expectation of future costs.
Revenues from the sale of smart card raw
materials and finished smart cards are recognized
when substantially all risks and rewards of
ownership are transferred to customers, generally
upon shipment.
Inventory Inventory, consisting of finished smart cards,
modules and other materials, 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.
F-11
Chipcards, Inc.
Summary of Accounting Policies
- --------------------------------------------------------------------------------
Depreciation of property and equipment is
generally computed using the straight-line method
over the following estimated useful lives:
-------------------------------------------------
Buildings and improvements 39 years
Office furniture and equipment 3 to 7 years
-------------------------------------------------
Research and The Company expenses the costs associated with
Development the research and development of new products as
incurred.
Stock-based The Company has adopted the provisions of
Compensation Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based
Compensation". Under this standard, companies are
encouraged, but not required, to adopt the fair
value method of accounting for employee
stock-based transactions. Under the fair value
method, compensation cost is measured at the
grant date based on the fair value of the award
and is recognized over the service period, which
is usually the vesting period. Companies are
permitted to continue to account for employee
stock-based transactions under Accounting
Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees", but
are required to disclose pro forma net income
(loss) and earnings (loss) per share as if the
fair value method had been adopted. The Company
has elected to continue to account for employee
stock-based compensation under APB. No. 25.
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 temporary 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 generally relate to
inventory valuation and deferred taxes. Due to a
certain degree of uncertainty involved, actual
results could differ materially from these
estimates.
F-12
Chipcards, Inc.
Summary of Accounting Policies
- --------------------------------------------------------------------------------
New Accounting In June 2001, the Financial Accounting Standards
Pronouncement Board finalized FASB Statements No. 141, Business
Combinations (SFAS 141), and No. 142, Goodwill
and Other Intangible Assets (SFAS142). SFAS 141
requires the use of the purchase method of
accounting and prohibits the use of the
pooling-of-interests method of accounting for
business combinations initiated after June 30,
2001. SFAS 141 also requires that the Company
recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet
certain criteria. SFAS 141 applies to all
business combinations initiated after June 30,
2001 and for purchase business combinations
completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the
Company reclassify the carrying amounts of
intangible assets and goodwill based on the
criteria in SFAS 141.
SFAS 142 requires, among other things, that
companies no longer amortize goodwill, but
instead test goodwill for impairment at least
annually. In addition, SFAS 142 requires that the
Company identify reporting units for the purposes
of assessing potential future impairments of
goodwill, reassess the useful lives of other
existing recognized intangible assets, and cease
amortization of intangible assets with an
indefinite useful life. An intangible asset with
an indefinite useful life should be tested for
impairment in accordance with the guidance in
SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to
all goodwill and other intangible assets
recognized at that date, regardless of when those
assets were initially recognized. SFAS 142
requires the Company to complete a transitional
goodwill impairment test six months from the date
of adoption. The Company is also required to
reassess the useful lives of other intangible
assets within the first interim quarter after
adoption of SFAS142.
The Company has not entered into any business
combinations. Therefore, the Company does not
expect that the implementation of these standards
will have an effect on its financial statements.
F-13
Chipcards, Inc.
Summary of Accounting Policies
- --------------------------------------------------------------------------------
SFAS 143, Accounting for Asset Retirement
Obligations, was issued in June 2001 and is
effective for fiscal years beginning after June
15, 2002. SFAS 143 requires that any legal
obligation related to the retirement of
long-lived assets be quantified and recorded as a
liability with the associated asset retirement
cost capitalized on the balance sheet in the
period it is incurred when a reasonable estimate
of the fair value of the liability can be made.
SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, was issued in
August 2001 and is effective for fiscal years
beginning after December 15, 2001. SFAS 144
provides a single, comprehensive accounting model
for impairments and disposal of long-lived assets
and discontinued operations.
SFAS 143 and SFAS 144 will be adopted on their
effective dates, and adoption is not expected to
result in any material effects on the Company's
financial statements.
Earnings 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-14
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
1. Related Party During 1999 and 2000, the Company's principal stockholders
Transactions advanced $525,324 to the Company. 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 commissions on new business, which is recognized
upon completion of the contract. At December 31, 2001 and
2000 approximately $200,000 and $90,000 in commissions
were payable to certain shareholders of the Company and
included its accrued commissions at December 31, 2001.
Total commissions earned by these shareholders were
$400,000 and $160,000 for the year ended December 31, 2001
and 2000.
The San Diego office is currently leased from Ampac
Technology, LLC. The two members of Ampac Technology, LLC
are both principal stockholders of the Company. One of the
members is also an officer of the Company. Ampac
Technology, LLC has entered into an agreement to transfer
title to the San Diego property to the Company upon the
completion of a public offering of the Company's common
stock, at a consideration of $150,000 plus an assumption
of the outstanding indebtedness on the property. The
Company believes that this price represents the fair
market value of the property, and that the terms of this
sale are no less favorable to them than could otherwise
have been obtained from an unaffiliated third party.
2. Inventory Inventory is comprised of finished cards, modules and
other raw materials. At December 31, 2001, the Company had
defective cards in inventory obtained from their
manufacturer. The Company is seeking recourse from the
vendor for costs of replacement and damages. It is
uncertain whether collection is probable and should their
claim be denied, the Company would bear the costs of
replacement. The Company expensed approximately $1,441,000
in defective inventory of which $360,000 is retained on
their books as a reserve for defective cards in excess of
their salvage value. Inventory is summarized as follows:
<Table>
<Caption>
December 31, 2001 2000
------------------------------------------------------------
Finished cards $ 915,901 $ 91,337
Modules and other materials 411,981 281,531
------------------------------------------------------------
1,327,882 372,868
Reserve 452,734 86,234
------------------------------------------------------------
$ 875,148 $286,634
============================================================
F-15
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
The activity in the inventory reserve is as follows:
December 31, 2001 2000
-------------------------------------------------------------------
Balance, beginning of year $ 86,234 $ 41,634
Charge to expense 1,440,646 77,380
Deductions and write-offs (1,074,146) (32,780)
-------------------------------------------------------------------
Balance, end of year $ 452,734 $ 86,234
===================================================================
3. Short-Term The Company has a $1,950,000 credit facility, bearing
Borrowings interest at prime rate plus 1.5% (6.25% at December 31,
2001), and maturing in September 2002. The credit facility
is guaranteed by the primary stockholders of the Company
and is collateralized by substantially all assets.
Borrowings cannot exceed 75% of eligible inventory, 70% of
eligible accounts receivable and 90% of the value of
letters of credits posted by customers to secure payment
to the Company. The facility was unused at December 31,
2001.
In September 2001, the Company entered into a line of
credit agreement permitting borrowings of up to $1,100,000
through September 2002. Outstanding borrowings will bear
interest at the prime rate plus 2% (6.75% at December 31,
2001), are guaranteed by two of the Company's principal
stockholders and are collateralized by substantially all
assets. Borrowings cannot exceed 50% of the value of
letters of credit posted by customers to secure payment to
the Company. There were no borrowings outstanding at
December 31, 2001.
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. These short-term
loans generally mature within three to six months. During
the year ended December 31, 2001, the Company received
various short-term advances ranging from $13,080 to
$460,000 with interest rates between 8.5% and 9.5%. At
December 31, 2001, there were no outstanding short-term
advances. At December 31, 2000, outstanding short-term
advances totaled $14,500, which was paid in January 2001.
The Company had a revolving line of credit of $150,000 for
purchase order financing. It bears interest at prime rate
plus 2% (6.75% at December 31, 2001) and matured 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.
F-16
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
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, 2001. Interest on such advances is calculated
at the bank's reference rate plus 3.625% (or 8.375% at
December 31, 2001) and expired in February 2002. At
December 31, 2001, there were no outstanding borrowings on
the line of credit.
The Company also has an unsecured $25,000 line of credit
bearing interest at prime rate plus 1.75% (6.5% at
December 31, 2001) that matures in September 2002 and a
$15,000 unsecured line of credit bearing interest at prime
rate plus 3% that matures in December 2002. Both lines of
credit were unused at December 31, 2001.
4. Long-Term Debt Long-term debt consists of:
December 31, 2001 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 of
approximately $414,000 due upon maturity in
August 2014. The note bears interest at the
weekly average yield on U.S. Treasury Securities
plus 2.46% (7.75% at December 31, 2001). $ 630,223 $ 639,229
Note payable, secured by real property guaranteed by
the Company's principal stockholders, bearing
interest at 8.12%, principal and interest due in
monthly installments of approximately $4,700 through
May 2020. 471,750 482,411
Other 3,037 7,593
---------------------------------------------------------------------------------------
1,105,010 1,129,233
Less current portion 25,201 28,070
---------------------------------------------------------------------------------------
$1,079,809 $1,101,163
=======================================================================================
F-17
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
Future minimum principal payments under the
long-term debt agreements are as follows:
Year ending December 31, Amount
---------------------------------------------------------------------------
2002 $ 25,201
2003 23,991
2004 25,968
2005 28,108
2006 29,791
Thereafter 971,951
---------------------------------------------------------------------------
$1,105,010
===========================================================================
5. Taxes on The significant components of income tax expense
Income (benefit) are as follows:
December 31, 2001 2000
---------------------------------------------------------------------------
Current
Federal $(64,000) $33,000
State (14,133) 34,600
---------------------------------------------------------------------------
$(78,133) $67,600
===========================================================================
Deferred tax assets are comprised of the following:
December 31, 2001 2000
---------------------------------------------------------------------------
Deferred revenues $ 12,000 $ 1,145,000
Net operating loss carryforwards 643,000 -
Accrued commissions 80,000 74,000
Stock compensation 101,000 -
Inventory reserve 180,000 34,000
Other 20,000 30,000
---------------------------------------------------------------------------
1,036,000 1,283,000
Less valuation allowance (1,036,000) (1,283,000)
---------------------------------------------------------------------------
Total $ - $ -
===========================================================================
F-18
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
The Company has federal and state tax net operating
loss carryforwards (NOL) as of December 31, 2001
available to reduce future taxable income, if any,
of approximately $1,745,000 and $864,000. The
benefits from these carryforwards expire through
2021 and 2011 for Federal and State purposes. Should
significant changes in the Company's ownership
occur, the annual amount of NOL carryforwards
available for future use would be limited.
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. As a result of
adjustments in deferred tax assets and use of NOL's
in the current year, the valuation allowance was
adjusted by ($247,000) and $107,000 during the years
ended December 31, 2001 and 2000.
In 2001, the Company elected to carryback NOL's from
prior periods, which were reserved for deferred
taxes and which resulted in a receipt of income tax
refunds and an income tax benefit for the year.
The following is a reconciliation of income taxes
determined by applying statutory rates to income
taxes reported:
Years ended December 31, 2001 2000
---------------------------------------------------------------------------
Federal taxes 34% (34)%
State taxes, net of federal tax benefit 6 (6)
Change in valuation allowance (68) 68
Other 71 15
---------------------------------------------------------------------------
Total (21)% 43%
===========================================================================
6. Stockholders' In March 2000, the Company issued 3,500,000 shares
Equity of common stock valued at approximately $103,500 to
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. Compensation expense of $50,000 and $0
for the years ended December 31, 2001 and 2000 was
recorded in connection with this award. The amount
is recorded as additional paid-in capital until such
time that the shares are issued; at which time it
will be reclassed to common stock. As of December
31, 2001, the shares were not issued.
F-19
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
Stock options
The 2000 Equity Incentive Plan (the "Plan") provides
for grants of stock options. Awards may be granted
over a 10-year period to employees of the Company as
well as nonemployees, including directors. The
aggregate number of shares of common stock that may
be issued under the Plan shall not exceed 2,500,000
shares.
Changes that occurred in options outstanding are
summarized below:
Weighted Average
Average Remaining
Exercise Contractual
Year ended December 31, 2001 Price Shares Life
------------------------------------------------------------------------------------------
Outstanding at beginning of year $ - -
Granted 5.00 1,050,000 8.79 years
Cancelled or expired 5.00 (240,000) 5.0 years
------------------------------------------------------------------------------------------
Outstanding at end of year $5.00 810,000 8.6 years
==========================================================================================
Exercisable at end of year $5.00 90,000 9.4 years
==========================================================================================
Under SFAS 123, "Accounting for Stock-Based
Compensation", compensation expense associated with
stock options issued to consultants is measured
based on the estimated fair value of services
received by the Company, or the fair value of the
options issued by the Company, whichever is more
reliably measurable. The Company estimates fair
value of each stock option at the grant date by
using the Black-Scholes model with the following
weighted average assumptions for grants in fiscal
years 2001, respectively: no dividend yield for any
year; expected volatility of 35%; risk-free interest
rates of approximately 5.3% and expected lives of
5.6 years.
Of the 1,050,000 options granted in 2001, 90,000
fully vested options were issued to consultants and
approximately $253,000 was recorded in related
compensation expense for 2001. No options were
granted to consultants in 2000.
The weighted average exercise fair value of options
granted on a per share basis was $2.32.
F-20
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
In December 2001, the Company cancelled an option
for 240,000 common shares issued to a consultant
during 2000. Since the consultant was terminated
prior to establishing a fixed price on the options,
no compensation expense was recorded for those
options.
The following table shows net loss and loss per
share if the Company had accounted for all options
under the fair value provisions of SFAS 123:
-----------------------------------------------------------
Net Income:
As stated $441,680
Pro forma $212,000
Per share as reported $ 0.04
Per share - basic and dilutive $ 0.02
===========================================================
The intrinsic value for options granted to employees
was zero. Accordingly, no compensation expense was
recorded during 2001 and 2000.
7. Commitments Production Line Contracts
and
Contingencies In connection with its sale of two smart card
production lines in 1999, the Company entered into
commitments with the production line purchaser
(Party A). The Company promised to sell raw
materials needed for the production of smart cards
at a fixed price per unit. Party A promised to sell,
and the Company was required to buy, an agreed-upon
amount of finished smart cards to the Company at a
fixed price per unit. The Company was also required
to post a letter of credit in favor of Party A for
the entire purchase price of finished smart cards.
Subsequent to December 31, 2000, as a result of
arbitration, commitments for material purchases and
sales were eliminated for one of the contracts. The
Company did not incur any losses related to the
arbitration. The other commitment expired as of
December 31, 2001.
8. Concentration of The Company currently derives 80% 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 collection contracts is not assured
given the Chinese economic infrastructure.
F-21
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
The Company subcontracts the manufacture of its
smart card production equipment and uses a single
supplier for this manufacture. The Company's ability
to supply equipment is substantially dependent on
the availability and quality of the supplier. The
loss of this supplier could have material adverse
effect on the Company's results of operations and
financial position.
The Company relies on one vendor for its supply on
Mifare microprocessors, which is the predominant
type of microprocessor for smart card systems. The
capability of this vendor to provide microprocessors
has a material impact on the Company's ability to
obtain finished smart cards. Should there be a
shortage in microprocessors, the Company would be
adversely affected by the loss of smart card sales.
Such a shortage occurred during the third quarter of
1999 through the first quarter of 2001 and forced
the Company to curtail fulfillment of orders
beginning January 2000. This caused cancelled orders
and impaired the Company's ability to expand smart
card sales. Orders totaling approximately $1,694,000
and $443,000 were canceled during the years ended
December 31, 2001 and 2000.
9. Earnings (Loss) Warrants to purchase 25,000 shares of the Company's
Per Share common stock and 35,000 contingently issuable shares
of common stock were outstanding at December 31,
2000. Because their effect would be anti-dilutive,
they were not included in the computation of diluted
net loss per common share. Options to purchase
810,000 shares of the Company's common stock were
outstanding at December 31, 2001 but did not have a
dilutive effect on earnings per share as these
options were not "in the money". Included in the
calculation of diluted net income per common share
for the year ended December 31, 2001 were 10,000
contingently issuable shares.
10. Segment The Company, from its headquarters in San Francisco
Reporting and engineering facility in Southern California, is
engaged in the construction and sale of smart cards,
components and production lines to customers in
primarily China, Korea and the United States. The
Company manages its business and believes it has
only one business segment. Substantially all of the
Company's revenue is derived from foreign customers.
F-22
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
Revenue from customers exceeding 10% of total
revenue:
December 31, 2001 2000
---------------------------------------------------------------------------
Customer A $3,432,000 $ -
Customer B 2,810,000 -
Customer C 2,490,000 -
Customer D 2,250,000 -
Customer E - 2,554,000
===========================================================================
Revenues were derived from the following
geographical areas:
Year ended December 31, 2001 2000
---------------------------------------------------------------------------
United States 3% 5%
China 81% 84%
Korea 13% 7%
Other Non-U.S. 3% 4%
===========================================================================
11. Accounting Prior to 2001, it had been the Company's policy to
Method recognize revenue for construction contracts of
smart card production lines under the percentage of
completion method accounting assuring a zero
estimate of gross profit until the contact was
complete and payment was received. During 2001, the
Company elected to change its method of accounting
for these production lines from the percentage of
completion method to the completed contract method.
The new accounting method was adopted because
management believes that the new method results in a
better recognition of revenues, since the Company
has historically renegotiated contract terms with
their customers. Therefore, the Company considered
it more accurate to recognize revenues upon
installation and final acceptance of the smart card
production line. This new method also more closely
correlates revenue recognition with the cash
realization relating to the sale, since payments are
substantially due when the majority of the work is
completed. Below is a table which summarizes the
impact of the changes to the financial statement:
F-23
Chipcards, Inc.
Notes to Combined Financial Statements
- --------------------------------------------------------------------------------
Net Income
Stockholders' Net (Loss) Per
Deficit Income (Loss) Shares
----------------------------------------------------------------------------------------------
December 31, 2000 - as previously reported $(1,747,294) $ (325,437) $(0.03)
Elimination of revenues under the completed
contract method (1,831,356) (1,831,356)
Elimination of cost of sales under the
completed contract method 1,831,356 1,831,356
----------------------------------------------------------------------------------------------
December 31, 2000 - as restated (1,747,294) (325,437) (0.03)
==============================================================================================
December 31, 2001 - as previously reported (1,079,844) 441,680 0.04
Increase in revenues under the completed
contract method 2,111,716 2,111,716
Increase in cost of sales under the completed
contract method (2,111,716) (2,111,716)
----------------------------------------------------------------------------------------------
December 31, 2001 - as restated (1,079,844) 441,680 0.04
==============================================================================================
F-24
<Page>
_______________________________________________________________________________
_______________________________________________________________________________
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 , 2002 (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
[CHIPCARDS LOGO]
EACH CONSISTING OF
ONE SHARE OF COMMON STOCK
AND ONE REDEEMABLE COMMON STOCK
PURCHASE WARRANT OF CHIPCARDS, INC.
-----------------
PROSPECTUS
-----------------
THE THORNWATER COMPANY, L.P.
99 WALL STREET
NEW YORK, NEW YORK 10005
DIRKS & COMPANY, INC.
18 EAST 53RD STREET
NEW YORK, NEW YORK 10022
, 2002
_______________________________________________________________________________
_______________________________________________________________________________
<Page>
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.
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.
II-1
<Page>
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.
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:
<Table>
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
--------
--------
</Table>
RECENT SALES OF UNREGISTERED SECURITIES
Since inception, we have issued the following securities without registering
such securities under the Securities Act:
<Table>
<Caption>
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
10/1/99.................... 25,000 Common Samuel de St. Services rendered(1)
Stock purchase Laurent
warrants
10/29/99................... 50,000 shares Fillian Lei Services rendered
of Common Stock
10/29/99................... 50,000 shares Timothy Norman Services rendered
of Common Stock
10/29/99................... 50,000 shares Paul Amadeo Services rendered
of Common Stock
10/29/99................... 50,000 shares Mo Jia Services rendered
of Common Stock
10/29/99................... 25,000 shares Jose Flores Services rendered
of Common Stock
10/30/99................... 100,000 shares Allen Yue Services rendered
of Common Stock
3/20/00.................... 3,000,000 Ross Mandell Consulting services
shares of
Common Stock
3/20/00.................... 500,000 shares Scott Ziegler Consulting services
of Common Stock
</Table>
(table continued on next page)
II-2
<Page>
(table continued from previous page)
<Table>
<Caption>
TITLE AND AMOUNT PERSON OR CLASS TOTAL OFFERING PRICE OF
DATE OF SECURITIES OF PERSONS TYPE OF CONSIDERATION
---- ------------- ---------- ---------------------
5/18/00 - 10/16/00......... 115,000 shares Private placement $575,000
of Common Stock investors
5/11/01.................... 240,000 options Michael Recca Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Allen Yue Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Eric Gravell Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Fillian Lei Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Paul Amadeo Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Timothy Norman Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 120,000 options Jose Flores Incentive Stock
to purchase Options(2)
Common Stock
5/11/01.................... 90,000 options Ziegler, Ziegler Incentive Stock
to purchase & Altman, LLP Options(2)
Common Stock
</Table>
- ---------
(1) All of these warrants have lapsed unexercised.
(2) All options are exercisable at the lower of $8.00 per share or the initial
public offering price of shares of common stock included in the units being
offered, provided that if the initial public offering is not consummated
prior to January 1, 2002, the option exercise price will be adjusted to
$5.00 per share.
The shares issued on December 5, 1993 were sold in reliance on the exemption
from registration set forth in Section 4(2) of the Securities Act of 1933 based
on the fact that the issuance was made to only two individuals, the co-founders,
who acquired the shares solely for investment and not in connection with a
distribution.
The shares issued on October 29, 1999 and October 30, 1999 were granted as a
stock bonus to employees of the Company and, consequently, did not involve a
'sale' under the Securities Act of 1933.
The shares issued on March 20, 2000 were sold in reliance on the exemption
from registration set forth in Section 4(2) of the Securities Act of 1933 based
on the fact that the issuance was made to only two individuals, each of whom
received the shares as compensation for providing consulting services, and each
of whom acquired the shares solely for investment and not in connection with a
distribution.
The shares issued on May 18, 2000 were sold in reliance on the exemption
from registration set forth in Section 4(2) of the Securities Act of 1933 based
on the fact that the issuance was made to a limited group of 11 individuals, all
of whom were accredited investors having pre-existing relationships with our
officers or directors, and all of whom acquired the shares solely for investment
and not in connection with a distribution.
The above table does not give effect to a 1,600 for 1 stock split effected
on February 25, 1999 or a 2.65 for 1 stock dividend declared on each share held
of record as of March 18, 2000.
II-3
<Page>
INDEX TO EXHIBITS
EXHIBITS FILED AS PART OF THIS REGISTRATION STATEMENT
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
------ -------
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, together with all Amendments thereto
3.2* -- 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
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.
</Table>
II-4
<Page>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
------ -------
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.
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 the Registrant and Hainan Pacific New High Tech
Company.
10.24* -- Letter Regarding Translation of Certain Exhibits.
10.25*** -- Consulting Agreement dated March 20, 2000, between Ross
Mandell and the Registrant
10.26*** -- Consulting Agreement dated March 20, 2000 between Scott
Ziegler and the Registrant
10.27* -- Technical Services and Licensing Agreement, dated May 8,
2001, between Hainan Pacific New High Tech Company and the
Registrant
10.28* -- Agreement for Purchase of Equipment and Supplement, dated
June 28, 2001, between the Registrant and Beijing Zhong
Dun Security Technology Development Company on behalf of
the Ministry of Security No. 1 Research Institute.
10.29* -- Technical Services and Licensing Agreement dated
June 28, 2001 between the Registrant and Beijing Zhong Dun
Security Technology Development Company on behalf of the
Ministry of Security No. 1 Research Institute.
10.30* -- Agreement for Purchase of Equipment, dated September 3,
2001, between the Registrant and Beijing Bu Lu Dun High
Tech Company Limited on behalf of the China Motor Vehicle
Safety Inspection Center.
10.31* -- Technical Services and Licensing Agreement dated
September 3, 2001 between the Registrant and Beijing on
behalf of the China Motor Vehicle Safety Inspection
Center.
10.32* -- Agreement for Purchase of Equipment, dated August 10,
2001, between the Registrant and Tranco Limited.
10.33* -- Technical Services and Licensing Agreement dated
August 10, 2001 between the Registrant and Tranco Limited.
10.34* -- Agreement for Purchase of Equipment, dated August 10,
2001, between the Registrant and Tranco Limited.
10.35* -- Technical Services and Licensing Agreement dated
August 10, 2001 between the Registrant and Tranco Limited.
</Table>
II-5
<Page>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
------ -------
10.36* -- Equipment Purchase Agreement, dated September 6, 2001,
between the Registrant and Shangdong Lu Neng Huang Tai
Industrial Group Limited.
10.37* -- Technical Services and Licensing Agreement, dated
September 6, 2001, between the Registrant and Shangdong Lu
Neng Huang Tai Industrial Group Limited.
10.38* -- Agreement of Transfer of Shares, dated September 6, 2001,
between the Registrant and Shangdong Lu Neng Huang Tai
Industrial Group Llimited.
10.39* -- Agreement of Transfer of Shares, dated September 6, 2001,
between the Registrant and Shangdong Lu Neng Huang Tai
Industrial Group Material Trading Company.
10.40* -- Agreement of Transfer of Shares, dated September 6, 2001,
between the Registrant and United Powers (USA).
10.41** -- Assignment Agreement dated October 24, 2001 between and
among Paul Amadeo, Jose Flores and the Registrant
regarding Integrated Computer-Aided Design (CAD) and
Robotic Systems for Rapid Prototyping and Manufacture of
Smart Cards
10.42** -- Assignment Agreement dated October 24, 2001 between Paul
Amadeo and the Registrant regarding Method and Apparatus
for Rapid Staking of Antennae in Smart Card Manufacture
10.43** -- Assignment Agreement dated July 20, 2001 between and
among Paul Amadeo, Timothy Norman and the Registrant
regarding Integration Welding and Testing in the
Manufacture of Smart Cards
10.44** -- Agreement for Purchase of Equipment dated April 10, 2002
between Shandong Huaguan Group General Company and the
Registrant
10.45** -- Agreement for Purchase of Equipment dated April 28, 2002
between Beijing Zhong Dun Security Technology Development
Company
10.46** -- Commercial Guaranty dated September 5, 2001 between Trans
Pacific National Bank and Eric Gravell
10.47** -- Commercial Guaranty dated September 5, 2001 between Trans
Pacific National Bank and Xiao Qin Jiang
10.48** -- Smart Card Marketplace, Alyxia T. Do, Frost & Sullivan
10.49** -- New Report Shows How Smart Cards Can Be Used to Improve
Privacy, Reduce Fraud, Increase Profits and Cut Costs,
Emma Newham, SJB Research
10.50** -- Agreement dated December 20, 2001 between Ross H. Mandell
and The Thornwater Company, L.P. terminating Consulting
Agreement dated January 29, 2001
10.51** -- Agreement Regarding Non-Involvement with The Thornwater
Company, L.P. dated January 29, 2002
10.52** -- Agreement Regarding Non-Involvement with the Rgistrant
dated February 11, 2002
10.53*** -- Subcontract Agreement between Ross H. Mandell and St.
James Holdings, LLC
10.54** -- Termination Agreement between Ross. H. Mandell and the
Registrant
23.1*** -- Consent of Ziegler, Ziegler & Altman LLP (to be included
in Exhibit 5.1)
23.2* -- Consent of BDO Seidman, LLP
23.3* -- Consent of Ross Mandell
23.4* -- Consent of Scott Ziegler
23.5* -- Consent of Paul Amadeo
23.6*** -- Consent of Francis Christian
23.7*** -- Consent of Jerry B. Collum
23.8** -- Consent of BDO Seidman, LLP
</Table>
II-6
<Page>
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
------ -------
23.8*** -- Consent of Paul Amadeo
</Table>
- ---------
* Previously filed.
** Filed herewith
*** To be filed by amendment.
II-7
<Page>
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.
(E) REQUEST FOR ACCELERATION OF EFFECTIVE DATE.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the 'Act') may be permitted to directors, officer and controlling
persons of the small business issuer pursuant to the foregoing provisions, or
otherwise, the small business issuer has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act, and is, therefore, unenforceable.
II-8
<Page>
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 15, 2002.
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.
<Table>
<Caption>
SIGNATURE NAME AND TITLE DATE
--------- -------------- ----
/s/ ALLEN YUE President and Director May 15, 2002
.........................................
ALLEN YUE
/s/ ERIC GRAVELL Executive Vice President and May 15, 2002
......................................... Director
ERIC GRAVELL
/s/ FILLIAN LEI Chief Financial Officer May 15, 2002
.........................................
FILLIAN LEI
</Table>
II-9
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as............................. 'TM'
The greater-than-or-equal-to sign shall be expressed as................ >=