-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VN9su1JUfIGDhOHQexI1ucxLWYoCkZxN8WptN5jIn9LpTloShzSNH1BXfxEQERaQ lqWd8TOKjxwCTqDnfvXdXg== 0000950117-02-001272.txt : 20020515 0000950117-02-001272.hdr.sgml : 20020515 20020515172009 ACCESSION NUMBER: 0000950117-02-001272 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 15 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHIPCARDS INC CENTRAL INDEX KEY: 0001140221 STANDARD INDUSTRIAL CLASSIFICATION: POWER, DISTRIBUTION & SPECIALTY TRANSFORMERS [3612] IRS NUMBER: 943191805 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-60896 FILM NUMBER: 02653823 BUSINESS ADDRESS: STREET 1: CITICORP CENTER STREET 2: ONE SANSONE STREET 19TH FLOOR CITY: SAN FRANCISCO STATE: CA ZIP: 94104 BUSINESS PHONE: 4159511078 SB-2/A 1 a29645.txt CHIPCARDS, INC. SB-2/A 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) ------------------- 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)
------------------- 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: 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
------------------- 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. ________________________________________________________________________________ CALCULATION OF REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- 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 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
(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. 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. -------------------
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
------------------- 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 TABLE OF CONTENTS
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
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 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 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 THE OFFERING 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.
- --------- (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 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.'
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
6 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 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 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 9 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 10 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 11 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. 12 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. 13 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 14 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: 15 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. 16 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. 17 USE OF PROCEEDS Our net proceeds from the sale of the units being offered in this offering at an assumed public offering price of $8.10 per unit are estimated to be $6,764,000, after deducting the 8% underwriting discount, the two and one-half percent non-accountable expense allowance payable to the underwriter, $120,000 payable to the underwriter for services under a consulting agreement, and an additional $365,500 in estimated offering expenses payable by us. This assumes that the underwriter's over allotment option is not exercised. If the underwriter's over allotment option is exercised in full, our net proceeds are estimated to be $7,851,425. We intend to use the net proceeds as described in the following table:
APPROXIMATE DOLLAR APPROXIMATE AMOUNT OF NET PROCEEDS PERCENTAGE ---------------------- ---------- Capital Equipment(1)............................... $2,750,000 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% ---------- ---- ---------- ----
- --------- (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. 18 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 19 common stock at the initial public offering price. The following table illustrates this dilution in net tangible book value to new investors: Initial public offering price per share of common stock..... $ 8.00 Net tangible book value per share before offering........... (0.09) 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 ------ ------
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.
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 ---------- ---- ---------- ---- ----- ---------- ---- ---------- ---- -----
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.
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 ----------- ----------- ----------- -----------
- --------- (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. 20 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. 21 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 22 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. 23 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 24 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 25 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. 26 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. 27 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. 28 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 29 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. 30 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 31 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 32 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 33 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. 34 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 35 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. 36 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 37 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; 38 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. 39 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. 40 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. 41 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. 42 MANAGEMENT The Directors, Executive Officers and significant employees of our company are as follows:
NAME AGE POSITION - ---- --- -------- Allen Yue(1).......................... 43 President, Director Eric Gravell(2)....................... 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*
- --------- (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 43 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 $70,000 per year and an incentive bonus equal to ten percent of the gross profits from any sales directly attributable to him. Each of the above employment agreements grants the employee a severance payment equal to base salary for a period of three months or, if shorter, the balance of the term, should the employee be terminated without cause. The employee is also entitled to three months of base salary in the event of his death or disability. 44 COMPENSATION OF DIRECTORS AND OFFICERS The following table sets forth the aggregate annual remuneration of our President and the four most highly paid executive officers other than the President who served as executive officers as of December 31, 2001: SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ----------------------------------------------- (A) (B) (C) (D) (E) - --- --- --- --- --- OTHER ANNUAL NAME & PRINCIPAL POSITION YEAR SALARY ($) 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)
- --------- (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.
NAME OF EMPLOYEE AMOUNT OF AWARD - ---------------- --------------- Fillian Lei................................................. 182,500 shares Timothy Norman.............................................. 182,500 shares Paul Amadeo................................................. 182,500 shares Jose Flores (engineer)...................................... 91,250 shares Mo Jia (head of Beijing office)............................. 182,500 shares
STOCK OPTIONS For the benefit of our employees, directors and consultants, we have adopted the Chipcards, Inc. 2000 Equity Incentive Plan. The plan provides for the issuance of options intended to qualify as incentive stock options for federal income tax purposes to our employees and non-employees, including employees who also serve as our directors. Qualification of the grant of options under the plan as incentive stock options for federal income tax purposes is not a condition of the grant and failure to so qualify does not affect the exercisability of the stock options. The number of shares of common stock authorized and reserved for issuance under the Plan is 2,500,000. 45 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. 46 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.
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%
- --------- (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. 47 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 48 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. 49 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. 50 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 51 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 52 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 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 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:
UNDERWRITER NUMBER OF UNITS ----------- --------------- The Thornwater Company, L.P................................. Dirks & Company, Inc........................................ Total................................................... 1,000,000 --------- ---------
This is a firm commitment underwriting. This means that the underwriters have agreed to purchase all of the units offered by this prospectus (other than those covered by the over-allotment option described below) if any units are purchased. Under the underwriting agreement, if an underwriter defaults in its commitment to purchase units, the commitments of non-defaulting underwriters may be increased or the underwriting agreement may be terminated, depending on the circumstances. The representative has advised us that the underwriters propose to offer the units directly to the public at the public offering price that appears on the cover page of this prospectus. In addition, the 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.
TOTAL WITHOUT TOTAL WITH FULL EXERCISE OF EXERCISE OF PER UNIT OVER-ALLOTMENT OPTION OVER-ALLOTMENT OPTION -------- --------------------- --------------------- $0.648....................................... $ $
We will pay all of the total expenses of the offering, which we estimate will be approximately $ ($ if the over-allotment is exercised). In addition, 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 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 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 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:
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 _______________________________________________________________________________ _______________________________________________________________________________ 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 _______________________________________________________________________________ _______________________________________________________________________________ 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 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: Registration Fees......................................... $ 5,197 NASD Listing Fee.......................................... 5,000 Boston Stock Exchange Listing Fee......................... 15,250 Printing and Engraving -- (estimated)..................... 50,000 Legal -- (estimated)...................................... 150,000 Accounting -- (estimated)................................. 250,000 Blue Sky fees and expenses -- (estimated)................. 25,000 Financial advisory fee.................................... 120,000 Miscellaneous Expenses -- (estimated)..................... 10,000 -------- Total................................................. $630,447 -------- --------
RECENT SALES OF UNREGISTERED SECURITIES Since inception, we have issued the following securities without registering such securities under the Securities Act:
TITLE AND AMOUNT PERSON OR CLASS TOTAL OFFERING PRICE OF DATE OF SECURITIES OF PERSONS TYPE OF CONSIDERATION ---- ------------- ---------- --------------------- 12/5/93.................... 500 shares of Eric Gravell $50 Common Stock 12/5/93.................... 500 shares of Alan Yue $50 Common Stock 10/1/99.................... 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 continued on next page) II-2 (table continued from previous page)
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
- --------- (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 INDEX TO EXHIBITS EXHIBITS FILED AS PART OF THIS REGISTRATION STATEMENT
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.
II-4
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.
II-5
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
II-6
EXHIBIT NUMBER EXHIBIT ------ ------- 23.8*** -- Consent of Paul Amadeo
- --------- * Previously filed. ** Filed herewith *** To be filed by amendment. II-7 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 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.
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
II-9 STATEMENT OF DIFFERENCES ------------------------ The trademark symbol shall be expressed as............................. 'TM' The greater-than-or-equal-to sign shall be expressed as................ >= EX-10 3 ex10-41.txt EXHIBIT 10.41 Attorneys' Docket No: 12543-005001 ASSIGNMENT For valuable consideration, we, PAUL AMADEO of San Diego, California, and JOSE FLORES of San Diego, California, hereby assign to American Pacific Technology, a California corporation having a place of business at 6827 Nancy Ridge Drive, San Diego, CA 92121; and its successors and assigns (collectively hereinafter called "the Assignee"), the entire right, title and interest throughout the world in the inventions and improvements which are subject of an application for United States Patent signed by us, entitled INTEGRATED COMPUTER-AIDED DESIGN (CAD) AND ROBOTIC SYSTEMS FOR RAPID PROTOTYPING AND MANUFACTURER OF SMART CARDS, filed October 12, 2001, and assigned U.S. Serial Number ____________, and we authorize and request the attorneys appointed in said application to hereafter complete this assignment by inserting above the filing date and serial number of said application when known; this assignment including said application, any and all United States and foreign patents, utility models, and design registrations granted for any of said inventions or improvements, and the right to claim priority based on the filing date of said application under the International Convention for the Protection of Industrial Property, the Patent Cooperation Treaty, the European Patent Convention, and all other treaties of like purposes; and we authorize the Assignee to apply in all countries in our name or in its own name for patents, utility models, design registrations and like rights of exclusion and for inventors' certificates for said inventions and improvements; and we agree for ourselves and our respective heirs, legal representatives and assigns, without further compensation to perform such lawful acts and to sign such further applications, assignments, Preliminary Statements and other lawful documents as the Assignee may reasonably request to effectuate fully this assignment. Date: 10/24/01 PAUL AMADEO ----------------------------- --------------------------------- PAUL AMADEO Date: 10/24/2001 JOSE FLORES ----------------------------- --------------------------------- JOSE FLORES EX-10 4 ex10-42.txt EXHIBIT 10.42 Attorney's Docket No. 12543-006001 ASSIGNMENT For valuable consideration, I, PAUL AMADEO of San Diego, California, hereby assign to American Pacific Technology, a California corporation having a place of business at 6827 Nancy Ridge Drive, San Diego, CA 92121; and its successors and assigns (collectively hereinafter called "the Assignee"), the entire right, title and interest throughout the world in the inventions and improvements which are subject of an application for United States Patent signed by us, entitled METHOD AND APPARATUS FOR RAPID STAKING OF ANTENNAE IN SMART CARD MANUFACTURE, filed October 12, 2001, and assigned U.S. Serial Number ____________, and I authorize and request the attorneys appointed in said application to hereafter complete this assignment by inserting above the filing date and serial number of said application when known; this assignment including said application, any and all United States and foreign patents, utility models, and design registrations granted for any of said inventions or improvements, and the right to claim priority based on the filing date of said application under the International Convention for the Protection of Industrial Property, the Patent Cooperation Treaty, the European Patent Convention, and all other treaties of like purposes; and I authorize the Assignee to apply in all countries in our name or in its own name for patents, utility models, design registrations and like rights of exclusion and for inventors' certificates for said inventions and improvements; and I agree for ourselves and our respective heirs, legal representatives and assigns, without further compensation to perform such lawful acts and to sign such further applications, assignments, Preliminary Statements and other lawful documents as the Assignee may reasonably request to effectuate fully this assignment. Date: 10/24/01 Paul Amadeo ----------------------------- ---------------------------------------- PAUL AMADEO EX-10 5 ex10-43.txt EXHIBIT 10.43 Attorney's Docket No.: 12543-000001 ASSIGNMENT For valuable consideration, we, PAUL AMADEO of San Diego, CA, TIMOTHY NORMAN of San Diego, CA, hereby assign to American Pacific Technology, a California corporation having a place of business at 6827 Nancy Ridge Drive, San Diego, CA 92121; and its successors and assigns (collectively hereinafter called "the Assignee"), the entire right, title and interest throughout the world in the inventions and improvements which are subject of an application for United States Patent signed by us, entitled INTEGRATION WELDING AND TESTING IN THE MANUFACTURING OF SMART CARDS, filed herewith, and assigned U.S. Serial Number (not yet assigned), and we authorize and request the attorneys appointed in said application to hereafter complete this assignment by inserting above the filing date and serial number of said application when known; this assignment including said application, any and all United States and foreign patents, utility models, and design registration granted for any of said inventions or improvements, and the right to claim priority based on the filing date of said application under the International Convention for the Protection of Industrial Property, the Patent Corporation Treaty, the European Patent Convention, and all other treaties of like purposes; and we authorize the Assignee to apply in all countries in our name or in its own name for-patents, utility models, design registrations and like rights of exclusion and for inventors' certificates for said inventions and improvements; and we agree for ourselves and our respective heirs, legal representatives and assigns, without further compensation to perform such lawful acts and to sign such further applications, assignments, Preliminary Statements and other lawful documents as the Assignee may reasonably request to effectuate fully this assignment. Date: 07/20/01 PAUL AMADEO ------------------------ --------------------------------- PAUL AMADEO Date: July 20th 2001 TIMOTHY NORMAN ------------------------ --------------------------------- TIMOTHY NORMAN EX-10 6 ex10-44.txt EXHIBIT 10.44 AGREEMENT FOR PURCHASE OF EQUIPMENT AMPAC-HG20010306 2001 1 AGREEMENT FOR PURCHASE OF EQUIPMENT CHAPTER I - GENERAL PRINCIPLES 1.1 The following contract is made by Shandong Huaguan Group General Company (hereinafter as Party A) and the American Pacific Aviation and Technology Corporation (hereinafter as Party B), based on the principle of mutual benefits and through negotiation, the purchase by Party A from Party B the production equipment of contactless smart cards. 1.2 It is agreed that Party B shall provide Party A with a full set, brand new, and state-of-art production equipment and complete production technology, technical information and all software for the production of contactless smart cards, to ensure the mechanically and electrically tested cards meeting the ISO/IEC7810, ISO/IEC10536, ISO/IEC14443 standards. 1.3 According to the laws and rules and regulations of the People's Republic of China and based on the principle of mutual benefits, the provisions of this agreement shall become effective and shall be executed at the same time with the "Agreement of Technical Services and Licensing". CHAPTER II - PARTIES 2.1 Party A: Shandong Huaguan Group General Company is a registered corporation in the People's Republic of China. Legal Address: 34 Wen Hua Road South Border, Lai Wu City, Shandong, People's Republic of China Telephone: (86) Fax: (86) Zip Code: 2.2. Party B: American Pacific Aviation and Technology Corp. Legal Address: One Sansome Street, 19th Street San Francisco, CA 94104, USA Telephone: (415) 951-1078 Fax: (415) 951-1046 2 CHAPTER III - NAME, SPECIFICATIONS, QUANTITY, PRICE AND DELIVERY OF EQUIPMENT 3.1 Party B shall provide Party A with a complete, brand new and state-of-art test equipment and accessories for the production of contactless smart cards. Said equipment shall be able to produce 750 pieces of smart cards per hour. The total cost of the equipment and the moulds -- including technical services, licensing and accessories -- shall be US$1,736,000 (One Million and Seven Hundred Thirty Six Thousand US Dollars), based on the CIF Airport price. 3.2 Before packaging said production test equipment for shipment, Party A shall send three technical staff to come to the United States to conduct preliminary inspection of the equipment. Party B shall pay for the expense of the two-way air tickets, and provide lodging and transportation in the United States for the staff of Party A. Staff of Party A will stay in the United States for two weeks. 3.3 Delivery date of equipment: Within four months upon Party A's remittance of the first deposit. CHAPTER IV - PAYMENT 4.1 Within 10 days upon effect of this contract, Party B shall provide a bank guarantee letter of 15% of the equipment total price, which is $260,400 (Two Hundred Sixty Thousand and Four Hundred US Dollars). Within three days upon receipt of the bank guarantee letter from Party B, Party A shall make payment to Party B in form of T/T. 4.2 A Letter of Credit of 85% of the total contractual price is issued on January 15, 2002, which is $1,475,600 (One Million Forty Hundred Seventy Five Thousand and Six Hundred US Dollars). 4.3 Upon approval of preliminary inspection by Party A in the United States, and upon receipt of the shipment slip and preliminary report by Party B after shipment, Party A shall pay Party B portion of the balance of the Letter of Credit, as specified in Provision 4.2, which shall be 75% of the total equipment price, that is, $1,302,000 (One Million Three Hundred and Two Thousand US Dollars). 4.4 Upon completion of installation and test run, Party A shall pay Party B the 3 balance of Letter of Credit, as specified in Provision 4.2, which shall be 10% of the total equipment price, that is, $173,600 (One Hundred Seventy Three Thousand and Six Hundred US Dollars). CHAPTER V - SPECIFICATIONS AND TECHNICAL CONDITIONS OF THE EQUIPMENT 5.1 The production line supplied by Party B must be brand new, complete and shall correspond to the specifications of Appendix I - "Details of Equipment, Moulds and Accessories". 5.2 The performance and quality of the equipment shall meet the following requirements: 5.2.1 Operation Capacity: Shall meet the specifications of the manual of the equipment 5.2.2 Production Capacity: 750 cards/hour 5.2.3 Product Specification: Shall meet the ISO standards 5.2.4 Product Quality: the strength and durability of the mechanically tested cards shall meet the ISO standards, and the electrically tested cards shall meet the IEC standards 5.3 The following accessorize shall be accompanied with the equipment delivered by Party B: 5.3.1 Special operation tools, maintenance and repair tools and testing tools (See Attachment 4) 5.3.2 Easily worn parts of equipment (the quantity shall be enough for one year normal consumption) (See Attachment 2) 5.3.3 Qualified raw materials to b used for the 106-hour test run production (during the test run period, fake chips will be used for five hours, and real chips will be used for another five hours. Products produced in real moulds during this period shall be the property of Party B). 5.4 The following documents shall be accompanied with the equipment delivered by Party B: 5.4.1 The quality approval certificate and the manual of the equipment 5.4.2 The packaging list of the equipment 5.4.3 Manuals of installation, testing, operation and maintenance 5.4.4 The quality assurance certificate and documentation, as specified in 4 Chapter VII 5.4.5 Drawings of easily worn parts and the list of accessories. 5.5 Upon effect of this contract, Party B shall, within forty days, mail a technical layout drawing and power supply information to Party A for the purpose of technical design 5.6 Party B shall, two months before the installation and test running of the equipment, send the following documents via air mail or dispatch staff to provide on-site guidance for Party A: 5.6.1 The installation diagram and the foundation diagram 5.6.2 The power parameters (including electrical power, compressed air, water and stream) of the equipment, and the technical information of power supply and special manufacturer requirements 5.7 The power utilization standards shall correspond to the power standards of the People's Republic of China, that is, 380+10 volts for the transformer, and 50+5% hertz for the frequency. CHAPTER VI - INSTALLATION, TROUBLE-SHOOTING, TEST RUNNING AND RECEIPT AND ACCEPTANCE 6.1 When conditions of Party A can accommodate, Party B shall be responsible for installing and test running the equipment, as well as training the staff for Party A, to ensure that successful installation and test running be completed within two weeks upon the arrival of the equipment in the shop. Party A shall provide technical staff, workers, tools, equipment, facilities and other needs to accomplish the job. 6.2 Test run and acceptance of the equipment shall meet the terms set in Provision 5.2. The result of which must be acknowledged by both Parties A and B before signing the "Acceptance Approval Certificate". 6.3 During test run period, if the approval rate of the products produced is lower than 97% (including repairable products), another test run shall be performed, which shall test run for another three working days -- materials for test run shall be provided by Party B -- until the products meet the acceptance standards. 5 6.4 Large volume of production shall only begin after receipt and acceptance of the equipment. 6.5 Party B shall assume the cost of its staff during their period of working in the factory. Party A shall provide food in the factory and transportation within the city. CHAPTER VII - QUALITY INSPECTION 7.1 Party B shall guarantee that the equipment is made of top materials, in top craftsmanship. The quality, specification and performance of the equipment shall meet the requirements specified in this contract. 7.2 Before delivery, Party B shall conduct a thorough and full inspection of the quality, specification and performance, as well as the quantity/weight of the equipment, and shall provide a certificate of inspection, along with the details and results of inspection confirming that the quality and quantity of the equipment meets the requirements of this contract. A quality and quantity inspection certificate shall be provided by Party B when the equipment is delivered to Party A. 7.3 Upon arrival of the equipment at the destination, Party A shall, in accordance to the laws and rules and regulations of the People's Republic of China, apply to have the equipment inspected by the Import and Export Inspection Bureau (hereinafter as Inspection Bureau). Parties A and B shall be both present at said inspection. Party A shall notify Party B thirty days in advance the inspection date and representative from Party B shall arrive at the inspection site on said inspection date. In the event Party B does not show up on time or does not send any representative to participate in the inspection, the Inspection Bureau shall continue the inspection as scheduled and Party A shall notify the result to Party B who shall acknowledge the result accordingly. 7.4 In the event that any quality or quantity error, or any missing part is found during the inspection that does not meet the requirements of this agreement, or any damage due to packaging, Party B shall within six weeks upon notice of said condition, make compensation, or shall make repairs at its own cost. In the event that any damage is caused by Party A, Party B shall replace the worn item as soon as possible, and the cost of replacement shall be assumed by Party A. 6 7.5 In the event the inspection finds any serious quality or quantity problem of the equipment, Party A shall have the right to return the equipment or request compensation based on the provisions of Chapter IX. 7.6 The warranty period of the equipment shall be 12 months, commencing the date when the equipment is received and accepted. During the warranty period Party B shall be responsible to repair or replace the equipment if the equipment is damaged or broken due its inherent problem. CHAPTER VIII - PACKAGING AND SHIPMENT 8.1 When packaging, Party B shall use a new and solid wood container with necessary measures taken to prevent moist, shock, rust and rough loading and unloading of the equipment to ensure that the package is suitable for long distance transportation. If the package material used is of the needle bush type, Party B shall provide proof that the material used has been fumigated. If the package material used is of the not the needle bush type, Party B shall provide description of the type of material used for the use of Party A during the Custom process. 8.2 Packaging and Delivery Marks Party B shall mark with paint at the four sides of the container such information as the number of the container, the size, weight, net weight, destination, receipt code, "face up", "handle with care", "no moist", "hoisting point" and "gravity point". 8.3 Shipment Information 8.3.1 When shipping, Party B shall fax Party A the following information: A. Date of Shipment, B. Port of Shipment, C. Port of Destination, and D. Number, Name, Quantity, Weight, Total Weight and Size of the Container. 8.3.2 Within five days after shipping, Party B shall send Party A via express mail the following information: A. Shipment Slip, with specification of the name and the quantity of the merchandize; 7 B. Packaging Slip: specifying the number, size, weight of the container, and the name, quantity, net weight of the merchandize, and the date of shipment; and C. Air bill of lading. D. The inspection certificate provided by the manufacturer, as specified under Chapter VII. E. Insurance policy. CHAPTER IX - COMPENSATION AND PENALTY 9.1 Within ten days upon arrival of the merchandize in the destination, in the event Party B finds that specifications, quantity and quality of the equipment do not match this contract, shall, by presenting the inspection certificate issued by the China Commercial Inspection Bureau, demand compensation from Party B. 9.2 Party A shall assume the actual cost of overtime for any delay of installation and test running of the equipment caused by Party A. 9.3 In the event Party B does not respond within 30 days upon compensation demand made by Party A, it shall be considered that Party B accept said claim. In the event Party B provides a timely objection, the matter shall be resolved by negotiations. In the event negotiations fail to settle the issue, any party shall have the right, according to Provision 11, request arbitration. 9.4 Except for force majeure as specified in Provision 10.1, in the event the Party B fails to deliver the merchandize on time according to the contract, Party A shall agree that Party B can postpone its delivery provided that Party B shall pay a penalty of 0.5% of the total cost for every delayed week but this penalty shall not exceed 5% of the total cost. In the event the delay of delivery exceeds ten weeks, Party A shall have the right to terminate the contract. 9.5 Without written agreement of Party B, Party A cannot transfer the related patent technology of the equipment to any third party, nor Party A can duplicate the equipment of Party B at its discreet. In the event Party B by its discreet allows any third party to use said technology, Party A shall pay a default sum of US$600,000 to Party B. In the event Party A at its discreet duplicates the technology of Party B, Party A shall pay a default sum of US$600,000 to Party B. Despite payment of the default sum, Party B shall reserve the right to pursue 8 claim against the third party and against Party A for infringement. CHAPTER X - FORCE MAJEURE 10.1 During the time of manufacturing or in the process of shipping, in the event of war, fire, flood, typhoon, earthquake or other force majeure acknowledged by both parties that causes Party B fail or delay to execute the provisions of this contract as schedule, Party B shall assume no liability. In the event of force majeure, Party B shall notify Party A immediately and shall within two weeks, send a government endorsed certificate to Party A via air mail. 10.2 Upon removal of force majeure, both parties shall negotiate whether the contract be continued. CHAPTER XI - ARBITRATION 11.1 In the event of any dispute arises during the execution of this agreement or is related to this agreement, both parties shall try to resolve the issue through friendly negotiation. In the event negotiations fail, said dispute shall be brought to the China International Economic and Trade Arbitration Committee, for arbitration in Beijing, according to the arbitration process set by said Committee. 11.2 The decision of the Arbitration Committee shall be final and shall have binding effect upon both parties. Arbitration fee shall be paid by the losing party. 11.3 During the period of arbitration, other non-disputed provisions of the contract shall be continued to execute. CHAPTER XII - GOVERNING LAWS AND VALIDATY 12.1 When executing this agreement, both Parties A and B shall comply with the laws and rules and regulations of the People's Republic of China. 12.2 This agreement shall become effective upon the date signed. 12.3 After this agreement becomes effective, both Parties A and B shall, if needed, negotiate revisions to accommodate the practicalities of executing this agreement. These revisions shall become effective when both parties sign the amendment. 9 Neither party can amend the agreement individually. CHAPTER XIII - DOCUMENTS 13.1 Interpretation of this agreement shall be based by the Chinese original. 13.2 This agreement is signed December 26, 2001. 13.3 This agreement contains four original copies. PARTY A: Shandong Huaguan Group General Company Company Representative: (Signature) PARTY B: The American Pacific Aviation and Technology Corporation Company Representative: (Signature) 10 TECHNICAL SERVICES AND LICENSING AGREEMENT This agreement is made between the Shandong Huaguan Group General Company, (hereinafter as Party A), of China, and the American Pacific Aviation and Technology Corporation (hereinafter as Party B), based on the principle of mutual benefits and through friendly negotiations, for the provision of technical services and patent technology (exclusive technology) by Party B to Party A for the production of contactless smart cards. 1. Party B shall provide Party A with the full set of technology (including technical process, operation rules, maintenance rules, inspecting and testing rules, and all drawings, information, software or patent technology) for the production of contactless smart cards and shall guarantee that the production equipment and products produced meet the requirements of the "Agreement for Purchase of Equipment". 2. The patent technology and exclusive technology provided by Party B to be used by Party A inside the People's Republic of China, in a non-exclusive manner, shall not involve any industrial property rights of any other countries or companies and Party A shall be legally protected that it has the legal right of utilization. 3. Without written permission of Party B, Party A shall not transfer the patent technology or exclusive technology to any third party, nor shall Party A duplicate the equipment provided by Party B. Without the permission of Party B, Party A shall not allow business or technical personnel of other party to look at the production line, nor shall Party A provide any technical information to any other party. Without consent of Party A, Party B shall not allow any personnel from any third party to visit the work site and study the production line. 4. Party B shall be responsible for providing all technical services of installation, trouble shooting, test running, receipt and acceptance and shall solve all the technical problems before receipt and acceptance to ensure that the equipment will be able produce 750 cards/hour. Party A shall provide lodging, food and transportation for technical staff from Party B and shall delegate special staff to coordinate the project to ensure that installation, trouble shooting and test running go through smoothly. Travel expenses for experts from Party B shall be paid by Party B. 11 5. Party B shall train the staff of Party A for a period of two weeks. Party A shall select qualified staff to receive training. In the event that members from Party A not fully master the production technology after the training period, said period can be extended to three or four weeks, the cost of such extension shall be assumed by Party A. 6. Party B shall cover the full cost of providing the complete technology (including the cost of providing technical details, operation rules, maintenance rules, inspection and testing rules, administration system, drawings and information and software and the compensation and travel expenses of experts from Party B sent to China) and the cost of patent technology and exclusive technology licensing, and staff training. All these costs are included in the equipment purchase cost paid by Party A and Party A shall pay no additional fee. In addition, at least half a year before the actual production starts, Party B shall send one to three technical staff to work at Party A's site to provide on-site production assistance and technical support. Cost of which shall be assumed by Party B. 7. This agreement, along with the "Agreement for Purchase of Equipment" and "Agreement for Purchase of Raw Materials and Sales of Products", shall become effective at the same time. 8. Default Both parties shall execute the provisions of the agreement sincerely. In the event any party fails to execute any of the above provisions, which causes the economic loss of the other party, the defaulting party shall compensate the loss. Claims and penalties shall be executed according to provisions of Chapter IX of the "Agreement for Purchase of Equipment". 9. Settlement of Dispute Any dispute over the agreement by Parties A and B shall be settled through friendly negotiation. In the event negotiation fails to settle the dispute, it shall be arbitrated by the China International Economic and Trade Arbitration Committee. Fee for arbitration shall be paid by the losing party. 10. This agreement shall become effective on the date when it is signed. 11. This agreement contains four original copies, with each party holding two copies 12 each. All copies bear equal validity. PARTY A: Shandong Huaguan Group General Company Representative of Company: (Signature) PARTY B: American Pacific Aviation and Technology Corporation Representative of Company: (Signature) 13 APPENDIX: EQUIPMENT, MOULDS AND ACCESSORIES
- ---------------------------------------------------------------------------------------------------- NO. QTY DESCRIPTION PART NUMBER - ---------------------------------------------------------------------------------------------------- 1 1 Pick/Place CICC-18 - ---------------------------------------------------------------------------------------------------- 2 1 Wire Embedder (2 heads) CICC-13 - ---------------------------------------------------------------------------------------------------- 3 1 Welder CICC-20 - ---------------------------------------------------------------------------------------------------- 4 1 Laminator CICC-9 - ---------------------------------------------------------------------------------------------------- 5 1 Pulling Power Test Machine - ---------------------------------------------------------------------------------------------------- 6 1 Temperature Test Machine - ---------------------------------------------------------------------------------------------------- 7 1 Card Testing Machine - ---------------------------------------------------------------------------------------------------- 8 1 Chip Testing Machine - ----------------------------------------------------------------------------------------------------
14 SUPPLEMENTARY AGREEMENT Shandong Huaguan Group General Company (hereinafter as Party A) and American Pacific Aviation and Technology Corporation (hereinafter as Party B), have revised the agreement for the purchase of the second contactless IC smart card production line by Party A from Party B in Beijing on April 20, 2002, the terms and conditions of which are as follow: 1. The two-head ultrasound wire embedder of the production line, as specified in the contract, be changed to a four-head ultrasound wire embedder. A Bonding Re-Work Station shall also be included. The total amount of which is US$364,000. 2. The contract, in the amount of US$1,736,000, signed on December 26, 2001, remains the same and shall be executed according to the original terms and conditions. As for the additional US$364,000, Party A shall expedite its process of bidding and mechanical and electric review in China, and upon completion of said process, shall make payment according to the contract. 3. This agreement and the former purchase agreement both are legally valid, with each party holding one copy. Matters not completed shall be resolved by negotiations. Representative of Party A: Wang Shi-fan Signature: Date: Representative of Party B: Yue Hao Signature: Date: April 10, 2002 15 EX-10 7 ex10-45.txt EXHIBIT 10.45 AGREEMENT FOR PURCHASE OF EQUIPMENT Number: 2002BZD (2)-012 2002 April 2002 1 AGREEMENT FOR PURCHASE OF EQUIPMENT CHAPTER I - GENERAL PRINCIPLES 1.1 This contract is made between the Beijing Zhong Dun Security Technology Development Company, on behalf of the Ministry of Security No. 1 Research Institute (hereinafter referred as Party A) and the American Pacific Technology Company (hereinafter referred as Party B), based on the principle of mutual benefit and through friendly negotiations, to purchase from Party B by Party A the equipment for the production of the contactless smart cards. 1.2 It is agreed that Party B shall provide four full sets, brand new, and state-of-art production line and the complete production technology, technical information and software for the production of contactless smart cards, which shall ensure that the strength and durability of the mechanically tested cards produced by Party A meet the standards of ISO/IEC7810, ISO/IEC10536, and ISO/IEC14443. 1.3 This contract is prepared in accordance to the pertinent laws and rules and regulations of China, and based on the principles of mutual benefits. CHAPTER II - PARTIES 2.1 Party A: The Beijing Zhong Dun Security Technology Development Company (The Ministry of Security No. 1 Research Institute) Legal Address: 1 Shou Ti Road South, Haiding District, Beijing, People's Republic of China Telephone: (86) 10-88513404 Fax: (86) 10-68428709 Zip Code: 100044 2.2. Party B: American Pacific Technology Corp. Legal Address: Sansome Street, 19th Street San Francisco, CA 94104, USA Telephone: (415) 951-1078 Fax: (415) 951-1046 CHAPTER III - NAME, SPECIFICATIONS, QUANTITY, PRICE AND DELIVERY OF EQUIPMENT 2 3.1 Party B shall provide Party A with four complete sets of brand new and state-of-art production equipment and accessories (see Appendix I - "Equipment Functions and Technical Specifications") for the production of contactless smart cards. Said production equipment shall be able to produce 2500 pieces of smart cards per hour. The total cost of the equipment shall be US$6,000,000 (Six Million Dollars), based on the CIF Beijing Airport cost, which shall include the equipment, moulds, accessories, installation test-run, and equipment maintenance. 3.2 Before packaging said production line for shipment, Party A shall send four technical staff to come to the United States to conduct preliminary inspection of the equipment. See Appendix V, "Equipment Acceptance Details" for preliminary inspection standards. Party B shall pay for the expense of the two-way air tickets, and provide lodging and transportation in the United States for the visiting staff of Party A. Staff of Party A will stay in the United States for two weeks. 3.3 Delivery Date of the Equipment: The equipment shall be delivered in two phases: the delivery date of each phase shall be within 4-1/2 months upon receipt of deposit from or issuance of Letter of Credit by Party A. CHAPTER IV - PAYMENT 4.1 As payment shall be made by two installments, the first payment shall be made upon delivery of two production lines in the first phase, the amount of which shall be 50% of the contract's total; and the second payment shall be made upon delivery of the other two production lines in the second phase, the amount of which shall be 50% of the contract's total. 4.2 Within 15 days upon effect of this contract, when phase 1 is executed, Party A shall issue Party B a Letter of Credit, which is 50% of the total contract amount, that is, US$3,000,000 (Three Million US Dollars). 4.3 Upon approval of preliminary inspection made by Party A in the United States and shipment of the equipment, Party A shall, based on the shipment slip and preliminary inspection report, pay portion 3 of the amount of the Letter of Credit specified in 4.2, that is, 90% of the total amount of the Letter of Credit, which is $2,700,000 (Two Million and Seven Hundred Thousand US Dollars). 4.4 Upon completion of installation, test-run and acceptance that the performance of the equipment meets the standards of "Appendix V - Equipment Acceptance Details), and upon signing of the "Receipt and Acceptance Certificate" by both parties, Party A shall pay Party B the balance of the Letter of Credit specified in 4.1, that is, 10% of the Letter of Credit amount, which is $300,000 (Three Hundred Thousand US Dollars). 4.5 Upon delivery of the first phase equipment, Party A shall issue Party B a Letter of Credit, which shall be 50% of the total contract amount, that is, US$3,000,000 (Three Million US Dollars). 4.6 Upon approval of preliminary inspection made by Party A in the United States and shipment of the equipment, Party A shall, based on the shipment slip and preliminary inspection report, pay portion of the amount of the Letter of Credit specified in 4.5, that is, 90% of the total amount of the Letter of Credit, which is $2,700,000 (Two Million and Seven Hundred Thousand US Dollars). 4.7 Upon completion of installation, test-run and acceptance that the performance of the equipment meets the standards of "Appendix V - Equipment Acceptance Details), and upon signing of the "Receipt and Acceptance Certificate" by both parties, Party A shall pay Party B the balance of the Letter of Credit specified in 4.1, that is, 10% of the Letter of Credit amount, which is $300,000 (Three Hundred Thousand US Dollars). CHAPTER V - SPECIFICATIONS AND TECHNICAL CONDITIONS OF THE EQUIPMENT 5.1 The production line supplied by Party B must be brand new, complete and shall correspond to the specifications of Appendix I - "Equipment Functions and Technical Specifications". 5.2 The performance and quality of the equipment shall meet the following requirements: 4 5.2.1 The operation capacity of the equipment shall meet the specifications of the manual of the equipment 5.2.2 The production capacity of the equipment: 2500 pieces/hour 5.2.3 Product Specification: 4 coil antenna, ISO7810 standard ID1_1 size (thickness excluded) Product Acceptance Rate: Single set equipment, one time acceptance rate >=98%. 5.2.4 Product Quality: the strength and durability of the cards, when mechanically and electronically tested, shall meet the ISO/IEC7810, ISO/IEC10536, ISO/IEC14443 and standards specified by Party A in Appendix V (Equipment Acceptance Details) of the contract. 5.3 Party B shall deliver the following supplements along with the equipment: 5.3.1 Special operation tools, maintenance and repair tools and testing tools (See Appendix IV) 5.3.2 Wearing parts of equipment (enough for one year normal consumption) (See Appendix II) 5.3.3 For test run purpose, provision of 16 hour consumption of fake chips, and 8 hours consumption of real chips. 5.4 Party B shall deliver the following technical documents when packaging and shipping the equipment: 5.4.1 The quality approval certificate and the manual of the equipment 5.4.2 The packaging list of the equipment 5.4.3 Manuals of installation, testing, operation and maintenance 5.4.4 The quality assurance certificate and documentation, as specified in Chapter VII 5.4.5 Drawings of wearing parts and the list of accessories. 5.5 Upon effect of the contract, Party B shall, within 10 working days, mail a technical layout drawing and power supply information to Party A for technical design purpose. 5.6 Party B shall, two months before the installation and test running of the equipment, mail the following documents to Party A or have staff work at Party A's place to provide instructions: 5.6.1 The installation diagram and the foundation diagram 5.6.2 The power parameters (including power, compressed air, water and stream) of the equipment, and the technical information of power 5 supply and special shop requirements 5.7 The power utilization standards shall correspond to those of the People's Republic of China, that is, 380+-10 volts for the transformer, and 50+-5% hertz for the frequency. CHAPTER VI - INSTALLATION, TROUBLE-SHOOTING, TEST RUNNING AND RECEIPT AND ACCEPTANCE 6.1 Party B shall be responsible for installing and trouble-shooting the equipment, and training the staff of Party A, ensuring that the installation and trouble shooting of the equipment be completed within two weeks after the arrival of the equipment in the shop. Party A shall provide the necessary technical staff, workers and other necessities to accommodate the project. 6.2 Methods and Procedures of Final Acceptance of the Equipment (See Appendix V - Equipment Acceptance Details) 6.3 The test run period shall be three working days, at eight hours per day. The purpose of the test run is to inspect the production equipment, and to examine whether the products produced meet the requirements specified in Provision 5.2. After approval of test results by Parties A and B, the receipt and acceptance certificate shall be signed. 6.4 During the test run period, if the acceptance rate of the product falls under the level of 98%, a second testing shall be made to test the equipment for another three working days, the cost of the materials for test run shall be assumed by Party B. If the acceptance rate is still under 98%, a maximum of another three working days can be extended. If it still fails to meet the demand, Party A shall have the right to request replacement and compensation. 6.5 Large volume of production shall not begin until receipt and acceptance is completed. 6.6 Party B shall assume the cost of its staff during their period of working in the factory. Party A shall provide food by the factory and transportation within the city. 6 CHAPTER VII - QUALITY INSPECTION 7.1 Party B shall guarantee that the equipment is made by top craftsmanship and of top materials. The quality, specification and performance of the equipment shall meet the requirements specified in this contract. 7.2 Before delivery, Party B shall conduct a thorough and full inspection of the quality, specification and performance, as well as the quantity/weight of the equipment, and shall provide a certificate of inspection, along with the details and results of the inspection confirming that the quality and quantity of the equipment meets the requirements of this contract. A quality and quantity inspection certificate shall be provided by Party B when the equipment is delivered to Party A. 7.3 Upon arrival of the equipment at the destination, Party A shall, in accordance to the laws and rules and regulations of the People's Republic of China, request that the Import and Export Inspection Bureau (hereinafter as Inspection Bureau) to conduct an inspection. Parties A and B shall both be present at said inspection. Party A shall notify Party B ten days in advance about the inspection date and representative from Party B shall arrive at the inspection site of A on said inspection date. In the event Party B fails to show up on time or fails to send any representative to participate in the inspection, the Inspection Bureau shall continue inspection as scheduled and the result of which shall be notified by Party A to Party B and Party B shall acknowledge the result accordingly. 7.4 In the event the inspection finds any quality or quantity error, or any missing part that does not meet the requirements of this agreement, or any damage due to packaging, Party B shall within six weeks make compensation, or shall make repairs at its own cost. In the event that any damage is caused by Party A, Party B shall replace the damaged item as soon as possible, and the cost of replacement shall be paid by Party A. 7.5 In the event the inspection finds any serious quality or quantity problem of the equipment, Party A shall have the right to return the equipment or request compensation based on the provisions of Chapter IX. 7.6 The warranty period of the equipment shall be 12 months, commencing the date when the equipment is received and accepted. During the warranty period Party 7 B shall be responsible for repairing the equipment if the damage of the equipment is caused by the defects of the equipment. CHAPTER VIII - PACKAGING AND SHIPMENT 8.1 When packaging, Party B shall use a new and solid wood container with necessary measures taken to prevent moist, shock, rust and rough loading and unloading of the equipment to ensure that the package is suitable for long distance transportation. If the package material used is of the conifruticeta type, Party B shall provide proof that the material used has been fumigated. If the package material used is of the non-conifruticeta type, Party B shall provide description of the type of material used which will be used by Party A during the Custom process. 8.2 Packaging and Delivery Marks Party B shall mark with non-erasable paint at the four sides of the container such information as the number of the container, the size, gross weight, net weight, destination, receipt code, "face up", "handle with care", "no moist", "hoisting point" and "gravity point". 8.3 Shipment Information 8.3.1 Within two days after shipping, Party B shall fax Party A the following information: A. Date of Shipment, B. Port of Shipment, C. Port of Destination, D. Number, Name, Quantity, Weight, Total Weight and Size of the Container. 8.3.2 Within two days after shipping, Party B shall send the following information to Party A via express mail: A. Invoice, with specification of the name and the quantity of the merchandise; B. Packaging Slip which specifies the number, size, weight of the container, and the name, quantity, net weight of the merchandise, and the date of shipment; C. Airway bill. D. The inspection certificate provided by the manufacturer, as 8 specified in Chapter VII. E. Insurance Policy F. Certification of original place of manufacture. CHAPTER IX - COMPENSATION AND PENALTY 9.1 In the event Party A, within 90 days upon the arrival of the equipment at the destination port, finds any disagreement of the specifications, quality and quantity of the equipment as specified in this contract, Party A shall, by presenting the inspection certificate of the Inspection Bureau, request compensation from Party B. 9.2 Party A shall assume the actual cost of overtime for any delay of installation and testing of the equipment caused by Party A. 9.3 In the event Party B fails to respond within 30 days after Party A makes its claim for compensation, it shall be considered that Party B accept the claim. In the event Party B presents a timely written dispute, both parties shall try to settle the dispute by negotiation. In the event the negotiation fails to settle the dispute, either party shall have the right, according to Article XI, request for arbitration. 9.4 Except for force majeure as specified in Provision 10.1, in the event the seller fails to deliver the merchandise on time according to the contract, Party A shall agree that Party B postpone delivery provided that Party B shall pay a penalty at 0.5% of the total cost for every delayed week but this penalty shall not exceed 5% of the total cost. In the event the delay of delivery exceeds ten weeks of the scheduled date, Party A shall have the right to terminate the contract and Party B shall still pay for the penalty for the actual delayed days. 9.5 Without written agreement of Party B, Party A cannot transfer the patent technology and licensing to any third party, nor Party A can duplicate the equipment of Party B. In the event Party A allows any third party to use said technology at its discretion, Party A shall pay Party B an amount of US$600,000 for violation of the contract. In the event Party A duplicates the technology of Party B, it shall pay Party B an amount of US$600,000 for defaulting the contract. Payment of this amount does not waive the right of Party B to prosecute against any third party or Party A for violation of rights. 9 CHAPTER X - FORCE MAJEURE 10.1 During the time of manufacturing or in the process of shipping, in the event of war, fire, flood, typhoon, earthquake or other force majeure acknowledged by both parties that causes Party B fail or delay to execute the provisions of this contract as schedule, Party B shall assume no liability. In the event of force majeure, Party B shall notify Party A immediately and shall within two weeks, send, via air mail, a government issued certificate to Party A confirming said force majeure. 10.2 When the force majeure vanishes, both parties shall negotiate whether to continue executing the contract. CHAPTER XI - ARBITRATION 11.1 In the event there arises any dispute during the execution of this agreement or over this agreement and when both sides fail to settle the dispute by friendly negotiation, said dispute shall be brought for arbitration. The dispute shall be heard by the China International Economic and Foreign Trade Arbitration Committee, in Beijing, according to the procedures set by said committee. 11.2 The decision of the Arbitration Committee shall be final and shall have binding effect upon both parties. Arbitration fee shall be paid by the losing party. 11.3 During the period of arbitration, both parties shall continue to execute other non-disputed terms of the contract. CHAPTER XII - GOVERNING LAWS AND VALIDATY 12.1 When executing this agreement, both Parties A and B shall comply with the laws and rules and regulations of the People's Republic of China. 12.2 This agreement shall become effective upon the issuance of Letter of Credit. 12.3 After this agreement becomes effective, both Parties A and B shall, if needed, discuss revisions to accommodate the practicalities of executing this agreement. These revisions shall become effective when signed by both parties. Neither party can amend the agreement on its own. 10 CHAPTER XIII - DOCUMENTS 13.1 This agreement includes four original copies, signed in Beijing, on April 28, 2002. PARTY A: Bejing Zhong Dun Security Technology Development Company (The Ministry of Security No. 1 Research Institute) Company Representative: Signature: (signature) 4/28/2002 PARTY B: The American Pacific Technology Corporation Company Representative: Signature: (signature) 4/28/2002 11 TECHNICAL SERVICES AND LICENSING AGREEMENT Technical Services and Licensing Agreement This agreement is made by the Beijing Zhong Dun Technology Development Company, on behalf of the Ministry of Security No. 1 Research Institute (hereinafter referred as Party A) and the American Pacific Technology Corporation (hereinafter referred as Party B), based on the principle of mutual benefits and through friendly negotiations, for the provision of technical services and licensing (patent technology) by Party B to Party A for the production of contactless smart cards. 1. Party B shall provide the full set of technology (including technical process, operation rules, maintenance rules, inspecting and testing rules, administration system and all drawings, information, software or patent technology) for the production of contactless smart cards and shall guarantee that the production equipment and products produced by Party A meet the requirements of the "Agreement for Purchase of Equipment". 2. The patent technology and exclusive technology provided by Party B to Party A shall not involve any industrial property right of other countries or companies and Party A shall be legally protected that it has the legal right of utilization. 3. Without written permission of Party B, Party A shall not transfer the patent technology or exclusive technology to any third party, nor Party A shall duplicate the equipment provided by Party B. Without the permission of Party B, Party A shall not allow business or technical personnel of other party to examine the production line or give any technical information from Party B to any third party. 4. Party B shall be responsible for providing all technical services of installation, trouble shooting, test running, receipt and acceptance, and shall solve all technical problems before receipt and acceptance to guarantee that the equipment will produce 2500 pieces/hour. Party A shall provide lodging and food for technical experts of Party B and shall assign special staff to coordinate the project to ensure that installation, trouble shooting and test running go through smoothly. The period for installation and test running the equipment shall be two weeks. The travel expenses of experts from Party B shall be assumed by Party B. 5. Party B shall train the staff of Party A for a period of two weeks. Party A shall 12 select qualified staff to receive training. In the event that members from Party A fail to master the production technology during the training period, said period can be extended to three or four weeks, the cost of such extension shall be assumed by Party A. 6. Party B shall cover the cost of providing the complete technology (including the cost of providing technical details, operation rules, maintenance rules, inspection and testing rules, administration system, drawings and information and software and the compensation and travel expenses of experts from Party B coming to China) and the cost of patent technology and exclusive technology licensing, and staff training. All these costs are included in the equipment purchase cost paid by Party A. With the exception of the equipment purchase cost, Party A shall pay no additional fee. In addition, at least in the first half year after the actual production starts, Party B shall send one to three technical staff to stay in Party A's site to help Party A produce and to provide technical support. The cost of which shall be assumed by Party B. 7. Default Both parties shall execute the provisions of the agreement sincerely. In the event any party fails to execute any of the above provisions that causes the economic loss of other party, the defaulting party shall compensate the loss. Claims and penalties shall be executed according to Chapter IX of the "Agreement for Purchase of Equipment". 8. Settlement of Dispute Any dispute over the agreement by Parties A and B shall be settled through friendly negotiation. In the event negotiation fails to settle the dispute, it shall be arbitrated by the China Economic and Foreign Trade Arbitration Committee in Beijing. Fee for arbitration shall be paid by the losing party. 9. This agreement shall become effective on the date signed by both parties. 10. This agreement contains four original copies. PARTY A: Being Zhong Dun Security Technology Development Company (The Ministry of Security No. 1 Research Institute) 13 Company Representative: Signature: (signature) PARTY B: The American Pacific Technology Corporation Company Representative: Signature: (signature) 14 APPENDIX 1 EQUIPMENT FUNCTION & TECHNICAL SPECIFICATIONS 15 Checklist of Equipment
------------------------------------------------------------------------------------------------- Production Equipment Serial Model Price No. Qty. Equipment No. (in US$10,000) ------------------------------------------------------------------------------------ 1 4 Hole Punch Machine CICC-001 4 ------------------------------------------------------------------------------------ 2 8 Pick & Place With Module Testing CICC-002 92 ------------------------------------------------------------------------------------ 3 8 Ultrasonic Wire Implanting (4) CICC-003 320 ------------------------------------------------------------------------------------ 4 8 Welding with Inline Testing CICC-004 180 ------------------------------------------------------------------------------------ 5 4 Bonding Re-work Station CICC-005 4 ------------------------------------------------------------------------------------------------- Total: US$6,000,000
16 IC HOLE PUNCH MACHINE 1. FUNCTION: Working with varied moulds, able to hole punch the 0.1mm-0.5mm PC, PET, PETG and PVC films into varied location holes and module holes based on varied specifications, to be used for follow-up process. With automatic protection device that will automatically stop during exceptional cases. Also included is the remnant collection system for easy machine cleaning, in avoidance of polluting the surrounding environment. 2. SYSTEM SET: Three high precision moulds (to hole punch 0.1mm, 0.3mm materials and location holes respectively), safety protection device, remnant collection system, hole punch time controller. 3. MATERIAL SPECIFICATIONS: Length x Width: 512 x 402 mm Thickness of Material: 0.1-0.5mm 4. PRODUCTION CAPACITY: 3,200 cards/hour 5. SYSTEM PARAMETERS: - -------------------------------------------------------------------------------- Hole punch pressure 30 tons - -------------------------------------------------------------------------------- Punching process 227-90 mm - -------------------------------------------------------------------------------- Punching Mould Foundation 910 x 660 mm - -------------------------------------------------------------------------------- Effective punching and area 4 x 10 rows of ID-I cards - -------------------------------------------------------------------------------- Punching precision +0.02 mm - -------------------------------------------------------------------------------- Power Supply 3 phase 380VAC+-5% - -------------------------------------------------------------------------------- Maximum Electric Current 40 Amp - -------------------------------------------------------------------------------- Power 3KVAz - -------------------------------------------------------------------------------- Frequency 50/60H - -------------------------------------------------------------------------------- Electrical Machinery 5Hp - -------------------------------------------------------------------------------- Hydraulic Pressure Oil Capacity 90 Liter - -------------------------------------------------------------------------------- Condensed Air Pressure 6bar - -------------------------------------------------------------------------------- Condensed Air Flow 25NL/min - -------------------------------------------------------------------------------- Condensed Air Conditions 5 micron filter, dry, oil free - --------------------------------------------------------------------------------
17 IC PICK AND PLACE 1. FUNCTION: Pick and place the moulds into corresponding holes of the PVC, PC, PET and PETG films. The placement position can be adjusted and fixed by adhesives. The advanced vision system allows the module be placed precisely in the assigned position. With automatic protection device that can automatically turn off the machine in exceptional cases. 2. SYSTEM SET: Chip punched moulds, thru-beam chip recognition sensor, high precision gluing system with improved back-pressure regulator, Adept Cartesian robot, Pentium 4 computer, LCD Monitor, articulated shuttle, vision system, automated punch cleaning system, improved vacuum generation, dual-discrete placement heads, interchangeable drawer, safety protection device. 3. MATERIAL SPECIFICATIONS: Length x Width: (512-600) x (400-402) mm Thickness of Material: 0.3 - 0.5 mm 4. CONSUMPTION MATERIALS: Glue: 2,500 cards/tube 5. PRODUCTION CAPACITY: 1,250 cards/hour/set (based on three rows of the module tapes). 6. SYSTEM PARAMETERS: - -------------------------------------------------------------------------------- Width 1800 mm - -------------------------------------------------------------------------------- Thickness 1100 mm - -------------------------------------------------------------------------------- Height 2000 mm - -------------------------------------------------------------------------------- Weight 400 kg - -------------------------------------------------------------------------------- Placement Area 4 x 10 rows of ID-I cards - -------------------------------------------------------------------------------- Placement Precision 0.1 mm - -------------------------------------------------------------------------------- Power Supply 3 phase 380VAC+-5% - -------------------------------------------------------------------------------- Maximum Electric Current 25 Amp - -------------------------------------------------------------------------------- Power 1.2 KVA - -------------------------------------------------------------------------------- Frequency 50/60 Hz - -------------------------------------------------------------------------------- Condensed Air Pressure 6bar - -------------------------------------------------------------------------------- Condensed Air Flow 100NL/min - -------------------------------------------------------------------------------- Condensed Air Conditions 5 micron filter, dry, oil free - --------------------------------------------------------------------------------
18 IC WIRE IMPLANTING MACHINE 1. FUNCTIONS: Said machine uses the 70,000 vibration/second and X, Y, Z three directional movement second generation ultrasound wire implanting head to implant the enamel-insulated wire accurately into the PC, adhesive coated PET, PETG and PVC material and coil into a wire coil The position, size, shape, and the circles of coil can be set up by the computer. With automatic protection device that can automatically turn off the machine in exceptional cases. 2. SYSTEM SET: Second generation ultrasound wire implant head (with four improved implanting heads in each station, which, when compared with the current equipment, the function remains the same, but the size becomes smaller), Adept Cartesian robot, Pentium 4 computer, integrated PC controlled ultrasonic power supplies, improved vacuum generation, LCD monitor, interchangeable drawer, safety protection device. 3. MATERIAL SPECIFICATIONS: Length x Width: (512-600) x (400-402) mm Thickness of Material: 0.1-0.5 mm 4. PRODUCTION CAPACITY: 1,250 cards/hour/workcell. 5. CONSUMPTION MATERIALS: Ultrasound head: 670,000 cards/head Wire: 6,250 cards/spool 6. SYSTEM PARAEMTERS: - -------------------------------------------------------------------------------- Width 1700 mm - -------------------------------------------------------------------------------- Thickness 1100 mm - -------------------------------------------------------------------------------- Height 2000 mm - -------------------------------------------------------------------------------- Weight 350 kg - -------------------------------------------------------------------------------- Implanting Area 4 x 10 rows of ID-I cards - -------------------------------------------------------------------------------- Power Supply 3 phase 380VAC+-5% - -------------------------------------------------------------------------------- Maximum Electric Current 20 Amp - -------------------------------------------------------------------------------- Power 1 KVA - -------------------------------------------------------------------------------- Frequency 50/60 Hz - -------------------------------------------------------------------------------- Condensed Air Pressure 6Bar - -------------------------------------------------------------------------------- Condensed Air Flow 400NL/min - -------------------------------------------------------------------------------- Condensed Air Conditions 5 micron filter, dry, oil free - --------------------------------------------------------------------------------
19 IC WELDING MACHINE 1. FUNCTIONS: Using the hot pressure welding method to weld the coil end enamel -insulated wire with the module chips. Outputs of the welding machine include constant power, constant electric current and constant voltage, with automatic compensation adjustment function. Adept Cartesian robot can perform welding in any set position within the operation area. Welding strength normally should be no less than 100 grams. With automatic function of polishing the chips. With automatic protection device. Able to turn off the machine automatically in exceptional cases. 2. SYSTEM SET: Two Integrated PC controlled high precision electric current generator, Adept Cartesian robot, dual-discrete bonding heads, one Vision System per head, using tungsten thermode, automated weld head temperature monitoring, Pentium 4 Computer, LCD Monitor, interchangeable drawer, safety protection device. 3. MATERIAL SPECIFICATIONS: Length x Width:(512-600) x (400-420) mm Thickness of Material: 0.1-0.5mm 4. CONSUMPTION MATERIALS: Thermode: 10,000 bonds/piece 5. PRODUCTION CAPACITY: 1,250 cards/hour/set 6. SYSTEM PARAMETERS: - -------------------------------------------------------------------------------- Height 1800 mm - -------------------------------------------------------------------------------- Width 1200 mm - -------------------------------------------------------------------------------- Thickness 2000 mm - -------------------------------------------------------------------------------- Weight 450 kg - -------------------------------------------------------------------------------- Welding Area 4 x 10 rows of ID-I cards - -------------------------------------------------------------------------------- Power Supply 3 phase 380VAC+-5% - -------------------------------------------------------------------------------- Maximum Electric Current 30 Amp - -------------------------------------------------------------------------------- Power 1.3 KVA - -------------------------------------------------------------------------------- Frequency 50/60 Hz - -------------------------------------------------------------------------------- Condensed Air Pressure 6Bar - -------------------------------------------------------------------------------- Condensed Air Flow 100NL/min - -------------------------------------------------------------------------------- Condensed Air Conditions 5 micron filter, dry, oil free - --------------------------------------------------------------------------------
20 IC BONDING RE-WORK STATION 1. FUNCTIONS: Reworking the problematic pieces from the welding machine. 2. SYSTEM SET: High precision current generator. 3. SYSTEM PARAMETERS: - -------------------------------------------------------------------------------- Height 1300 mm - -------------------------------------------------------------------------------- Width 1000 mm - -------------------------------------------------------------------------------- Thickness 1300 mm - -------------------------------------------------------------------------------- Weight 250 kg - -------------------------------------------------------------------------------- Power Supply 3 phase 380VAC+-5% - -------------------------------------------------------------------------------- Maximum Electric Current 2 Amp - -------------------------------------------------------------------------------- Power 3KVA - -------------------------------------------------------------------------------- Frequency 50/60 Hz - -------------------------------------------------------------------------------- Condensed Air Pressure 7Bar - -------------------------------------------------------------------------------- Condensed Air Flow 100NL/min - -------------------------------------------------------------------------------- Condensed Air Conditions 5 micron filter, dry, oil free - --------------------------------------------------------------------------------
21 APPENDIX 2 SPARE PARTS & WEARING PARTS 22 IC HOLE PUNCH MACHINE
- --------------------------------------------------------------------------- NO. QTY. Spare Parts' Specifications - --------------------------------------------------------------------------- 1 4 Die for 0.3 mm - --------------------------------------------------------------------------- 2 4 Die for 0.1 mm - --------------------------------------------------------------------------- 3 4 Die for Location Pin - --------------------------------------------------------------------------- 4 4 Start Cycle Button - --------------------------------------------------------------------------- 5 4 Emergency Stop Button - --------------------------------------------------------------------------- 6 4 Hydraulic Valve 600 psi Relief - --------------------------------------------------------------------------- 7 4 4PDT/110V Relay - --------------------------------------------------------------------------- 8 4 30A/RK5 Fuse - --------------------------------------------------------------------------- 9 4 2.5A/500V Fuse - --------------------------------------------------------------------------- 10 8 4A/500 V Fuse - --------------------------------------------------------------------------- 11 4 Drop-in Oil Filter - --------------------------------------------------------------------------- 12 40 Vacuum bags - ---------------------------------------------------------------------------
23 MODULE PLACEMENT MACHINE
- ---------------------------------------------------------------------------------------------------- NO. QTY. Spare Parts' Specifications - ---------------------------------------------------------------------------------------------------- 1 48 Door Lock - ---------------------------------------------------------------------------------------------------- 2 120 Vacuum Bowl - ---------------------------------------------------------------------------------------------------- 3 8 Sheet Hand Vertical Limit Sensor - ---------------------------------------------------------------------------------------------------- 4 8 Sheet Hand Left and Right Limit Sensor - ---------------------------------------------------------------------------------------------------- 5 72 Controller's Fuse - ---------------------------------------------------------------------------------------------------- 6 4 Muffler - ---------------------------------------------------------------------------------------------------- 7 8 Sheet Hand Main Vertical Moving Cylinder - ---------------------------------------------------------------------------------------------------- 8 8 Sheet Hand Deputy Vertical Moving Cylinder - ---------------------------------------------------------------------------------------------------- 9 48 The Leaf for the Door - ---------------------------------------------------------------------------------------------------- 10 8 Soft Start-up Valve - ---------------------------------------------------------------------------------------------------- 11 8 Slides for Drawers - ---------------------------------------------------------------------------------------------------- 12 4 Guide unit for pulling reel (including 2 guides and their bushing) - ---------------------------------------------------------------------------------------------------- 13 8 Bad module recognizing unit (sensor, amplifier and fiber) - ---------------------------------------------------------------------------------------------------- 14 36 Plunger's tip - ---------------------------------------------------------------------------------------------------- 15 8 Hand Vacuum Valve Assembly - ---------------------------------------------------------------------------------------------------- 16 36 Finger Plunger Height Sensor - ---------------------------------------------------------------------------------------------------- 17 8 Relay for Dispenser - ---------------------------------------------------------------------------------------------------- 18 8 Adhesive Dispense Manifold - ---------------------------------------------------------------------------------------------------- 19 8 Adhesive Dispense Motor - ---------------------------------------------------------------------------------------------------- 20 8 Module Tape Index Sensor - ---------------------------------------------------------------------------------------------------- 21 8 Module Tape Reel Feed Sensor - ---------------------------------------------------------------------------------------------------- 22 8 Shuttle Position Sensor - ---------------------------------------------------------------------------------------------------- 23 8 Adhesive Pressure Regulator - ---------------------------------------------------------------------------------------------------- 24 8 24 VDC Power Supply - ---------------------------------------------------------------------------------------------------- 25 8 Vaccum Generator with Dual Sensor/Switch - ---------------------------------------------------------------------------------------------------- 26 8 Drawer Prox. Sensor - ---------------------------------------------------------------------------------------------------- 27 240 syringes Glue - ----------------------------------------------------------------------------------------------------
24 IC WIRE IMPLANTING MACHINE
- --------------------------------------------------------------------------------------------- NO. QTY. Spare Parts' Specifications - --------------------------------------------------------------------------------------------- 1 24 Door Lock - --------------------------------------------------------------------------------------------- 2 80 Vacuum Bowl - --------------------------------------------------------------------------------------------- 3 8 Sheet Hand Vertical Limit Sensor - --------------------------------------------------------------------------------------------- 4 8 Sheet Hand Left and Right Limit Sensor - --------------------------------------------------------------------------------------------- 5 8 Controller's Fuse - --------------------------------------------------------------------------------------------- 6 8 Muffler - --------------------------------------------------------------------------------------------- 7 8 Sheet Hand Main Vertical Moving Cylinder - --------------------------------------------------------------------------------------------- 8 8 Sheet Hand Deputy Vertical Moving Cylinder - --------------------------------------------------------------------------------------------- 9 24 The Leaf for the Door - --------------------------------------------------------------------------------------------- 10 8 Soft Start-up Valve - --------------------------------------------------------------------------------------------- 11 8 Slides for Drawers - --------------------------------------------------------------------------------------------- 12 96 Ultrasound Horn - --------------------------------------------------------------------------------------------- 13 144 Cutter Knife - --------------------------------------------------------------------------------------------- 14 4 Head Drive System - --------------------------------------------------------------------------------------------- 15 8 US Head Spool Dancer - --------------------------------------------------------------------------------------------- 16 16 Spool Motor - --------------------------------------------------------------------------------------------- 17 8 US Head Screw Assortment - --------------------------------------------------------------------------------------------- 18 8 US Head Clamp Solenoid - --------------------------------------------------------------------------------------------- 19 8 Vacuum Generator with Dual Sensor/Switch - --------------------------------------------------------------------------------------------- 20 8 Drawer Prox. Sensor - --------------------------------------------------------------------------------------------- 21 12 Spool Motor Speed Control - --------------------------------------------------------------------------------------------- 22 12 Dancer Position Sensor - --------------------------------------------------------------------------------------------- 23 64 rolls Wire - ---------------------------------------------------------------------------------------------
25 IC WELDING AND REWORKING MACHINE
- --------------------------------------------------------------------------------------------- NO. QTY. Spare Parts' Specifications - --------------------------------------------------------------------------------------------- 1 48 Door Lock - --------------------------------------------------------------------------------------------- 2 120 Vacuum Bowl - --------------------------------------------------------------------------------------------- 3 8 Sheet Hand Vertical Limit Sensor - --------------------------------------------------------------------------------------------- 4 8 Sheet Hand Left and Right Limit Sensor - --------------------------------------------------------------------------------------------- 5 72 Controller's Fuse - --------------------------------------------------------------------------------------------- 6 8 Muffler - --------------------------------------------------------------------------------------------- 7 8 Sheet Hand Main Vertical Moving Cylinder - --------------------------------------------------------------------------------------------- 8 8 Sheet Hand Deputy Vertical Moving Cylinder - --------------------------------------------------------------------------------------------- 9 24 The Leaf for the Door - --------------------------------------------------------------------------------------------- 10 8 Soft Start-up Valve - --------------------------------------------------------------------------------------------- 11 8 Slides for Drawers - --------------------------------------------------------------------------------------------- 12 8 Guide for Head's Vertical Moving - --------------------------------------------------------------------------------------------- 13 72 Thermode Cleaning Brush - --------------------------------------------------------------------------------------------- 14 36 Bad Card Marker - --------------------------------------------------------------------------------------------- 15 8 Pressure Regulator - --------------------------------------------------------------------------------------------- 16 8 Relay for Weld Trigger - --------------------------------------------------------------------------------------------- 17 720 Dressing Stone - --------------------------------------------------------------------------------------------- 18 72 Stamp Refill - --------------------------------------------------------------------------------------------- 19 8 Vacuum Generator with Dual Sensor/Switch - --------------------------------------------------------------------------------------------- 20 8 Drawer Prox. Sensor - --------------------------------------------------------------------------------------------- 21 400 Thermode - ---------------------------------------------------------------------------------------------
26 APPENDIX 3 TECHNICAL DOCUMENTATION LIST 27 Accompanied documentations include: 1. Equipment Approval Certificate and Quality Certificate 2. Operation, Repair, Usage and Maintenance Manuals of Each Equipment 3. Assembly Illustrations of Equipment 4. Theoretical Illustration and Wiring Illustration of the Electric System 5. Illustrations of Wearing Parts of the Equipment 6. Backup copy of the accompanied software 7. Backup copy of PLC Procedures 28 APPENDIX 4 TOOL LIST 29
- -------------------------------------------------------------------------------------------- NO. NAME OF TOOL QTY. - -------------------------------------------------------------------------------------------- 1. Torque Wrench 2 - -------------------------------------------------------------------------------------------- 2. US Head Shim Kit 2 set - -------------------------------------------------------------------------------------------- 3. Multi-meter 2 - -------------------------------------------------------------------------------------------- 4. Precision Drill Set 2 set - -------------------------------------------------------------------------------------------- 5. Electrical Tape 2 - -------------------------------------------------------------------------------------------- 6. Foam Mounting Tape 2 - -------------------------------------------------------------------------------------------- 7. Assorted Tweezer Set 2 set - -------------------------------------------------------------------------------------------- 8. Scribe 2 set - -------------------------------------------------------------------------------------------- 9. Pick Set 2 set - -------------------------------------------------------------------------------------------- 10. Inspection Mirror 2 - -------------------------------------------------------------------------------------------- 11. Snap Ring Pliers 2 - -------------------------------------------------------------------------------------------- 12. Torpedo Level 2 - -------------------------------------------------------------------------------------------- 13. Oiling Pen 2 - -------------------------------------------------------------------------------------------- 14. Allen Wrench Sets 12 - -------------------------------------------------------------------------------------------- 15. Socket Set 2 set - -------------------------------------------------------------------------------------------- 16. Machinist Square 2 - -------------------------------------------------------------------------------------------- 17. Tap and Die Set 78 - -------------------------------------------------------------------------------------------- 18. Ignition Wrench Set 4 - -------------------------------------------------------------------------------------------- 19. Needle file Set 20 - -------------------------------------------------------------------------------------------- 20. Bastard Files 14 - -------------------------------------------------------------------------------------------- 21. Precision Pliers 10 - -------------------------------------------------------------------------------------------- 22. Step Drill 2 - -------------------------------------------------------------------------------------------- 23. Screw Driver Set 40 - -------------------------------------------------------------------------------------------- 24. Angle Screw Driver Set 12 - -------------------------------------------------------------------------------------------- 25. Drill Bit Set 2 - -------------------------------------------------------------------------------------------- 26. Wire Stripper 2 - -------------------------------------------------------------------------------------------- 27. Miniature Pliers 6 - -------------------------------------------------------------------------------------------- 28. Adjustable Wrench Set 6 - -------------------------------------------------------------------------------------------- 29. Locking Pliers 6 - -------------------------------------------------------------------------------------------- 30. Pliers 6 - -------------------------------------------------------------------------------------------- 31. Knife Set 2 - -------------------------------------------------------------------------------------------- 32. Hacksaw 2 - -------------------------------------------------------------------------------------------- 33. Hacksaw blades 12 - -------------------------------------------------------------------------------------------- 34. Ball peen hammer 2 - -------------------------------------------------------------------------------------------- 35. Wd-40 4 - -------------------------------------------------------------------------------------------- 36. Flashlight 2 - -------------------------------------------------------------------------------------------- 37. Wire Brushes 4 - -------------------------------------------------------------------------------------------- 38. X-acid knife Set 2 - -------------------------------------------------------------------------------------------- 39. Magnifying glass 2 - -------------------------------------------------------------------------------------------- 40. 45 mm Steel Rule 2 - -------------------------------------------------------------------------------------------- 41. Solding Iron Set 2 - --------------------------------------------------------------------------------------------
30 Technical Agreement Appendix 5 EQUIPMENT ACCEPTANCE DETAILS 31 I. GENERAL PRINCIPLES Materials used during the Acceptance shall be PVC or PETG. Moulds used shall be the MIFARE MOA2. Production rate shall be based on arrangement of 4 x 8 cards. Acceptance shall be based on inlays that have not been laminated. 1.1 According to the Technical Agreement Appendix 1 "Equipment Functions and Technical Specifications", a test run of the equipment and its production capacity, and examination of the production acceptance rate shall be performed. 1.2 Equipment items to be inspected shall include: o Information and material accompanied with the equipment o Appearance o Equipment functions o Equipment system 1.3 Inspection and acceptance shall be conducted in two phases: 1.3.1 Preliminary inspection of equipment delivered 1.3.2 Final inspection of equipment 2. METHODS AND PROCEDURES OF INSPECTION AND ACCEPTANCE 2.1 Preliminary Inspection of the Equipment To be performed in the shop of Party B. 2.1.1 Inspection of Equipment Functions Hole Punch Machine a. Consistency of the size and the location of the punch hole b. Any adhesive debris found in the hole punch area Pick and Place with Module a. Function of identifying and removing the unqualified modules b. Smoothness of the hole punch and pick and place functions. Any blocking situations due to halting of these functions c. Function of adjusting the placement of the module d. Smoothness of auto feeding and receiving pieces 32 e. Trouble shooting alarming system f. Proper operation of the equipment display system Wire Implanting Machine a. Whether the ultrasonic rate meets the standard of 70,000 times/round b. Adjustment of the position, size, forms and distance of the wire coil c. Inspection and record of the frequency of wire breaking during operation d. Proper operation of the monitor system e. Smoothness of auto feeding and receiving pieces f. Trouble shooting alarming system Welder a. Inspect by samples, whether the pulling force meeting the standards (sampling based on the GB2828 special inspection level S-3 AQL=0.65) b. Whether the function of pog-pin welding is successful c. When welding is not successful, whether the bad card marker is able to mark on the corresponding card d. Function of auto polishing welded pieces e. Proper operation of the monitor system f. Adjustment and display functions of the power generator g. Smoothness of auto feeding and receiving pieces h. Automatic indication of replacement of welded pieces i. Proper operation of the equipment display system j. Trouble shooting alarming system 2.1.2 Inspection of the Equipment System Use the fake modules to test run steadily for two hours and use the real modules to test run steadily for another two hours. Since the system is a separate machine, actual operation can be carried on by items. The operation of using the fake modules and the real modules must be run continuously. The time spent in adjusting the software and technical parameters, and fixing the hardware problems during the test run period must be included in the operation time. Adjustment contents and frequency must be recorded. The time required for preparation and starting the machine is excluded. All products (excluding test products during the repair time) shall be included in the total production number. The one-time acceptance rate of the pick and 33 place machine, wire implanting machine and the welding machine shall be at 98% or above. After four hour of operation for each equipment, each equipment shall be able to produce an average of 2500 cards per hour. 2.2 Final Inspection and Acceptance of Equipment To be performed at the shop of Party A. Items to be inspected include: o Information and material accompanied with the equipment o Appearance o Equipment functions o Equipment system 2.2.1 Inspection Of The Information And Materials Accompanied With The Equipment o Verify with Appendix 1 of the Agreement, "List of Production Line Equipment and Laboratory Devices" o Verify with Appendix 2 of the Agreement, "Equipment Parts and Consumption Parts" o Verify with Appendix 3 of the Agreement, "List of Technical Documents" o Verify with Appendix 4 of the Agreement, "List of Maintenance Tools" o Verify with the approved raw materials provided by Party B for 24-hour test run operation use. 2.2.2 Inspection of Appearance Inspect the frame and the door. The structure of the equipment shall be solid and the door switches shall be acute. Inspect whether the equipment has been bumped or damaged. The plated surface of the conveyance section of the equipment shall be polished, bright, with no defects or rusty spots. 2.2.3 Inspection And Acceptance Of The Equipment Function Inspect the Approval Certificate (including inspection details and results) and Quality Certificate provided by Party B, based on the requirements of 2.1.1. 34 2.2.4 Inspection And Acceptance Of The Equipment System Use fake modules for steady operation for two days, eight hours a day. Use real modules on the third day for eight hours. Since the equipment includes separate machines, actual operation can be performed units by units. During the test run period, the time spent in adjusting the software and technical parameters, and fixing the hardware problems period shall be included in the operation time. Adjustment contents and frequency must be recorded. The required time for preparation and starting the machine is excluded. All products (excluding test products during the repair time) shall be included in the total production number. The one-time acceptance rate of the pick and place machine, wire implanting machine and the welding machine shall be at 98% or above. The total acceptance rate of products that have not been laminated shall be over 98%. After test running 24 hours, the average production capacity shall be 2500 cards/hour. 35 EX-10 8 ex10-46.txt EXHIBIT 10.46 COMMERCIAL GUARANTY - ------------------------------------------------------------------------------------------------- Principal Loan Date Maturity Loan No Call/Coll Account Officer Initials 211 013 [illegible] - ------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or Item. Any item above containing "***" has been omitted due to text length limitations. Borrower: Chipcards, Inc. fka American Pacific Technology Lender: Trans Pacific National Bank Corp. (American Pacific Aviation and Techonology 46 Second St. Corp.) San Francisco, CA 94105 1 Sansome St., 19th Floor (415) 543-3377 San Francisco, CA 94104-4448 Guarantor: Eric J. Gravell 880 Rosemount Rd. Oakland, CA 94610 - -------------------------------------------------------------------------------------------------
AMOUNT OF GUARANTY. The amount of this Guaranty Is Unlimited. CONTINUING UNLIMITED GUARANTY. For good and valuable consideration, Eric J. Gravell ("Guarantor") absolutely and unconditionally guarantees and promises to pay to Trans Pacific National Bank ("Lender") or its order, in legal tender of the United States of America, the Indebtedness (as that term Is defined below) of Chipcards, Inc. fka American Pacific Technology Corp. (American Pacific Aviation and Techonology Corp.) ("Borrower") to Lender on the terms and conditions set forth In this Guaranty. Under this Guaranty, the liability of Guarantor is unlimited and the obligations of Guarantor are continuing. INDEBTEDNESS GUARANTEED. The Indebtedness guaranteed by this Guaranty includes any and all of Borrower's indebtedness to Lender and is used in the most comprehensive sense and means and includes any and all of Borrower's liabilities, obligations and debts to Lender, now existing or hereinafter incurred or created, including, without limitation, all loans, advances, interest, costs, debts, overdraft indebtedness, credit card indebtedness, lease obligations, other obligations, and liabilities of Borrower, or any of them, and any present or future judgments against Borrower, or any of them; and whether any such Indebtedness is voluntarily or involuntarily incurred, due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined; whether Borrower may be liable Individually or jointly with others, or primarily or secondarily, or as guarantor or surety; whether recovery on the Indebtedness may be or may become barred or unenforceable against Borrower for any reason whatsoever; and whether the Indebtedness arises from transactions which may be voidable on account of infancy, insanity, ultra vires, or otherwise. DURATION OF GUARANTY. This Guaranty will take effect when received by Lender without the necessity of any acceptance by Lender, or any notice to Guarantor or to Borrower, and will continue in full force until all Indebtedness incurred or contracted before receipt by Lender of any notice of revocation shall have been fully and finally paid and satisfied and all of Guarantor's other obligations under this Guaranty shall have been performed in full. If Guarantor elects to revoke this Guaranty, Guarantor may only do so in writing. Guarantor's written notice of revocation must be mailed to Lender, by certified mail, at Lender's address listed above or such other place as Lender may designate in writing. Written revocation of this Guaranty will apply only to advances or new Indebtedness created after actual receipt by Lender of Guarantor's written revocation. For this purpose and without limitation, the term "new Indebtedness" does not include Indebtedness which at the time of notice of revocation is contingent, unliquidated, undetermined or not due and which later becomes absolute, liquidated, determined or due. This Guaranty will continue to bind Guarantor for all Indebtedness incurred by Borrower or committed by Lender prior to receipt of Guarantor's written notice of revocation, including any extensions, renewals, substitutions or modifications of the Indebtedness. All renewals, extensions, substitutions, and modifications of the Indebtedness granted after Guarantor's revocation, are contemplated under this Guaranty and, specifically will not be considered to be new Indebtedness. This Guaranty shall bind Guarantor's estate as to Indebtedness created both before and after Guarantor's death or incapacity, regardless of Lender's actual notice of Guarantor's death. Subject to the foregoing, Guarantor's executor or administrator or other legal representative may terminate this Guaranty in the same manner in which Guarantor might have terminated it and with the same effect. Release of any other guarantor or termination of any other guaranty of the Indebtedness shall not affect the liability of Guarantor under this Guaranty. A revocation Lender receives from any one or more Guarantors shall not affect the liability of any remaining Guarantors under this Guaranty. Guarantor's obligations under this Guaranty shall be in addition to any of Guarantor's obligations, or any of them, under any other guaranties of Borrower's Indebtedness or any other person heretofore or hereafter given to Lender unless such other guaranties are modified or revoked in writing; and this Guarantor shall not, unless provided in this Guaranty, affect, invalidate, or supersede any such other guaranty. It is anticipated that fluctuations may occur in the aggregate amount of Indebtedness covered by this Guaranty, and Guarantor specifically acknowledges and agrees that reductions in the amount of Indebtedness, even to zero dollars ($0.00), prior to Guarantor's written revocation of this Guaranty shall not constitute a termination of this Guaranty. This Guaranty is binding upon Guarantor and Guarantor's heirs, successors and assigns so long as any of the guaranteed Indebtedness remains unpaid and even though the Indebtedness guaranteed may from time to time be zero dollars ($0.00). OBLIGATIONS OF MARRIED PERSONS. Any married person who signs this Guaranty hereby expressly agrees that recourse under this Guaranty may be had against both his or her separate property and community property. GUARANTOR'S AUTHORIZATION TO LENDER. Guarantor authorizes Lender, either before or after any revocation hereof, without notice or demand and without lessening Guarantor's liability under this Guaranty, from time to time: (A) prior to revocation as set forth above, to make one or more additional secured or unsecured loans to Borrower, to lease equipment or other goods to Borrower, or otherwise to extend additional credit to Borrower; (B) to alter, compromise, renew, extend, accelerate, or otherwise change one or more times the time for payment or other terms of the Indebtedness or any part of the Indebtedness, including increases and decreases of the rate of interest on the Indebtedness; extensions may be repeated and may be for longer than the original loan term; (C) to take and hold security for the payment of this Guaranty or the Indebtedness, and exchange, enforce, waive, subordinate, fail or decide not to perfect, and release any such security, with or without the substitution of new collateral; (D) to release, substitute, agree not to sue, or deal with any one or more of Borrower's sureties, endorsers, or other guarantors on any terms or in any manner Lender may choose; (E) to determine how, when and what application of payments and credits shall be made on the Indebtedness; (F) to apply such security and direct the order or manner of sale thereof Including without limitation, any nonjudicial sale permitted by the terms of the controlling security agreement or deed of trust, as Lender in its discretion may determine; (G) to sell, transfer, assign or grant participations in all or any part of the Indebtedness; and (H) to assign or transfer this Guaranty in whole or in part. GUARANTOR'S REPRESENTATIONS AND WARRANTIES. Guarantor represents and warrants to Lender that (A) no representations or agreements of any kind have been made to Guarantor which would limit or qualify in any way the terms of this Guaranty; (B) this Guaranty is executed at Borrowers request and not at the request of Lender; (C) Guarantor has full power, right and authority to enter into this Guaranty; (D) the provisions of this Guaranty do not conflict with or result in a default under any agreement or other instrument binding upon Guarantor and do not result in a violation of any law, regulation, court decree or order applicable to Guarantor; (E) Guarantor has not and will not, without the prior written consent of Lender, sell lease, assign, encumber, hypothecate transfer, or otherwise dispose of all or substantially all of Guarantor's assets, or any interest therein; (F) upon Lender's request, Guarantor will provide to Lender financial and credit information in form acceptable to Lender, and all such financial information which currently has been, and all future financial information which will be provided to Lender is and will be true and correct in all material respects and fairly present Guarantor's financial condition as of the dates the financial information is provided; (G) no material adverse change has occurred in Guarantor's financial condition since the date of the most recent financial statements provided to Lender and no event has occurred which may materially adversely affect Guarantor's financial condition; (H) no litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Guarantor is pending or threatened; (I) Lender has made no representation to Guarantor as to the creditworthiness of Borrower; and (J) Guarantor has established adequate means of obtaining from Borrower on a continuing basis information regarding Borrower's financial condition. Guarantor agrees to keep adequately informed from such means of any facts, events, or circumstances which might in any way affect Guarantor's risks under this Guaranty, and Guarantor further agrees that, absent a request for information, Lender shall have no obligation to disclose to Guarantor any information or documents acquired by Lender in the course of its relationship with Borrower. GUARANTOR'S FINANCIAL STATEMENTS. Guarantor agrees to furnish Lender with the following: Annual Statements. As soon as available, but in no event later than thirty (30) days after the end of each fiscal year, Guarantor's balance sheet and income statement for the year ended, prepared by Guarantor. Tax Returns. As soon as available, but in no event later than thirty (30) days after the applicable filing dale for the tax reporting period ended, Federal and other governmental tax returns, prepared by Guarantor. All financial reports required to be provided under this Guaranty shall be prepared In accordance with GAAP, applied on a consistent basis, and certified by Guarantor as being true and correct. GUARANTOR'S WAIVERS. Except as prohibited by applicable law, Guarantor waives any right to require Lender to (A) make any presentment, protest, demand, or notice of any kind, including notice of change of any terms of repayment of the Indebtedness, default by Borrower or any other guarantor or surety, any action or nonaction taken by Borrower, Lender, or any other guarantor or surety of Borrower, or the creation of new or additional Indebtedness; (B) proceed against any person, including Borrower, before proceeding against Guarantor; (C) proceed against any collateral for the Indebtedness, including Borrower's collateral, before proceeding against Guarantor; (D) apply any payments or proceeds received against the Indebtedness in any order; (E) give notice of the terms, time, and place of any sale of the collateral pursuant to the Uniform Commercial Code or any other law governing such sale; (F) disclose any information about the Indebtedness, the Borrower, the collateral, or any other guarantor or surety, or about any action or nonaction of Lender; or (G) pursue any remedy or course of action in Lender's power whatsoever. COMMERCIAL GUARANTY Loan No: 1805520002 (Continued) Page 2 - ------------------------------------------------------------------------------ Guarantor also waives any and all rights or defenses arising by reason of (H) any disability or other defense of Borrower, any other guarantor or surety or any other person; (I) the cessation from any cause whatsoever, other than payment in full, of the Indebtedness; (J) the application of proceeds of the Indebtedness by Borrower for purposes other than the purposes understood and intended by Guarantor and Lender; (K) any act of omission or commission by Lender which directly or indirectly results in or contributes to the discharge of Borrower or any other guarantor or surety, or the Indebtedness, or the loss or release of any collateral by operation of law or otherwise; (L) any statute of limitations in any action under this Guaranty or on the Indebtedness; or (M) any modification or change in terms of the Indebtedness, whatsoever, including without limitation, the renewal, extension, acceleration, or other change in the time payment of the Indebtedness is due and any change in the interest rate, and including any such modification or change in terms after revocation of this Guaranty on Indebtedness incurred prior to such revocation. Guarantor waives all rights and any defenses arising out of an election of remedies by Lender even though that the efection of remedies, such as a non-judicial foreclosure with respect to security for a guaranteed obligation, has destroyed Guarantor's rights of subrogation and reimbursement against Borrower by operation of Section 580d of the California Code of Civil Procedure or otherwise. Guarantor waives all rights and defenses that Guarantor may have because Borrower's obligation is secured by real property. This means among other things: (1) Lender may collect from Guarantor without first foreclosing on any real or personal property collateral pledged by Borrower. (2) If Lender forecloses on any real property collateral pledged by Borrower: (a) the amount of Borrower's obligation may be reduced only by the price for which the collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price. (b) Lender may collect from Guarantor even if Lender, by foreclosing on the real property collateral, has destroyed any right Guarantor may have to collect from Borrower. This is an unconditional waiver of any rights and defenses Guarantor may have because Borrower's obligation is secured by real property. These rights and defenses include, but are not limited to, any rights and defenses based upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure. Guarantor understands and agrees that the foregoing waivers are waivers of substantive rights and defenses to which Guarantor might otherwise be entitled under state and federal law. The rights and defenses waived include, without limitation, those provided by Caliornia laws of suretyship and guaranty, anti-deficiency laws, and the Uniform Commercial Code. Guarantor acknowledges that Guarantor has provided these waivers of rights and defenses with the intention that they be fully relied upon by Lender. Until all Indebtedness is paid in full, Guarantor waives any right to enforce any remedy Lender may have against the Borrower or any other guarantor, surety, or other person, and further, Guarantor waives any right to participate in any collateral for the Indebtedness now or hereafter held by Lender. In addition to the waivers set forth above, if now or hereafter Borrower is or shall become insolvent and the Indebtedness shall not at all times until paid be fully secured by collateral pledged by Borrower, Guarantor hereby forever waives and gives up in favor of Lender and Borrower, and Lender's and Borrower's respective successors, any claim or right to payment Guarantor may now have or hereafter have or acquire against Borrower, by subrogation or otherwise, so that at no time shall Guarantor be or become a "creditor" of Borrower within the meaning of 11 U.S.C. section 547(b), or any successor provision of the Federal bankruptcy laws. GUARANTOR'S UNDERSTANDING WITH RESPECT TO WAIVERS. Guarantor warrants and agrees that each of the waivers set forth above is made with Guarantor's full knowledge of its significance and consequences and that, under the circumstances, the waivers are reasonable and not contrary to public policy or law. If any such waiver is determined to be contrary to any applicable law or public policy, such waiver shall be effective only to the extent permitted by law or public policy. SUBORDINATION OF BORROWER'S DEBTS TO GUARANTOR. Guarantor agrees that the Indebtedness of Borrower to Lender, whether now existing or hereafter created, shall be superior to any claim that Guarantor may now have or hereafter acquire against Borrower, whether or not Borrower becomes insolvent. Guarantor hereby expressly subordinates any claim Guarantor may have against Borrower, upon any account whatsoever, to any claim that Lender may now or hereafter have against Borrower. In the event of insolvency and consequent liquidation of the assets of Borrower, through bankruptcy, by an assignment for the benefit of creditors, by voluntary liquidation, or otherwise, the assets of Borrower applicable to the payment of the claims of both Lender and Guarantor shall be paid to Lender and shall be first applied by Lender to the Indebtedness of Borrower to Lender. Guarantor does hereby assign to Lender all claims which it may have or acquire against Borrower or against any assignee or trustee in bankruptcy of Borrower; provided however, that such assignment shall be effective only for the purpose of assuring to Lender full payment In legal tender of the Indebtedness. If Lender so requests, any notes or credit agreements now or hereafter evidencing any debts or obligations of Borrower to Guarantor shall be marked with a legend that the same are subject to this Guaranty and shall be delivered to Lender. Guarantor agrees, and Lender is hereby authorized, in the name of Guarantor, from time to time to execute and file financing statements and continuation statements and to execute such other documents and to take such other actions as Lender deems necessary or appropriate to perfect, preserve and enforce its rights under this Guaranty. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Guaranty: Amendments. This Guaranty, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Guaranty. No alteration of or amendment to this Guaranty shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. Attorneys' Fees; Expenses. Guarantor agrees to pay upon demand all of Lender's costs and expenses, including Lender's attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Guaranty. Lender may hire or pay someone else to help enforce this Guaranty, and Guarantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Guarantor also shall pay all court costs and such additional fees as may be directed by the court. Caption Headings. Caption headings In this Guaranty are for convenience purposes only and are not to be used to interpret or define the provisions of this Guaranty. Governing Law. This Guaranty will be governed by, construed and enforced In accordance with federal law and the laws of the State of California. This Guaranty has been accepted by Lender in the State of California. Integration. Guarantor further agrees that Guarantor has read and fully understands the terms of this Guaranty; Guarantor has had the opportunity to be advised by Guarantor's attorney with respect to this Guaranty; the Guaranty fully reflects Guarantor's intentions and parol evidence is not required to interpret the terms of this Guaranty. Guarantor hereby Indemnities and holds Lender harmless from all losses, claims, damages, and costs (including Lender's attorneys' fees) suffered or incurred by Lender as a result of any breach by Guarantor of the warranties, representations and agreements of this paragraph. Interpretation. In all cases where there is more than one Borrower or Guarantor, then all words used in this Guaranty in the singular shall be deemed to have been used in the plural where the context and construction so require; and where there is more than one Borrower named in this Guaranty or when this Guaranty is executed by more than one Guarantor, the words "Borrower" and "Guarantor" respectively shall mean all and any one or more of them. The words "Guarantor," "Borrower," and "Lender" include the heirs, successors, assigns, and transferees of each of them. If a court finds that any provision of this Guaranty is not valid or should not be enforced, that fact by itself will not mean that the rest of this Guaranty will not be valid or enforced. Therefore, a court will enforce the rest of the provisions of this Guaranty even if a provision of this Guaranty may be found to be invalid or unenforceable. If any one or more of Borrower or Guarantor are corporations, partnerships, limited liability companies, or similar entities, it is not necessary for Lender to inquire into the powers of Borrower or Guarantor or of the officers, directors, partners, managers, or other agents acting or purporting to act on their behalf, and any Loan indebtedness made or created in reliance upon the professed exercise of such powers shall be guaranteed under this Guaranty. Notices. Any notice required to be given under this Guaranty shall be given in writing, and, except for revocation notices by Guarantor, shall be effective when actually delivered, when actually received by telefacsimile (unless otherwise required by law), when deposited with a nationally recognized overnight courier, or, if mailed, when deposited in the United States mail, as first class, certified or registered mail postage prepaid, directed to the addresses shown near the beginning of this Guaranty. All revocation notices by Guarantor shall be in writing and shall be effective upon delivery to Lender as provided in the section of this Guaranty entitled "DURATION OF GUARANTY." Any party may change its address for notices under this Guaranty by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. For notice purposes, Guarantor agrees to keep Lender informed at all times of Guarantor's current address. Unless otherwise provided or required by law, if there is more than one Guarantor, any notice given by Lender to any Guarantor is deemed to be notice given to all Guarantors. No Waiver by Lender. Lender shall not be deemed to have waived any rights under this Guaranty unless such waiver is given In writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Guaranty shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Guaranty. No prior waiver by Lender, nor any course of dealing between Lender and Guarantor, shall constitute a waiver of any of Lender's rights or of any of Guarantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Guaranty, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender. Successors and Assigns. Subject to any limitations stated in this Guaranty on transfer of Guarantors interest, this Guaranty shall be binding upon and inure to the benefit of the parties, their successors and assigns. ADDITIONAL PROVISIONS. "Guarantor waives its rights of subrogation, reimbursement, indemnification, and contribution and any other rights and COMMERCIAL GUARANTY Loan No: 1805520002 (Continued) Page 3 - ------------------------------------------------------------------------------ defenses that are or may become available to the guarantor by reason of California Civil Code Sections 2787 to 2855, inclusive. Guarantor waives all rights and defenses that the guarantor may have because the debtor's debt is secured by real properly. This means, among other things: 1. The creditor may collect from the gurantor without first foreclosing on the real or personal property collateral pledged by the debtor. 2. If the creditor forecloses on any real property collateral pledged by the debtor: a) The amount of the debt may be reduced by only the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price. b) The creditor may collect from the guarantor even if the creditor, by foreclosing on the real property collateral, has destroyed any right the guarantor may have to collect from the debtor. This is an unconditional and irrevocable waiver of any rights and defenses the guarantor may have because the debtor's debt is secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580d, or 726 of the Code of Civil Procedure. Guarantor waives all rights and defenses arising out of an election of remedies by the creditor, even though that election of remedies, such as nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed the guarantor's rights of subrogation and reimbursement against the principal by operation of Section 580d of the Code of Civil Procedure or otherwise.". DEFINITIONS. The following capitalized words and terms shall have the following meanings when used in this Guaranty. Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America. Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require. Words and terms not otherwise defined in this Guaranty shall have the meanings attributed to such terms in the Uniform Commercial Code: Borrower. The word "Borrower" means Chipcards, Inc. fka American Pacific Technology Corp. (American Pacific Aviation and Techonology Corp.), and all other persons and entities signing the Note in whatever capacity. GAAP. The word "GAAP" means generally accepted accounting principles. Guarantor. The word "Guarantor" means each and every person or entity signing this Guaranty, including without limitation Eric J. Gravell. Guaranty. The word "Guaranty" means the guaranty from Guarantor to Lender, including without limitation a guaranty of all or part of the Note. Indebtedness. The word "Indebtedness" means Borrower's indebtedness to Lender as more particularly described in this Guaranty. Lender. The word "Lender" means Trans Pacific National Bank, its successors and assigns. Related Documents. The words "Related Documents" mean all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, security deeds, collateral mortgages, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness. GUARANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS COMMERCIAL GUARANTY AND GUARANTOR AGREES TO ITS TERMS. THIS COMMERCIAL GUARANTY IS DATED SEPTEMBER 5, 2001. GUARANTOR: X Eric J. Gravell ----------------------------------------- Eric J. Gravell, Individually EX-10 9 ex10-47.txt EXHIBIT 10.47 COMMERCIAL GUARANTY
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References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or item. Any item above containing "***" has been omitted due to text length limitations. Borrower: Chipcards, Inc. fka American Pacific Technology Lender: Trans Pacific National Bank Corp. (American Pacific Aviation and Technology 46 Second St. Corp.) San Francisco, CA 94105 1 Sansome St., 19th Floor (415) 543-3377 San Francisco, CA 94104-4448 Guarantor: Xiao Qin Jiang 2885 Churchill Drive Hillsborough, CA 94010 ==================================================================================================
AMOUNT OF GUARANTY. The amount of this Guaranty is Unlimited. CONTINUING UNLIMITED GUARANTY. For good and valuable consideration, Xiao Qin Jiang ("Guarantor") absolutely and unconditionally guarantees and promises to pay to Trans Pacific National Bank ("Lender") or its order, in legal tender of the United States of America, the indebtedness (as that term is defined below) of Chipcards, Inc. fka American Pacific Technology Corp. (American Pacific Aviation and Technology Corp.) ("Borrower") to Lender on the terms and conditions set forth in this Guaranty. Under this Guaranty, the liability of Guarantor is unlimited and the obligations of Guarantor are continuing. INDEBTEDNESS GUARANTEED. The Indebtedness guaranteed by this Guaranty includes any and all of Borrower's Indebtedness to Lender and is used in the most comprehensive sense and means and includes any and all of Borrower's liabilities, obligations and debts to Lender, now existing or hereinafter incurred or created, including, without limitation, all loans, advances, interest, costs, debts, overdraft indebtedness, credit card indebtedness, lease obligations, other obligations, and liabilities of Borrower, or any of them, and any present or future judgments against Borrower, or any of them; and whether any such indebtedness is voluntarily or involuntarily incurred, due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined; whether Borrower may be liable individually or jointly with others, or primarily or secondarily, or as guarantor or surety; whether recovery on the Indebtedness may be or may become barred or unenforceable against Borrower for any reason whatsoever; and whether the Indebtedness arises from transactions which may be voidable on account of infancy, insanity, ultra vires, or otherwise. DURATION OF GUARANTY. This Guaranty will take effect when received by Lender without the necessity of any acceptance by Lender, or any notice to Guarantor or to Borrower, and will continue in full force until all Indebtedness incurred or contracted before receipt by Lender of any notice of revocation shall have been fully and finally paid and satisfied and all of Guarantor's other obligations under this Guaranty shall have been performed in full. It Guarantor elects to revoke this Guaranty, Guarantor may only do so in writing. Guarantor's written notice of revocation must be mailed to Lender, by certified mail, at Lender's address listed above or such other place as Lender may designate in writing. Written revocation of this Guaranty will apply only to advances or new Indebtedness created after actual receipt by Lender of Guarantor's written revocation. For this purpose and without limitation, the term "new Indebtedness" does not include Indebtedness which at the time of notice of revocation is contingent, unliquidated, undetermined or not due and which later becomes absolute, liquidated, determined or due. This Guaranty will continue to bind Guarantor for all Indebtedness incurred by Borrower or committed by Lender prior to receipt of Guarantor's written notice of revocation, including any extensions, renewals, substitutions or modifications of the Indebtedness. All renewals, extensions, substitutions, and modifications of the Indebtedness granted alter Guarantor's revocation, are contemplated under this Guaranty and, specifically will not be considered to be new Indebtedness. This Guaranty shall bind Guarantor's estate as to Indebtedness created both before and after Guarantor's death or incapacity, regardless of Lender's actual notice of Guarantor's death. Subject to the foregoing, Guarantor's executor or administrator or other legal representative may terminate this Guaranty in the same manner in which Guarantor might have terminated it and with the same effect. Release of any other guarantor or termination of any other guaranty of the Indebtedness shall not affect the liability of Guarantor under this Guaranty. A revocation Lender receives from any one or more Guarantors shall not affect the liability of any remaining Guarantors under this Guaranty. Guarantor's obligations under this Guaranty shall be in addition to any of Guarantor's obligations, or any of them, under any other guaranties of Borrower's Indebtedness or any other person heretofore or hereafter given to Lender unless such other guaranties are modified or revoked in writing; and this Guarantor shall not, unless provided in this Guaranty, affect, invalidate, or supersede any such other guaranty. It is anticipated that fluctuations may occur in the aggregate amount of Indebtedness covered by this Guaranty, and Guarantor specifically acknowledges and agrees that reductions in the amount of Indebtedness, even to zero dollars ($0.00), prior to Guarantor's written revocation of this Guaranty shall not constitute a termination of this Guaranty. This Guaranty is binding upon Guarantor and Guarantor's heirs, successors and assigns so long as any of the guaranteed Indebtedness remains unpaid and even though the Indebtedness guaranteed may from time to time be zero dollars ($0.00). OBLIGATIONS OF MARRIED PERSONS. Any married person who signs this Guaranty hereby expressly agrees that recourse under this Guaranty may be had against both his or her separate property and community property. GUARANTOR'S AUTHORIZATION TO LENDER. Guarantor authorizes Lender, either before or after any revocation hereof, without notice or demand and without lessening Guarantor's liability under this Guaranty, from time to time: (A) prior to revocation as set forth above, to make one or more additional secured or unsecured loans to Borrower, to lease equipment or other goods to Borrower, or otherwise to. extend additional credit to Borrower; (B) to alter, compromise, renew, extend, accelerate, or otherwise change one or more times the time for payment or other terms of the Indebtedness or any part of the Indebtedness, including increases and decreases of the rate of interest on the Indebtedness; extensions may be repeated and may be for longer than the original loan term; (C) to take and hold security for the payment of this Guaranty or the Indebtedness, and exchange, enforce, waive, subordinate, fail or decide not to perfect, and release any such security, with or without the substitution of new collateral; (D) to release, substitute, agree not to sue; or deal with any one or more of Borrower's sureties, endorsers, or other guarantors on any terms or in any manner Lender may choose; (E) to determine how, when and what application of payments and credits shall be made on the Indebtedness (F) to apply such security and direct the order or manner of sale thereof, including without limitation, any nonjudicial sale permitted by the terms of the controlling security agreement or deed of trust, as Lender in its discretion may determine; (G) to sell, transfer, assign or grant participations in all or any part of the Indebtedness; and (H) to assign or transfer this Guaranty in whole or in part. GUARANTOR'S REPRESENTATIONS AND WARRANTIES. Guarantor represents and warrants to Lender that (A) no representations or agreements of any kind have been made to Guarantor which would limit or qualify in any way the terms of this Guaranty; (B) this Guaranty is executed at Borrower's request and not at the request of Lender; (C) Guarantor has full power, right and authority to enter into this Guaranty; (D) the provisions of this Guaranty do not conflict with or result in a default under any agreement or other instrument binding upon Guarantor and do not result in a violation of any law, regulation, court decree or order applicable to Guarantor; (E) Guarantor has not and will not, without the prior written consent of Lender, sell, lease, assign, encumber, hypothecate, transfer, or otherwise dispose of all or substantially all of Guarantor's assets, or any interest therein; (F) upon Lender's request, Guarantor will provide to Lender financial and credit information in form acceptable to Lender, and all such financial information which currently has been, and all future financial information which will be provided to Lender is and will be true and correct in all material respects and fairly present Guarantor's financial condition as of the dates the financial information is provided; (G) no material adverse change has occurred in Guarantor's financial condition since the dale of the most recent financial statements provided to Lender and no event has occurred which may materially adversely affect Guarantor's financial condition; (H) no litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Guarantor is pending or threatened; (I) Lender has made no representation to Guarantor as to the creditworthiness of Borrower; and (J) Guarantor has established adequate means of obtaining from Borrower on a continuing basis information regarding Borrower's financial condition. Guarantor agrees to keep adequately informed from such means of any facts, events, or circumstances which might in any way affect Guarantor's risks under this Guaranty, and Guarantor further agrees that, absent a request for information, Lender shall have no obligation to disclose to Guarantor any information or documents acquired by Lender in the course of its relationship with Borrower. GUARANTOR'S FINANCIAL STATEMENTS. Guarantor agrees to furnish Lender with the following: Annual Statements. As soon as available, but in no event later than thirty (30) days after the end of each fiscal year, Guarantor's balance sheet and income statement for the year ended, prepared by Guarantor. Tax Returns. As soon as available, but in no event later than thirty (30) days after the applicable filing date for the tax reporting period ended, Federal and other governmental tax returns, prepared by Guarantor. All financial reports required to be provided under this Guaranty shall be prepared in accordance with GAAP, applied on a consistent basis, and certified by Guarantor as being true and correct. GUARANTOR'S WAIVERS. Except as prohibited by applicable law, Guarantor waives any right to require Lender to (A) make any presentment, protest, demand, or notice of any kind, including notice of change of any terms of repayment of the Indebtedness, default by Borrower or any other guarantor or surety, any action or nonaction taken by Borrower, Lender, or any other guarantor or surety of Borrower, or the creation of new or additional Indebtedness; (B) proceed against any person, including Borrower, before proceeding against Guarantor; (C) proceed against any collateral for the Indebtedness, including Borrower's collateral, before proceeding against Guarantor; (D) apply any payments or proceeds received against the Indebtedness in any order; (E) give notice of the terms, time, and place of any sale of the collateral pursuant to the Uniform Commercial Code or any other law governing such sale; (F) disclose any information about the Indebtedness, the Borrower, the collateral, or any other guarantor or surety, or about any action or nonaction of Lender; or (G) pursue any remedy or course of action in Lender's power whatsoever. COMMERCIAL GUARANTY Loan No: 1805520002 (Continued) Page 2 ================================================================================ Guarantor also waives any and all rights or defenses arising by reason of (H) any disability or other defense of Borrower, any other guarantor or surety or any other person; (I) the cessation from any cause whatsoever, other than payment in full, of the Indebtedness; (J) the application of proceeds of the Indebtedness by Borrower for purposes other than the purposes understood and intended by Guarantor and Lender; (K) any act of omission or commission by Lender which directly or indirectly results in or contributes to the discharge of Borrower or any other guarantor or surety, or the Indebtedness, or the loss or release of any collateral by operation of law or otherwise; (L) any statute of limitations in any action under this Guaranty or on the Indebtedness; or (M) any modification or change in terms of the Indebtedness, whatsoever, including without limitation, the renewal, extension, acceleration, or other change in the time payment of the Indebtedness is due and any change in the interest rate, and including any such modification or change in terms after revocation of this Guaranty on Indebtedness incurred prior to such revocation. Guarantor waives all rights and any defenses arising out of an election of remedies by Lender even though that the election of remedies, such as a non-judicial foreclosure with respect to security for a guaranteed obligation, has destroyed Guarantor's rights of subrogation and reimbursement against Borrower by operation of Section 580d of the California Code of Civil Procedure or otherwise. Guarantor waives all rights and defenses that Guarantor may have because Borrower's obligation is secured by real property. This means among other things: (1) Lender may collect from Guarantor without first foreclosing on any real or personal property collateral pledged by Borrower. (2) If Lender forecloses on any real property collateral pledged by Borrower: (a) the amount of Borrower's obligation may be reduced only by the price for which the collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price. (b) Lender may collect from Guarantor even if Lender, by forclosing on the real property collateral, has destroyed any right Guarantor may have to collect from Borrower. This is an unconditional waiver of any rights and defenses Guarantor may have because Borrower's obligation is secured by real property. These rights and defenses include, but are not limited to, any rights and defenses based upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure. Guarantor understands and agrees that the foregoing waivers are waivers of substantive rights and defenses to which Guarantor might otherwise be entitled under state and federal law. The rights and defenses waived include, without limitation, those provided by California laws of suretyship and guaranty, anti-deficiency laws, and the Uniform Commercial Code. Guarantor acknowledges that Guarantor has provided these waivers of rights and defenses with the intention that they be fully relied upon by Lender. Until all Indebtedness is paid in full, Guarantor waives any right to enforce any remedy Lender may have against the Borrower or any other guarantor, surety, or other person, and further, Guarantor waives any right to participate in any collateral for the Indebtedness now or hereafter held by Lender. In addition to the waivers set forth above, If now or hereafter Borrower is or shall become insolvent and the Indebtedness shall not at all times until paid be fully secured by collateral pledged by Borrower, Guarantor hereby forever waives and gives up in favor of Lender and Borrower, and Lender's and Borrower's respective successors, any claim or right to payment Guarantor may now have or hereafter have or acquire against Borrower, by subrogation or otherwise, so that at no time shall Guarantor be or become a "creditor" of Borrower within the meaning of 11 U.S.C. section 547(b), or any successor provision of the Federal bankruptcy laws. GUARANTOR'S UNDERSTANDING WITH RESPECT TO WAIVERS. Guarantor warrants and agrees that each of the waivers set forth above is made with Guarantor's full knowledge of its significance and consequences and that, under the circumstances, the waivers are reasonable and not contrary to public policy or law. If any such waiver is determined to be contrary to any applicable law or public policy, such waiver shall be effective only to the extent permitted by law or public policy. SUBORDINATION OF BORROWER'S DEBTS TO GUARANTOR. Guarantor agrees that the Indebtedness of Borrower to Lender, whether now existing or hereafter created, shall be superior to any claim that Guarantor may now have or hereafter acquire against Borrower, whether or not Borrower becomes insolvent. Guarantor hereby expressly subordinates any claim Guarantor may have against Borrower, upon any account whatsoever, to any claim that Lender may now or hereafter have against Borrower. In the event of insolvency and consequent liquidation of the assets of Borrower, through bankruptcy, by an assignment for the benefit of creditors, by voluntary liquidation, or otherwise, the assets of Borrower applicable to the payment of the claims of both Lender and Guarantor shall be paid to Lender and shall be first applied by Lender to the Indebtedness of Borrower to Lender. Guarantor does hereby assign to Lender all claims which it may have or acquire against Borrower or against any assignee or trustee in bankruptcy of Borrower; provided however, that such assignment shall be effective only for the purpose of assuring to Lender full payment in legal tender of the Indebtedness. If Lender so requests, any notes or credit agreements now or hereafter evidencing any debts or obligations of Borrower to Guarantor shall be marked with a legend that the same are subject to this Guaranty and shall be delivered to Lender. Guarantor agrees, and Lender is hereby authorized, in the name of Guarantor, from time to time to execute and file financing statements and continuation statements and to execute such other documents and to take such other actions as Lender deems necessary or appropriate to perfect, preserve and enforce its rights under this Guaranty. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Guaranty: Amendments. This Guaranty, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Guaranty. No alteration of or amendment to this Guaranty shall be effective unless given In writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. Attorneys' Fees; Expenses. Guarantor agrees to pay upon demand all of Lenders costs and expenses, including Lender's attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Guaranty. Lender may hire or pay someone else to help enforce this Guaranty, and Guarantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Guarantor also shall pay all court costs and such additional fees as may be directed by the court. Caption Headings. Caption headings in this Guaranty are for convenience purposes only and are not to be used to interpret or define the provisions of this Guaranty. Governing Law. This Guaranty will be governed by, construed and enforced in accordance with federal law and the laws of the State of California. This Guaranty has been accepted by Lender in the State of California. Integration. Guarantor further agrees that Guarantor has read and fully understands the terms of this Guaranty; Guarantor has had the opportunity to be advised by Guarantor's attorney with respect to this Guaranty; the Guaranty fully reflects Guarantor's intentions and parol evidence is not required to interpret the terms of this Guaranty. Guarantor hereby indemnifies and holds Lender harmless from all losses, claims, damages, and costs (including Lender's attorneys' fees) suffered or incurred by Lender as a result of any breach by Guarantor of the warranties, representations and agreements of this paragraph. Interpretation. In all cases where there is more than one Borrower or Guarantor, then all words used in this Guaranty in the singular shall be deemed to have been used in the plural where the context and construction so require; and where there is more than one Borrower named in this Guaranty or when this Guaranty is executed by more than one Guarantor, the words "Borrower" and "Guarantor" respectively shall mean all and any one or more of them. The words "Guarantor," "Borrower;" and "Lender" include the heirs, successors, assigns, and transferees of each of them. If a court finds that any provision of this Guaranty is not valid or should not be enforced, that fact by itself will not mean that the rest of this Guaranty will not be valid or enforced. Therefore, a court will enforce the rest of the provisions of this Guaranty even if a provision of this Guaranty may be found to be invalid or unenforceable. If any one or more of Borrower or Guarantor are corporations, partnerships, limited liability companies, or similar entities, it is not necessary for Lender to inquire into the powers of Borrower or Guarantor or of the officers, directors, partners, managers, or other agents acting or purporting to act on their behalf, and any Loan indebtedness made or created in reliance upon the professed exercise of such powers shall be guaranteed under this Guaranty. Notices. Any notice required to be given under this Guaranty shall be given in writing, and, except for revocation notices by Guarantor, shall be effective when actually delivered, when actually received by telefacsimile (unless otherwise required by law), when deposited with a nationally recognized overnight courier, or, if mailed, when deposited in the United States mail, as first class, certified or registered mail postage prepaid, directed to the addresses shown near the beginning of this Guaranty. All revocation notices by Guarantor shall be in writing and shall be effective upon delivery to Lender as provided in the section of this Guaranty entitled "DURATION OF GUARANTY." Any party may change its address for notices under this Guaranty by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. For notice purposes, Guarantor agrees to keep Lender informed at all times of Guarantor's current address. Unless otherwise provided of required by law, if there is more than one Guarantor, any notice given by Lender to any Guarantor is deemed to be notice given to all Guarantors. No Waiver by Lender. Lender shall not be deemed to have waived any rights under this Guaranty unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Guaranty shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Guaranty. No prior waiver by Lender, nor any course of dealing between Lender and Guarantor, shall constitute a waiver of any of Lender's rights or of any of Guarantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Guaranty, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender. Successors and Assigns. Subject to any limitations stated in this Guaranty on transfer of Guarantor's interest, this Guaranty shall be binding upon and inure to the benefit of the parties, their successors and assigns. ADDITIONAL PROVISIONS. "Guarantor waives its rights of subrogation, reimbursement, indemnification, and contribution and any other rights and COMMERCIAL GUARANTY Loan No: 1805520002 (Continued) Page 3 ================================================================================ defenses that are or may become available to the guarantor by reason of California Civil Code Sections 2787 to 2855, inclusive. Guarantor waives all rights and defenses that the guarantor may have because the debtor's debt is secured by real property. This means, among other things: 1. The creditor may collect from the guarantor without first foreclosing on the real or personal property collateral pledged by the debtor. 2. If the creditor forecloses on any real property collateral pledged by the debtor: a) The amount of the debt may be reduced by only the price for which that collateral is sold at the foreclosure sale, even if the collateral Is worth more than the sale price. b) The creditor may collect from the guarantor even if the creditor, by foreclosing on the real property collateral, has destroyed any right the guarantor may have to collect from the debtor. This is an unconditional and irrevocable waiver of any rights and defenses the guarantor may have because the debtor's debt is secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580d, or 726 of the Code of Civil Procedure. Guarantor waives all rights and defenses arising out of an election of remedies by the creditor, even though that election of remedies, such as nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed the guarantor's rights of subrogation and reimbursement against the principal by operation of Section 580d of the Code of Civil Procedure or otherwise." DEFINITIONS. The following capitalized words and terms shall have the following meanings when used in this Guaranty. Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America. Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require. Words and terms not otherwise defined in this Guaranty shall have the meanings attributed to such terms in the Uniform Commercial Code: Borrower. The word "Borrower" means Chipcards, Inc. fka American Pacific Technology Corp. (American Pacific Aviation and Technology Corp.), and all other persons and entities signing the Note in whatever capacity. GAAP. The word "GAAP" means generally accepted accounting principles. Guarantor. The word "Guarantor" means each and every person or entity signing this Guaranty, including without limitation Xiao Qin Jiang. Guaranty. The word "Guaranty" means the guaranty from Guarantor to Lender, including without limitation a guaranty of all or part of the Note. Indebtedness. The word "Indebtedness" means Borrower's indebtedness to Lender as more particularly described in this Guaranty. Lender. The word "Lender" means Trans Pacific National Bank, its successors and assigns. Related Documents. The words "Related Documents" mean all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, security deeds, collateral mortgages, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness. GUARANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS COMMERCIAL GUARANTY AND GUARANTOR AGREES TO ITS TERMS. THIS COMMERCIAL GUARANTY IS DATED SEPTEMBER 5, 2001. GUARANTOR: X Xiao Qin Jiang ------------------------------ Xiao Qin Jiang, Individually ================================================================================ EX-10 10 ex10-48.txt EXHIBIT 10.48 Page 1 of 4 Smart Card Marketplace Smart cards | Usage | Markets Smart Cards Smart cards will be the key to allow consumers' to connect between numerous wired and wireless devices by providing user identification, authentication and security, and enabling electronic transactions. Smartcards are mobile billboards, engender loyalty and can be co-branded and are able to provide a secure transaction platform - be it in the form of credit, debit, or stored value (e-purse). Smartcard may incorporate Elliptic Curve Cryptography (ECC) key pairs or any other security algorithm in a wireless framework that can be deployed globally and by using the Funge dual slot mobile phone accessory these features of a smartcard can be delivery wirelessly. The smart card could carry a number of option features, a magnetic stripe, bar code, biometric identification, and the like. Smartcards can also operate in a contactless environment inside the Funge'TM' dual slot accessory enables smartcard transactions to be delivered over wireless networks including applications in the healthcare, transportation, and finance markets. Smart Card Usage Smart cards can be used to improve privacy, reduce fraud, increase profits, and cut costs. The smart card market is growing at close to 50% a year and as many as three to four billion smart cards will be issued in the year 2000 compared with the eight hundred million issued in 1996. Although many people are already using smart cards in some shape or form - the ubiquitous phone card, the Mondex cash card, certain customer loyalty cards, and mobile phones - most have no idea what a smart card actually is and how the "plastic card containing a silicon chip" will change their lives. In addition to the use of smart cards in the financial sector to reduce fraud and increase security, there are a number of other areas in which smart card usage will increase profits, and reduce costs, including: national ID, passports, mobile telecommunications, home entertainment, public telephones, public transport, utilities, leisure, government benefits, road tolls, local government, health care, education, employee cards, military applications, customer loyalty and fleet administration. One possible financial development is a variation on the electronic purse in which the smart wallet with a built-in modem interface acting as the 'ATM in your pocket' will enable the bank to download funds to the wallet holder's stored value smart card. A mobile phone (which already contains a smart card, storing personal information and increasing security) might also be used as a portable smart card terminal and there are (3) three items that are currently taking top priority with manufacturers of smart cards: 1. Linking smart cards with PC technology, which will enable smart cards to have far wider applications. 2. Finding a common operating system (such as Java or Multos) meaning that cards can be both multi-functional and usable on different operating systems. Page 2 of 4 3. Developing cards with crypto-processors to offer public key encryption, to meet demands for the highest levels of security for payments via the Internet or PC. Smart Card Worldwide Market Update The relentless advance of the smart cards market continues: growth in 1998 was at 33 percent and expected growth in 1999 is at 29 percent. Outside of the memory phone card volumes, the real market jewel was still the digital wireless telecommunications (GSM) application, which accounted for over 38 percent of worldwide revenues. So what really changed in the last year? Largely it was a sense in the market that if we were not really out of the market canyon funk yet, we as an industry were dealing with it head on. Gemplus, Schlumberger, and Gieseke & Devrient largely finished their reorganizations -- with the last bit of the reorg being Daniel LeGal, former head of Gemplus, leaving under mutual agreement. Oberthur bought spicy De La Rue, and in one swift move reinvigorated itself for future competition. Despite these moves, the money still would belong to software with card prices still steep in decline, even in the beloved GSM vertical market. In the chip markets, Siemens became Infineon and still led the market in market share, though ST Micro still overwhelmed with its sale of microcontrollers. Atmel showed its muscles by acquiring the former Motorola smart card chip division in addition to being one of the two qualified silicon platforms for the Windows OS. Philips Semiconductors still pushed on as customers embraced the XA crypto machine in key markets such as pay TV and banking. Lastly, the industry welcomed the first real 32-bit core courtesy of NEC, who showed silicon at Cartes and is expected to go to mass production in Q1 2000. Other 32-bit cores are estimated to be available by Q3 2000. Worldwide Smart Cards Market [GRAPH] On the software side, we saw Java begin to dig its nails into the GSM market as Java SIM cards exploded onto the market with approximately over 10 million sold into Europe. Was Windows doomed? Hardly so - this event was but the first jab, and Microsoft itself no doubt has some tricks up its sleeves, such as already at least 30 trials and projects in Europe and North America using Windows for Smart Cards (and yes, the name is really Windows for Smart Cards and not Smart Cards for Windows, as initially proposed). Then of course MultOS continued its own attack on the market: not only was American Express using MultOS in its first Blue cards, but also several key Japanese banks in their own trials. Words of wisdom then as we go into the year 2000: watch the government market in the United States and the great debut of network access and security smart card markets in that country. Give an eye out to wily ISV and DSC boutiques worldwide like Platform Page 3 of 4 Seven, Cardsoft, and JSource (and also to ACG, a different sort of animal unto itself). Finally, the best of luck to the card vendors who seek to continue their transformation to being software-directed houses. By Alyxia T. Do, Principle Analyst, Frost & Sullivan Smart Cards - Asia Pacific Region The Asian Pacific smart cards market remains vibrant and kicking and what is impressive about the region is not only the number of cards sold which is estimated to have been 150 million in 1998, but the market share the region holds in terms of revenue contribution to the global smart card market. Indeed, the Asia Pacific generated over 17 percent of the worldwide revenues for the smart cards market, coming in second after Europe with 70 percent and beating out Latin America with 7 percent market share. Frost & Sullivan estimates that by 2004, the region will command at least a quarter of the revenue market shares worldwide, with China by itself commanding nearly a third of market. The World Smart Card Market: Regional Market Shares by Revenue 1998 - Frost & Sullivan
Region Market Share (%) ------ ---------------- Latin America 7.0 North America 6.1 Asia Pacific 17.9 Europe 67.1
Source: Frost & Sullivan Research Digital Cellular Phones, Government Programs, and Network Security Driving Applications A quick look at the breakdown of the smart cards market by application in the region also reveals a great diversity of programs and projects. Though phone cards still dominate in terms of units with 50 percent market share, subscriber identification applications (e.g. GSM handsets, pay TV set-top boxes) take the purse with over 66 percent revenue market share in regional card sales. Indeed, the GSM segment has been the honey in the card manufacturer's revenue pot since the early 1990s, and this segment will continue to grow even sweeter. Up until this point, digital cellular SIM card sales have been principally dependent on the growth of the GSM market within Asia Pacific, but in the future SIM cards will find their way dual-frequency phones if the UMTS initiative has anything to do with it. What this means is that smart cards will ride the explosion not only of GSM handset technologies, but also of the CDMA handset technologies. Having a SIM card serve CDMA is a key success factor when considering that cellular phone powerhouses such as Japan and Korea have or are moving towards the CDMA standard. To give an idea of what type of market potential smart cards are looking at, Frost & Sullivan Telecommunications research shows a combined CDMA and GSM handset market forecast of over 200 million handsets to be sold in 2002. Another vertical market of immense interest for the region is the institutional card market, which encompasses card issuance for government, university, and health identification. Despite a hard hit in its economy, Malaysia pleasantly surprises with its continued efforts Page 4 of 4 in the Multimedia Super Corridor project with the intended issuance of a citizen's multiapplication card. Taiwan and Singapore are also key governments pushing nation-wide smart cards. In the university setting, programs such as the University of Hong Kong show technical innovation as students are using their multi-functional combi-cards to do everything from withdraw cash to access campus buildings. And for health identification, the latest project is that of Thailand's SynergyNet which aims to make convert its magnetic stripe medical card network into a smart card one, resulting in a potential market of 5 million cards to be issued in 2002. Given this high level of activity in the institutional smart card markets for Asia, then, it is not a surprise that Frost & Sullivan expects this vertical market to hold 30 percent revenue market share in the region in 2004. The Vertical Markets in the Asian Pacific Smart Card Market: Application Market Shares by Revenue, 1998 & 2004 - Frost & Sullivan
1998 2004 Vertical Market (%) (%) - --------------- --- --- Financial 11 15 Phone Cards 9 13 Subscriber Management (GSM, Pay TV) 66 26 Institutional (Govt, Health, University) 7 30 Network security 1 8 Transportation 7 7 Other 1 1
Finally, though a major thrust of the network authentication market will belong to North America and Europe, the Asian Pacific network security markets nevertheless are likely to do well. From being a market with less than 1 percent unit market share regionally, this vertical market is foreseen to achieve nearly 10 percent unit market share in the next 5 years. Though other two-way authentication hardware methods such as USB tokens are likely to provide stiff competition, smart cards are seen to be the dominant hardware token market for the Asia Pacific. The key target customers in this arena will be the plethora of large electronics and information technology firms located throughout the region. These corporations will not only want to increase security levels in the face of increasing global electronic terrorism and espionage, but also use the smart card in order to take advantage of electronic business-to-business commerce based on intricate and complex intranet, extranet, and Internet models. As a result, the smart card used for network authentication today will tomorrow be a dynamic multi-functional card carrying the necessary programs to enable company workers to engage in on-site secured e-commerce. EX-10 11 ex10-49.txt EXHIBIT 10.49 New Report Shows How Smart Cards Can Be Used To Improve Privacy, Reduce Fraud, Increase Profits And Cut Costs The smart card market is growing at close to 50% a year according to a new edition of the most comprehensive industry research report, The Smart Card, published today by SJB Research. This means that as many as three to four billion smart cards will be issued in the year 2000 compared with the eight hundred million issued in 1996. Although many people are already using smart cards in some shape or form - the ubiquitous phone card, the Mondex cash card, certain customer loyalty cards, mobile phones - most have no idea what a smart card actually is and how the "plastic card containing a silicon chip" will change their lives. According to The Smart Card, these cards are changing the way in which people live and work and even greater changes can be expected in the years to come. Details of the changes in the industry over the past 18 months, the current status and forecasts of future trends, are covered in four sections of The Smart Card - Technology, Applications, the Structure of the Industry, and the Future: Market Trends and Forecasts. Smart cards are already widely used in the financial sector to reduce fraud and increase security. However, The Smart Card finds that there are a number of other areas in which smart card usage will increase profits, and reduce costs. These are all covered in the report, including: national ID, passports, mobile telecommunications, home entertainment, public telephones, public transport, utilities, leisure, government benefits, road tolls, local government, health care, education, employee cards, military applications, customer loyalty and fleet administration. There are case studies of 63 smart card installations around the world. The Smart Card is available both in printed format (GBP497/ US$849) and on CD-ROM (GBP1,491/ US$2,467). Of the 800 million smart cards produced worldwide in 1996, 625 million were telephone cards. "However, other applications are increasingly coming to the fore, especially in the financial sector" says David Jones, co-author of The Smart Card. "For example, in France, all 21 million banking cards are now smart cards; Germany has issued 55 million bank cards; in the UK, trials of bank cards incorporating chips are now taking place in Northampton and Dunfermline, and if successful, a national roll-out will begin in 1998, involving the issue of ninety million chip-based credit, debit, charge and ATM cards." The Smart Card suggests that one possible financial development is a variation on the electronic purse (already trialed in the UK by Mondex in Swindon). "The smart wallet with a built-in modem interface acting as the "ATM in your pocket" will enable the bank to download funds to the wallet holder's stored value smart card". A mobile phone (which already contains a smart card, storing personal information and increasing security) might also be used as a portable smart card terminal. In the US, one of the strongest growth areas is likely to be the Campus Card - a single card which has multiple functions. For instance, it can be used as an ID card, a payment card (for cafeterias, launderettes etc) and as an access card to buildings and computer networks. Such cards are currently being trialed at a number of universities around the world, including Exeter University in the UK, City University of Hong Kong and Newcastle University in Australia. Rapid expansion is expected in Asia (particularly in South-East Asia), where the continent's percentage of the world market is set to rise to three times its present amount by the year 2000. The Smart Card comments that "this growth is being influenced by the active encouragement of governments - in Malaysia and Singapore, for instance". Contrary to what you might expect, Japan is not yet a growth area, as consumers and banks remain happy with cash. In the Third World, smart cards have great potential as they offer the opportunity to overcome poorly developed telecommunications, ponderous means of payment and paper-heavy public records (for health, social security and ID). According to The Smart Card, three items are currently taking top priority with manufacturers of smart cards: linking smart cards with PC technology, which will enable smart cards to have far wider applications; finding a common operating system (such as Java or Multos) meaning that cards can be both multi-functional and usable on different operating systems: and developing cards with cryptoprocessors to offer public key encryption, to meet demands for the highest levels of security for payments via the Internet or PC. Co-authored by the editor of Ctt (formerly Card Technology Today), David Jones, and published by SJB Research, the specialist market information provider, The Smart Card is a truly comprehensive research report, highly esteemed in the industry for its ability to both communicate to the beginner the essential technologies and techniques underlying a successful smart card system, and to act as a signpost to the road ahead for even the most experienced smart card expert. Its 323 pages contain: 66 tables; 31 figures; tabulated details of 425 applications; details of 238 suppliers; contact details for over 280 companies; and 63 case studies of smart card installations around the world. It is available in both printed and CD-ROM format. For further information or to see the complete contents list of The Smart Card, please contact: Emma Newham, SJB Research, Bank Chambers, Langport, Somerset TA10 9PD, UK. Tel: +44 1458 253344, Fax: +44 1458 253366. E-mail: enewham@sjbresearch.com. http://www.sjbresearch.com EX-10 12 ex10-50.txt EXHIBIT 10.50 ROSS H. MANDELL C/O SKY CAPITAL HOLDINGS, LTD. 110 WALL STREET NEW YORK, NEW YORK, 10005 December 20, 2001 The Thornwater Company, L.P. 99 Wall Street New York, New York 10005 ATTN: Robert Grabowski RE: Consulting Agreement dated January 29, 2001 ("Consulting Agreement") Gentlemen: Reference is made to the Consulting Agreement. By your signature below it is agreed that the Consulting Agreement is terminated effective with the close of business, New York local time on December 31, 2001, on and subject to the terms and conditions of this letter. Except as expressly set forth in Paragraph 5 of the Consulting Agreement, subsequent to the termination neither party will have any further obligations or liabilities to the other pursuant to the Consulting Agreement. Any and all obligations and liabilities of the parties under the Consulting Agreement which arose or accrued prior to the effective date of the termination shall be unaffected by the termination. Very truly yours, Ross H. Mandell Ross H. Mandell Agreed and accepted: The Thornwater Company, L.P. By: Robert Grabowski ---------------------------------- Robert Grabowski, an authorized Signatory of the General Partner EX-10 13 ex10-51.txt EXHIBIT 10.51 Agreement Regarding Non-Involvement with The Thornwater Company, L.P. STATE OF NEW YORK ) )ss.: COUNTY OF NASSAU ) ROSS H. MANDELL states the following under penalty of perjury: 1. I was a registered representative with The Thornwater Company, L.P. ("Thornwater") until January 2001. Thereafter, I was a consultant to Thornwater pursuant to a written Consulting Agreement dated January 29, 2001. 2. This statement confirms that I resigned as a consultant to Thornwater effective as of December 31, 2001 and have otherwise repudiated the terms of my Consulting Agreement with Thornwater. 3. I confirm that I will not directly or indirectly be involved in, control or otherwise direct Thornwater's business. 4. I further confirm that I have agreed not to subcontract to any person any of the services I will or may perform pursuant to my consulting agreement with Chipcards, Inc. dated January 29, 2001. /s ----------------------------- Ross H. Mandell EX-10 14 ex10-52.txt EXHIBIT 10.52 Agreement Regarding Non-Involvement with Chipcards, Inc. STATE OF NEW YORK ) ) ss: COUNTY OF NASSAU ) ROSS H. MANDELL states the following under penalty of perjury: 1. I am a shareholder of Chipcards, Inc. (the "Company"). I was previously a consultant to the Company pursuant to a written consulting agreement, and was proposed to be a member of its Board of Directors upon the listing of its stock on the Nasdaq SmallCap Market. 2. This statement confirms that my consulting agreement with the Company has been terminated, and that I have agreed not to be an officer, director, employee or consultant to the Company at any time. 3. I confirm that I will not directly or indirectly be involved in, control or otherwise direct the Company's business. Dated: February 11, 2002 Ross H. Mandell ----------------------- Ross H. Mandell EX-10 15 ex10-54.txt EXHIBIT 10.54 TERMINATION OF CONSULTING AGREEMENT THIS TERMINATION OF CONSULTING AGREEMENT (the "Agreement") is entered into by and among American Pacific Technology, Inc. (a/k/a Chipcards, Inc.), a California corporation (the "Company") and Ross H. Mandell (the "Consultant"), on this 23rd day of January, 2002 (the "Execution Date"). Recitals WHEREAS, on March 20, 2000, the Company and the Consultant entered into a Consulting Agreement (the "Consulting Agreement"); and WHEREAS, on October 31, 2001, Mandell sub-contracted a portion of his consulting duties under the Agreement to St. James Holdings, LLC ("St. James") and, as consideration therefor, transferred 500,000 shares of the common stock to St. James; WHEREAS, the parties wish to terminate the Consulting Agreement (including the rights and obligations of St. James) and provide for the payment of $200,000 in cash to the Consultant; and NOW THEREFORE, in consideration of these mutual promises set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: AGREEMENT 1. Termination. Effective as of the date hereof, the Consulting Agreement (including the rights and obligations of St. James thereunder) shall be terminated and shall be of no further force or effect. 2. Payment to Consultant. In consideration of the termination of the Consulting Agreement, the Company agrees to pay to the Consultant $200,000 in immediately available funds by cashiers check or wire transfer to an account designated by Consultant. Such payment shall be made on the date of the closing of the Company's initial public offering or any private offering in which the Company receives net proceeds of $4,000,000 or more. 3. Effect of Termination. Notwithstanding the termination of the Consulting Agreement, the Company acknowledges that all consideration previously delivered to the Consultant (including by operation of Paragraph 3 of the Consulting Agreement) shall be deemed earned and the Consultant shall retain all right, title and interest to such consideration. 4. Governing Law. This Agreement, and the legal relations between the parties, shall be governed by, and construed in accordance with, the substantive laws of the state of New York. 5. Representations and Warranties. The Company has the full power and authority to execute, deliver and perform this Agreement. This Agreement when executed and delivered by the Company will constitute a valid and legally binding obligation of the Company, enforceable in accordance with its terms. 6. Counterparts. The Agreement may be executed in any number of counterparts, or duplicate originals, both of which shall be regarded as one and the same instrument, and which are the official and governing version of the interpretation of this Agreement. 7. Entire Agreement. This Agreement supercedes all prior written and oral understandings, promises, and agreements between the parties hereto with respect to the Consultant's employment with the Company. This Agreement constitutes the entire agreement between the parties hereto with respect to the Consultant's employment with the Company, and may be amended, waived, modified or superseded only by a written agreement signed by both parties hereto and is binding on the parties hereto and their respective successors, assigns, and personal representatives. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written. COMPANY: American Pacific Technology Inc. (a/k/a Chipcards.com Inc.) Allen Yue ----------------------------------- Allen Yue President CONSULTANT: Ross H. Mandell ---------------------------------- Company will constitute a valid and legally binding obligation of the Company, enforceable in accordance with its terms. 6. Counterparts. The Agreement may be executed in any number of counterparts, or duplicate originals, both of which shall be regarded as one and the same instrument, and which are the official and governing version of the interpretation of this Agreement. 7. Entire Agreement. This Agreement supercedes all prior written and oral understandings, promises, and agreements between the parties hereto with respect to the Consultant's employment with the Company. This Agreement constitutes the entire agreement between the parties hereto with respect to the Consultant's employment with the Company, and may be amended, waived, modified or superseded only by a written agreement signed by both parties hereto and is binding on the parties hereto and their respective successors, assigns, and personal representatives. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written. COMPANY: American Pacific Technology Inc. (a/k/a Chipcards.com Inc.) -------------------------------- Name: Title: CONSULTANT: Ross H. Mandell Ross H. Mandell ------------------------------- EX-23 16 ex23-8.txt EXHIBIT 23.8 Consent of Independent Certified Public Accountants Board of Directors Chipcards, Inc. San Francisco, California We hereby consent to the use in the Prospectus constituting a part of Amendment 2 to this Registration Statement of our report dated February 6, 2002, relating to the combined financial statements of Chipcards, Inc., which is contained in that Prospectus. We also consent to the reference to us under the caption "Experts" in the Prospectus. /s/ BDO Seidman, LLP San Francisco, California May 10, 2002 -----END PRIVACY-ENHANCED MESSAGE-----