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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2002

OR

For the transition period from            to            

Commission File Number 000-30612

ACTIVCARD S.A.

(Exact name of Registrant as specified in its charter)

6623 Dumbarton Circle, Fremont, California 94555

(Address of principal executive offices including Zip code)

(510) 574-0100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Shares (par value Euro 1.00)

(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  ¨  NO  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  YES  x  NO  ¨

As of June 30, 2002 the aggregate market value of voting and non-voting stock held by non-affiliates of ActivCard S.A. was approximately $216,230,000, based on the closing price of its securities Common Stock as reported on the Nasdaq National Market on such date. Shares held by officers, directors and holders of more than 10% of our outstanding securities have been excluded from this calculation because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of common shares and American depositary shares outstanding on April 30, 2003 was approximately 42,033,301.

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EXPLANATORY NOTE:

In August 2002, ActivCard S.A. formed a new entity, ActivCard Corp., a Delaware corporation, to undertake a registered exchange offer for the purpose of moving the domicile of the publicly listed entity in the ActivCard group of companies from the Republic of France to the State of Delaware in the United States. The exchange offer closed on February 3, 2003, with ActivCard Corp. acquiring 94.8% of the outstanding ActivCard S.A. securities. ActivCard S.A. believes it is not currently able to file with the U.S. Securities and Exchange Commission (the “SEC”) a Certificate of Termination of Registration on Form 15 pursuant to Rule 12g-4 of the Securities Exchange Act of 1934 (the “Exchange Act”). As a result, both ActivCard S.A. and ActivCard Corp. are currently required to file periodic and current reports with the SEC pursuant to the Exchange Act.

As of December 31, 2002, the end of the period covered by this report, ActivCard S.A. was a “foreign private issuer” within the meaning of the Exchange Act. As a result, ActivCard S.A. is required to file an annual report with the SEC and may do so on Form 20-F. Because ActivCard Corp. has already prepared and filed an annual report on Form 10-K for the year ended December 31, 2002, ActivCard S.A. has elected to satisfy its annual reporting obligations on this Form 10-K.

Unless otherwise expressly indicated, references to the “Company”, “ActivCard”, “we”, “us” and “our” refer to the consolidated group of ActivCard companies, excluding ActivCard Corp.

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and certain information incorporated herein by reference contain forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Annual Report on Form 10-K, other than statements that are purely historical, are forward-looking statements. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions also identify forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements. Forward-looking statements in this Annual Report on Form 10-K include, without limitation, statements regarding operating results, product development, marketing initiatives, business plans and anticipated trends. The forward-looking statements in this Annual Report on Form 10-K are subject to additional risks and uncertainties further discussed under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors” and are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K.

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PART I

ITEM 1.    BUSINESS

General

ActivCard Corp. was incorporated in the State of Delaware in August 2002 for the purpose of changing the domicile of the publicly listed company in the ActivCard group of companies, previously ActivCard S.A., from the Republic of France to the United States. ActivCard S.A. was organized in 1988 as a société anonyme, or limited liability corporation, under the laws of the Republic of France. On January 6, 2003 ActivCard Corp. commenced a registered public exchange offer in which holders of ActivCard S.A. securities were asked to exchange each ActivCard S.A. common share and each ActivCard S.A. American depositary share (“ADS”) they held for one share of ActivCard Corp. common stock. The registered exchange offer closed on February 3, 2003 with 24,409,937 common shares and 15,417,729 ADS’s exchanged for an equivalent number of shares of ActivCard Corp. common stock. The exchanged common shares and ADS’s represented 94.8% of the outstanding securities of ActivCard S.A. Because the financial statements set forth in this Annual Report on Form 10-K present financial data for periods preceding the change in domicile, these financial statements present the financial position and results of operations and cash flows for ActivCard S.A. Unless otherwise indicated, references to “ActivCard”, “we”, “us” and “our” refer to the consolidated group of ActivCard companies.

From our founding in 1988 until 1994, we provided software and hardware engineering services for defense-related companies, government agencies and multilateral institutions and developed, manufactured and sold customized portable products, similar in form to tokens, for large-scale applications, such as interactive television. At this time, we decided to devote our resources principally to the development of computer and communications network security products and contract engineering services. The first ActivCard token and software development kit products were introduced in 1995 and we developed the ActivPack authentication server software in 1996. In early 1997, we chose to focus our efforts as a provider of products, rather than engineering services, to enhance our gross margins and leverage our engineering investments. In January 1999, we introduced ActivCard Gold, a smart card-based client solution for digital identification.

In January 2002, we acquired certain assets from two privately held companies based in South Africa for $1.2 million. The underlying assets purchased and liabilities assumed comprised a business that develops and markets biometric authentication systems and related software development kits.

In February 2002, we executed a plan to dispose of the hosting operations of Authentic8. As a result of our decision to dispose of these operations, we recorded a $16.8 million charge to earnings in 2002, which was comprised of an impairment of goodwill and other intangibles of $15.0 million, a write-down of property and equipment of $645 thousand and an operating loss of $1.2 million.

Throughout 2002, we restructured operations to enhance operational efficiency and better align our cost structure with expected revenues. As a result, we recorded restructuring and business realignment costs of $8.6 million, which consisted of $2.6 million of severance and other costs associated with the termination of 90 employees, facility exit costs of $6.0 million, consisting primarily of approximately nine years of minimum lease payments due under certain excess facilities lease agreements, net of estimated sublease revenue and other direct costs.

In February, 2003, we entered into an agreement with VeriSign for the disposition of the assets and certain liabilities of the hosting operations of Authentic8.

Also in February 2003, William Crowell and Richard White were elected to serve on our Board of Directors.

Our headquarters are located at 6623 Dumbarton Circle, Fremont, California, 94555. The telephone number is (510) 574-0100. Additional information about ActivCard is available on our website at www.activcard.com. We will make available on our website free of charge our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and any amendments to those Reports filed or furnished

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pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with and furnish them to the Securities and Exchange Commission, or the SEC. Information contained on our website is not part of this Annual Report on Form 10-K or our other filings with the SEC.

Business Overview

We develop, market and support digital identity systems and products that enable our customers to issue, use and maintain digital identities in a secure, manageable and reliable manner. Our systems and products include software and hardware products that facilitate the authentication of a user to a network, a system or an application through a number of different personal security devices, such as a smart card, token, biometric device, mobile phone or personal digital assistant. Our customers have a broad range of applications and systems with specific security and digital identity requirements. Each of these applications or systems typically has a separate and distinct database and administrator. Our systems support a broad range of authentication methods including passwords, public key infrastructure, remote network-access login, biometrics, multi-function smart cards and multi-function smart cards with picture identification that can also be used for physical access control. For example, combining certain of our Company’s products, such as ActivCard tokens and ActivPack authentication server software provides a customer with a single function security system for remote network access login.

Alternatively, combining a smart card, a card reader, ActivCard Java Applets, ActivCard Gold client software and the ActivCard Identity Management System creates a single platform that provides a customer with multi-function capabilities that can support a broad range of security requirements, as well as personal information about the user. By consolidating these credentials and applications onto a single personal security device, such as a smart card or mobile phone, security is increased because the user need only manage a single personal security device as opposed to multiple devices for each database. By taking advantage of the programmable capabilities of the chip residing on the smart card, system administrators have the ability to manage the credentials stored on the smart card remotely. Further, by consolidating the credentials on a smart card, system administrators only need to manage a single device instead of many devices.

Our products enhance network security by providing two-factor authentication, which is combining something a user has, such as a personal security device like a smart card or a token, with something a user knows, such as a PIN. The two factors are required to access a network. The network service provider or system administrator authenticates a user’s personal security device to the network database, gaining increased assurance that the person utilizing the network service or application is who they say they are.

Our products are based on an open architecture and are designed to be inter-operable across a complex mix of systems and applications. Organizations deploying our products have the flexibility to offer diverse services and to select from different deployment strategies and providers of various authentications technologies, card operating systems, directory services, certificate authorities and network management systems.

We sell our products directly to end user customers and indirectly through distribution partners, such as system integrators, original equipment manufacturers (OEMs), value-added resellers (VARs), and distributors. We have strategic relationships with Northrop Grumman, Sun Microsystems, Schlumberger, EDS, Novell and VeriSign.

We market our digital identity systems to government entities, financial institutions and other enterprises including telecommunications, healthcare, networking technology and manufacturing companies.

We have two operating segments: Digital Identity Solutions and Managed Authentication Services. For each of the years ended December 31, 2002 and 2001, greater than 99% of the revenues were from the Digital Identity Solutions segment. For the year ended December 31, 2000, 100% of the revenues were from the Digital Identity Solutions Segment.

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Revenues by geographic market were as follows:

The following table represents customers that exceeded 10% of our revenues for the periods reported:

An increasing proportion of our revenues come directly or indirectly from the U.S. government. U.S. government customers have historically demonstrated a tendency to increase purchases in the third quarter of a calendar year in connection with the end of the U.S. government fiscal year and decrease purchases in the fourth quarter of a calendar year. We have experienced this form of seasonality in the past and anticipate to experience this in the future, as well.

As with many companies that have a substantial presence in Europe, we also experience seasonality in our business in the third quarter of the calendar year due to the traditional slowdown of economic activity throughout Europe in the summer months.

If, as anticipated, our revenues reflect an increasing proportion of software licenses in the future, we may experience another form of seasonality typical of other software companies. Software customers have a tendency to delay purchases until the fourth quarter as driven by an annual budgetary process. This typically causes first quarter revenues to be lower than the previous fourth quarter revenues. Although we have not experienced such seasonality in the past, we may in the future.

As a substantial proportion of our operating expenses are fixed, a small variation in the timing of recognition of revenue can cause significant variations in operating results from quarter to quarter.

Industry background

Networks currently enable people, businesses, governments and other entities to communicate, conduct commerce, access and share information, entertain, provide services and conduct countless other activities. Individuals and organizations are now using computer networks for increasingly sensitive tasks, such as attracting new customers, accessing new markets, improving customer service and satisfaction, and lowering support and distribution costs. The use of computer networks is extending to a number of more valuable and sensitive activities, including business-to-business transactions, electronic data interchange (EDI) and on-line retail purchases and payments. On-line companies have enjoyed dramatic growth in their customer base and revenue as consumers execute an increasing number of transactions over the network.

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As networks expand, new devices are introduced, new applications are developed and network transactions continue to proliferate. Networking technologies, including wireless technologies, will further enable communication and the sharing of information, for example, between devices and appliances without interaction from human beings.

The proliferation of network computing and the extension of corresponding network services to a user involve a relationship between a user and a network service provider or system administrator. A network service provider can generally be defined as a provider of a service, for example on-line banking, and the user, in this example, a bank’s customer. Together, the user and the network service provider form a trusted community, where the network service provider extends access or capabilities for a service through a network to the user. The network service provider needs assurance of the identity and security of the user being served. Further, the user of a network service must gain assurance that his or her privacy or personal information is not being compromised when transacting over the network. A network service provider will only provide a service and a user will only conduct transactions over a network if the following is achieved:

Historically, network access control issues have been addressed by security products and solutions. While security is a significant factor when transacting over networks, customers are increasingly looking for broader product solutions that provide multi-function and multi-service capabilities compared to single function solutions, seamless integration of multiple applications onto existing network infrastructure and the preservation of existing network infrastructure investment. Investment in the build-out of private, public and hybrid networks has been substantial in recent years as applications for users have proliferated and network features and functionalities have been introduced. However, the administrative complexity of a network is typically compounded by the variety of systems in place for each of its services and applications. Network administrators are faced with a multitude of challenges when overlaying applications and services on to their networks. Today, network administrators require digital identity solutions that:

The ActivCard solution

We have developed a broad range of products based on open standards that provide customers with increased assurance that users are who they say when logging on to a network. ActivCard’s personal security

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devices, such as a smart card or token, bind the user to a credential that they can carry with them. This enables organizations to adopt more efficient network based processes with increased security.

ActivCard digital identity software allows organizations to remotely initialize, personalize, and manage user credentials and applications before and after issuance of a personal security device. This complete lifecycle management capability enables organizations to offer uninterrupted user services. With ActivCard digital identity systems, organizations can consolidate multiple credentials, applications, policies, and profiles used to access a variety of network services.

Organizations use ActivCard technology to offer a variety of network services including:

Business strategy

Our objective is to become the leading supplier of digital identity systems, enabling organizations to integrate digital identity services quickly and efficiently into their applications. To achieve this objective, we are pursuing the following principal strategies:

Expand our base of strategic partners, system integrators, OEMs and distributors.    We are committed to expanding our base of strategic partners, system integrators, original equipment manufacturers and distributors to ensure that our technology is available on as many servers and software platforms as possible. We have integrated our authentication technology into the network management systems and Internet security suites of industry leaders, such as Microsoft, VeriSign, Sun Microsystems, Schlumberger and Novell. We expect these and our other strategic relationships to provide significant market leverage as the need for managing digital identity systems develops in step with the increase in network transactions and the consequent increased need for security.

Maintain technological leadership in digital identity systems.    We will continue to invest in the development of state-of-the art digital identity systems that are focused on the creation, distribution, protection and control of multiple credentials. We also play a driving role with key industry organizations such as Global Platform, Liberty Alliance, and the Smart Card Alliance.

Make our digital identity system the platform for accessing next generation network services.    We believe that users of network services will increase their usage of the smart card if it is easy-to-use, has appealing applications and protects their personal credentials. We will continue to develop our digital identity system to address user requirements by solving the network service providers’ challenges with respect to card issuance, card management and post-issuance management of applications using two-factor authentication.

Leverage our existing customer base.    We intend to leverage our existing customer base, which has deployed our smart card client software and token-based authentication solutions to more than 5.4 million users worldwide. We will seek to migrate these customers to our new product offerings, including ActivCard Gold and AIMs. We also intend to market our product offerings to new customers by referencing our existing customer base.

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Key benefits

Consolidating personal credentials and applications

Our technology uniquely enables migration and consolidation of multiple credentials and applications onto a single smart card device. This has the principal benefits of:

Updating devices after they have been issued to users

ActivCard provides highly secure systems for managing the entire lifecycle of personal security devices in an open environment. From initialization and personalization to issuance and management, our server products deliver a modular, scalable, network-based system for administering multi-functional personal security devices. Issuers can remotely deploy and update the credentials, applications and data, and instantly enforce network security policies. This can be done without replacing the user device and without disrupting user network services. The ActivCard Identity Management System has the following post-issuance management capabilities:

Enabling multiple system administrators to independently manage content on the same personal security device

ActivCard technology enables multiple database administrators to manage their respective applications independently on a single user device while maintaining privacy and confidentiality. Managing multiple applications on a single personal security device eliminates duplicative expenses. Multiple system administrators can share the cost of a single management system rather than having to pay each for his own personalization, issuance, management and applications systems.

Enabling interoperability

ActivCard products are designed to open industry standards and interoperate across a complex mix of technologies, including smart cards, operating systems, PKI applications, and networks. This enables customers to leverage past and future IT investments.

Our products include authentication products and identity management products.

Authentication products

We have authentication products that enable customers to provide secure access to critical network applications and resources. These products integrate with industry standard network equipment and software applications to provide solutions for LAN, Remote Access, and Web Access. Our authentication products include:

ActivCard Gold, an easy-to-use, easy to install, smart card-based client software package. For corporate environments, ActivCard Gold provides a high level of security to the desktop environment, either for local area

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network access or when users are at remote locations. ActivCard Gold supports industry partners such as Entrust, Microsoft, Baltimore, IPlanet and VeriSign for smart card based e-mail digital signature and PKI applications.

ActivCard Gold for Common Access Card provides the same desktop security features as ActivCard Gold but utilizes a U.S. Department of Defense issued Common Access Card. ActivCard Gold for Common Access Card allows government agencies to leverage a military issued digital ID for network security applications.

ActivCard Trinity, a client/server authentication solution that incorporates smart card, biometrics, tokens, and managed static passwords. Trinity allows customers to manage access to network applications through an administrative interface with advanced security policies. Trinity provides a means for customers to reduce password management costs by providing a single sign-on experience with strong authentication.

ActivPack, a high performance authentication server that supports tokens, smart cards, and USB Keys. Through the use of our dynamic password technology, ActivPack provides secure remote access for customers with Cisco, Nortel, Checkpoint or other industry standard network access systems.

ActivCard Tokens, handheld digital identity devices that provide two-factor authentication for end users. Each device generates a unique one time dynamic password that can be validated by the authentication server. Tokens allow authentication of the user or the server or the validation of a transaction.

ActivReader, a secure smart card reader that offers trusted display and PIN pad enabled applications such as transaction verification, on a secure connected device. ActivReader has been certified compliant with the standard secure electronic transmission protocol used by Europay, MasterCard and Visa International.

Identity management products

ActivCard’s identity management products are based on our large-scale issuance, provisioning and management infrastructure solution, currently in production with the U.S. Department of Defense.

ActivCard Identity Management System has distributed issuance capabilities that can issue thousands of digital identity cards on a daily basis. Unlike legacy card management systems, the ActivCard Identity Management System is able to perform real-time issuance, with high security, over common TCP/IP networks. The ActivCard Identity Management System allows organizations such as large-scale service providers, financial service organizations, corporate enterprises and healthcare benefit providers to seamlessly integrate ActivCard technology into their existing infrastructure and cost effectively deploy, utilize and manage digital identity products.

ActivCard JavaCard Applets are software applications that execute on a smart card chip. ActivCard provides a variety of applications for managing multiple types of credentials including PIN, PKI, dynamic password, biometrics, static passwords and data. Our system integrator partners are able to customize solutions for their customers integrating ActivCard Java Card Applets into their applications.

Services

We also offer customers a variety of services, which range from advanced customer support to supporting system integrators addressing large-scale deployments of our products. We retain a number of industry experts in the field of smart cards, biometrics, authentication, and network security. ActivCard has established a number of programs to help customers successfully plan and manage the deployment of digital identity. In addition, ActivCard offers customization services to adapt our software products for specific customer requirements and to re-brand devices and readers. We also offer support and maintenance services for our software products that typically include telephone support, on-site support, installation and software updates, bug fixes and upgrades depending on the support and maintenance package purchased.

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Sales

We market and sell our products and technologies through a network of distribution partners, such as systems integrators, value-added resellers, original equipment manufacturers and distributors, which are supported by our indirect sales organization. Our sales organization is responsible for soliciting prospective customers and providing technical advice and support with respect to our products and technologies.

We have sales offices in France, Germany, Singapore, Japan, Sweden, United Kingdom, Australia, Canada, South Africa and the United States.

Our system integrators, resellers and distribution partners typically incorporate products from a variety of suppliers to address end user requirements. We currently have over 70 selling partners in over 40 countries worldwide. These partners include VeriSign (United States), EDS (worldwide), Northrop Grumman, Maximus and Raytheon (United States), SchlumbergerSema (worldwide), Allasso and Dimension Data (France, Italy, Spain, Netherlands, United Kingdom), Fujitsu Siemens, Integralis and Entrada (Germany, UK, Switzerland), Unit4 (Netherlands), Siemens Network Systems (United Kingdom), Intercede (UK), PT Inputronik (Indonesia), NCL Communications (Japan), Protect Data (Sweden, Norway, Denmark, Finland, Czech Republic and Slovakia), Logos (Croatia) and Zaslon & Crea (Slovenia).

Our relationships with particular distribution partners are evidenced through distribution contracts that are structured in a manner that seeks to reduce potential risks to us as a manufacturer. The terms applicable to channel distribution vary depending upon the type of distribution partner being utilized. For instance, we typically use distributors and resellers to market and distribute our hardware and client software products and we engage systems integrators if it is likely that the customer will require installation of more complex back-end server software products. We generally engage original equipment manufacturers if our client software and/or middleware is bundled or integrated into the distribution partner’s product for final distribution, either directly or through another distribution channel, to the ultimate end-user customer.

We provide technical support from offices located in Suresnes, France; Fremont, California; Tokyo, Japan; Ottawa, Canada; Melbourne, Australia and Singapore. These offices provide technical support to our integration and distribution partners, who, in turn, provide first level support to their customers. We offer formalized training programs and have established “ActivCard Authorized” reseller programs in the marketplace.

In addition, we provide telephone and online support services to answer inquiries related to implementation, integration and operation of our products and technologies. We are increasing the resources we dedicate to technical service and support in line with the increased distribution of our products, including a technical service web site with controlled access through the Internet. We offer a maintenance program for the software products covering updates and minor software releases. Our standard practice is to provide a warranty on all our products for one year after shipment for hardware products and three months after shipment for software products.

Business development

Our business development efforts are focused on establishing and managing collaborative relationships with strategic industry participants. We have developed significant strategic relationships with partners in an effort to incorporate our products into third-party products, conduct joint research and development efforts and develop joint proposals and presentations for products and services and reseller arrangements. Strategic relationships assist us in expanding our sales, marketing and technical capabilities and increase the distribution and market acceptance of our digital identity technologies, systems and products.

Our strategic partners include the following:

VeriSign, a leading provider of digital trust services, has integrated our digital identity products with the VeriSign Digital Trust Services framework, enabling a new class of scalable provisioning, management and authentication solutions that consolidate a user’s many independent credentials on a single platform. We do not have a formal reseller agreement with VeriSign.

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Schlumberger, one of the world’s largest smart card manufacturers, has partnered with us to deliver products to the market based on our digital identity technology. We have an original equipment manufacturer distribution agreement with Schlumberger, which provides that Schlumberger may resell a number of our products, including ActivCard Gold client software and integrate our digital identity software into its products. This agreement has been in effect since June 1999 and renews automatically every year unless terminated upon 30 days notice. We have provided related services on a subcontracted basis. We also procure smart cards and smard card chip modules from Schlumberger for integration into our software products for sale to end-user customers, both directly as well as through our distribution channel.

EDS integrates and supports our digital identity solutions for government ID projects. We do not have a formal agreement with EDS; however, EDS has sold our products into some of the larger departments within the U.S. Department of Defense.

Novell has embedded our digital identity framework into its core product lines through Novell Directory Services. Under our agreement with Novell, we license software and devices providing electronic authentication and digital certificate services to Novell for integration and distribution with Novell’s product solution on a worldwide, non-exclusive basis. This agreement has been in effect since May 1998 and renews automatically every year. Novell may terminate the agreement on 90 days notice and we may terminate the agreement on one year’s notice.

Northrop Grumman distributes our digital identity and authentication software and hardware products to government agencies through their SEWP government procurement contract. Our subcontract agreement with Northrop Grumman expires in July 2003.

In addition, we have worked with Sun Microsystems to integrate our digital identity technology into the Sun Open Net Environment Platform for Network Identity. ActivCard has leveraged several components of the Sun ONE platform to enable applications, data, and user credentials to be securely loaded on Sun’s Java Cards providing these card-based applications with secure, two-factor authentication to network services that help enterprises manage and control the identities of employees, partners and customers.

Marketing

We have organized our marketing efforts into two functional groups to support our business strategies as follows:

Product marketing.    The product marketing organization is responsible for defining market opportunities, developing a product roadmap and establishing a business plan to position ActivCard as a provider of digital identity systems. Our product marketing effort supports our strategy by defining products that meet market needs and are deliverable through selected channels. We focus our product marketing efforts on meeting market requirements and the timely delivery of products to market. Specifically, our solutions marketing efforts focus on, in particular, government entities, financial institutions and other enterprises to deliver solutions directly to and indirectly through system integrators, resellers and service provider partners. Close coordination with the product strategies of our strategic partners enhance the market viability and acceptance of their products and solutions.

Channel marketing.    Our channel marketing strategy combines different programs and mediums to increase brand, product and channel awareness. We use direct marketing methods and leverage our strategic partners in order to maximize our market exposure, while at the same time controlling our marketing costs. These efforts include an emphasis on press and analyst communications, advertising, public relations, the World Wide Web, telemarketing, trade shows, channel promotions and seminars. Our marketing programs are designed to target information technology managers, service operators, distributors, value-added resellers and industry-leading integration partners.

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Research and development

We develop technology-oriented solutions for advanced credential management capabilities, which are based on customer requirements but with broad market applicability. The focus of our research and development organization is to implement advanced technology rapidly and in a manner that can be integrated into large-scale systems. Specific areas in which we are investing research and development resources include security devices such as tokens and readers, digital identity applets to be loaded on smart cards and other personal devices such as PDAs or cellular phones, smart card middleware and client software allowing the use of smart cards in conjunction with PC applications, authentication secure sign-on software, smart card applets and credential issuance management software, as well as evaluation and implementation of specifications defined by international standards organizations.

Our research and development organization possesses a broad range of industry expertise, including hardware and software design, cryptographic technology, network application, Java and smart cards. Additionally, we have experience in delivering products and technology for various market segments, such as banking, healthcare, defense, enterprise computing and telecommunications.

We have increased the resources assigned to the technical direction function that is focused on designing the architecture of our software and hardware technology. These additions have made us capable of supporting the requirements of the advanced integration solutions necessary for success in the broader networking market.

Our research and development expenses were $8.1 million in 2000, $18.2 million in 2001 and $19.4 million in 2002.

Intellectual property

We rely on a combination of patents, trade secrets, copyright and trademark law, nondisclosure agreements and technical measures to protect our intellectual property and proprietary rights. We have entered into confidentiality and licensing agreements with our employees and distributors, as well as with our customers and potential customers seeking proprietary information. We also limit access to and distribution of our software, documentation and other proprietary information.

We currently have 117 issued worldwide patents, 34 of which have been issued in the United States. Three major patents issued in the United States are directly applicable to our current product offerings. These patents cover the following various aspects of security technology:

In addition to the patents granted in the United States, we have been granted patents or have pending patent applications on these inventions in Europe, Australia, Canada, Mexico, Taiwan, Singapore, Hong Kong and Japan. The three U.S. patents expire at various dates ranging from 2011 to 2018. The foreign patents on these inventions expire at various dates ranging from 2006 to 2018.

We also have 180 pending patent applications worldwide, of which 80 have been filed in the U.S., relating to our recently introduced and planned products focused on multi-function applications, development of secure network connections between the server and personal computing devices and pre- and post-issuance management of these applications on multiple personal computing devices, secure key management and biometric technology.

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Backlog

Our customers typically require prompt delivery of our products and as such, our product revenue is generally booked and shipped in the same quarter. Our backlog is not material at any point in time and is not indicative of future revenue. The timing and volume of customer orders are difficult to forecast and are typically made pursuant to standard purchase orders that can be rescheduled, reduced or cancelled prior to shipment without significant penalty.

Manufacturing, source of supply and quality control

We have established relationships with hardware assemblers and multinational software reproducers. Our suppliers include IDT and ATM in Hong Kong for hardware assembly and Metatec in The Netherlands for software reproduction. We place purchase orders with these manufacturers and suppliers, the terms of which are negotiated on an order-by-order basis. Additionally, we have outsourcing arrangements for product warehousing and fulfillment services. Our global production and distribution capacity supports our current requirements and can easily be increased by augmenting existing production lines with current suppliers. We maintain ownership of all manufacturing tools, molds and software, supply all critical components and define all manufacturing processes and quality control plans, thereby granting us the ability to relocate the manufacturing process should any unforeseen interruption occur.

Software.    Our software products, such as ActivCard Gold and ActivPack for Windows NT, are produced and packaged in Suresnes, France and Breda, The Netherlands. High capacity CD-ROM replication, full-service kit assembly, warehousing, and direct-to-user product fulfillment is provided by Metatec in The Netherlands.

Hardware.    ActivCard hardware, including tokens, smart card readers, and the ActivReader trusted terminal/smart card reader are assembled by our Hong Kong and Shanghai-based manufacturers at facilities that are either ISO9000 and ISO9002 or are in the process of becoming certified. ISO9000 refers to the international guidelines on quality management and system elements established by ISO (International Organization for International Standardization), an international body of normalization organizations. ISO9002 is a quality assurance model used by companies that design, produce, install, inspect and test service items. Our hardware products are shipped directly to distribution partners, customers or to corporate warehouses in Hong Kong; Singapore; Fremont, California and Suresnes, France for subsequent distribution.

Suppliers.    Our products are designed and built with high quality standard parts and components. Our current suppliers include Samsung, OKI, Maxim and Siemens AG. We generally maintain a three-month supply of critical components, including microcontrollers, LCDs and transistors. The relationships with our suppliers of critical components have existed for over three years and we have not suffered any material breaks in supply during that period. We currently purchase smart cards from Schlumberger and, PCMCIA smart card readers and USB Smart Card Readers from SCM Microsystems.

Quality Control.    We maintain strict internal and external quality control processes, which are performed during product design, production and acceptance. We contract with SGS (Switzerland) to assure that our quality control specifications are adequately met at various levels from inventory audits to final product inspections. During 2001, we fully implemented a computer-assisted production and inventory management system to increase quality as production volumes advance.

Competition

The network security industry is highly competitive and evolving, and we may be unable to compete successfully in the future, which may harm our business. We compete in numerous markets, including:

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These markets are characterized by rapidly changing technology and industry standards, evolving user needs and the frequent introduction of new products. We believe that the principal factors affecting competition in our markets include product functionality, performance, scalability, flexibility and features of products, use of open standards technology, quality of service and support, reputation and price.

Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, technical and marketing resources than we have. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products than we can. In addition, certain of our competitors may determine, for strategic reasons, to consolidate, to substantially lower the price of their products or to bundle their products with other products, such as hardware products or other software products. We expect that there will be additional consolidation in the digital identity market and such consolidation may materially adversely impact our competitive position. In addition, current and potential competitors have established or may establish financial or strategic relationships among themselves, with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We may not be able to compete successfully against current and future competitors. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which would materially adversely affect our business, operating results and financial condition.

Our competitors include, among others, RSA Security, Inc., a token and network security manufacturer and cryptographic technology supplier; SSP—Litronic Division, a supplier of data security products and services; Datakey, Inc., makers of proprietary smart cards and token solutions; Gemplus S.C.A., a smart card manufacturer; and Vasco Data Security, Inc., a token manufacturer and supplier. In addition, we expect additional competition from other emerging and established companies.

We intend to leverage our financial strength by investing in the development of a broader product offering for our customers. We will focus on providing our customers with a comprehensive card issuance, management and smart card middleware software suite with advanced functionality and features in all of our products.

Employees

On December 31, 2002, we had 282 employees, of whom 137 were engaged in research, development, quality assurance and third-line support, 90 were engaged in marketing, sales and customer support, 12 were engaged in operations, 27 were engaged in general administration and 16 were engaged in corporate and IT functions. As of December 31, 2002, 141 employees, including our executive officers, were located in North America, 127 were based in Europe and 14 were based in the Asia/Pacific region. We consider our relationships with our employees to be satisfactory and we are not a party to any collective bargaining agreement.

The future success of our operations depends in large part on our ability to recruit and retain senior management, engineers, marketing, sales and service professionals and other key personnel. Qualified employees are in great demand across each of these disciplines, and there can be no assurance that we will be successful in retaining or recruiting key personnel.

Environmental Matters

Neither compliance with federal, state and local provisions regulating discharge of materials into the environment, nor remedial agreements or other actions relating to the environment, has had, or is expected to have, a material effect on our capital expenditures, financial condition, results of operations or competitive position.

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ITEM 2.    PROPERTIES

Our principal administrative, research and development, sales, marketing and support facilities consisted of 40,000 square feet of leased office space in Fremont, California; 12,000 square feet of leased office space in Suresnes, France; 15,000 square feet of leased office space in Ottawa, Canada; 2,500 square feet of leased office space in Centreville, Virginia; 2,200 square feet of leased office space in Montpellier, France; and 2,300 square feet leased space in Melbourne, Australia. We occupy these premises under leases and sub-leases expiring in February 2011, June 2006, June 2008, June 2003, June 2005 and November 2004, respectively. In February 2002 and June 2002, we vacated approximately 12,281 square feet, 2,700 square feet and 11,700 square feet of leased facilities in Fremont, California, Suresnes, France and Melbourne, Australia, respectively. We are currently seeking to sublet the vacated space in Fremont, California and Suresnes, France and have successfully sublet the vacated office space in Melbourne, Australia.

The lease of our office in Suresnes, France, may, at our option, be terminated on June 30, 2003 without penalty. We also lease, pursuant to short-term leases, facilities in Singapore, primarily as offices for our sales force and technical support personnel. We believe that our facilities are adequate for our current operations.

ITEM 3.    LEGAL PROCEEDINGS

In the ordinary course of business, we are, from time to time, named as defendant in various legal proceedings. We maintain comprehensive liability insurance and believe that our coverage is sufficient to ensure that we are adequately protected from any material financial loss as a result of any legal claims made against us.

In March 2002, we filed a lawsuit in the United States District Court, District of Delaware, against Vasco Data Systems International alleging infringement of U.S. patent no. 5,937,068 entitled “System and Method for User Authentication Employing Dynamic Encryption Variables”, which was issued by the U.S. Patent and Trademark Office on August 10, 1999. The complaint also alleges false designation of origin in violation of the Lanham Act and common law trade dress infringement. In May 2002, Vasco filed a response to our complaint and filed counterclaims, including claims of non-infringement and patent invalidity. The parties are still in the discovery process and a trial date has been tentatively set for June 2004.

Litigation carries a number of significant risks, is often unpredictable and can be very expensive, even if resolved in our favor. Litigation may also divert the attention of management and deplete other resources.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

ActivCard Corp.’s common stock began trading on the Nasdaq National Market and Nasdaq Europe under the symbol “ACTI” on February 4, 2003 upon completion of the registered public exchange offer to acquire the outstanding securities of ActivCard S.A. Prior to completion of the exchange offer, ActivCard S.A. common shares were quoted on Nasdaq Europe and ActivCard S.A. American depositary shares (“ADS”) were quoted on the Nasdaq National Market, both under the symbol “ACTI”.

The table below sets forth for the periods indicated the high and low closing sale prices of the common shares of ActivCard S.A. on Nasdaq Europe and the ADSs on the Nasdaq National Market.

We have never declared or paid cash dividends on our common stock. We currently intend to retain all future earnings to finance future growth and therefore do not anticipate paying any dividends in the foreseeable future.

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ITEM 6.    SELECTED FINANCIAL DATA

The following selected consolidated financial data for each of the last five years has been derived from our audited consolidated financial statements. The following selected consolidated financial data reflects certain hosting operations of the former Authentic8 as discontinued operations. See Note 5 to the Consolidated Financial Statements.

The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes to the Consolidated Financial Statements.

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ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related notes included in Item 8, “Financial Statements and Supplementary Data” in the Annual Report on Form 10-K. This discussion contains forward-looking statements, which involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements as a result of certain factors, including but not limited to those discussed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K. See “Forward Looking Statements” at the beginning of this Annual Report on Form 10-K.

We develop, market and support digital identity solutions that enable our customers to issue, use and maintain digital identities in a secure, manageable and reliable manner. We market our solutions to the government, financial institutions, network service providers and enterprise customers directly through our own sales organization and indirectly through system integrators, resellers and original equipment manufacturers.

Until 2000, the majority of our revenues were comprised of hardware products such as ActivCard tokens and ActivReaders and, to a lesser extent, ActivPack authentication server software. In 1999, we began to focus development efforts on smart card related products, primarily in the form of software applications embedded on the smart card and client/server software to support multi-function capabilities including card issuance, provisioning and management of digital identities. In 2001 and 2002, 41% and 54% of revenues were derived from smart card related software, primarily from ActivCard Gold, ActivPack authentication server and license fees from product development agreements for the ActivCard Identity Management System and ActivCard Java Card Applets, respectively.

Hardware and software and maintenance revenues, expressed as a percentage of total revenues, are as follows:

Hardware revenues are comprised of tokens, readers and cards.

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Revenues by geographic region, expressed as a percentage of total revenues, are as follows:

Revenues by customer segment, expressed as a percentage of total revenues, are as follows:

In 2000, Europe accounted for the majority of revenues, primarily from marketing our ActivCard Token products to European banks for secure network access and online banking applications. In 2001 and 2002, North America accounted for the majority of revenues, with accelerating deployments of our smart-card based software products, such as ActivCard Gold and the ActivCard Identity Management System, primarily to the U.S. Department of Defense.

We anticipate that the majority of our future revenue growth will be from marketing digital identity solutions, comprising the ActivCard Identity Management System, authentication servers, ActivCard Gold client software and ActivCard Java Card Applets on a smart card for purposes of providing network service providers and database administrators with identity issuance, usage, provisioning, life-cycle management and post-issuance management capabilities. As such, future development efforts will focus on software for the management of the smart card and mobile-related personal security devices. Further, end users of our products may migrate directly to supply sources to procure the related hardware elements, such as the smart cards themselves and smart card readers for large deployments, instead of procuring these through our company.

Our revenues have historically been invoiced in U.S. dollars, although we do offer Euro-based pricing on our worldwide price list. Operating expenses for ActivCard companies outside the United States are paid in the local currency. We hedge our non-functional currency denominated assets and liabilities to mitigate the effects of exchange rate fluctuations on earnings.

An increasing proportion of our revenues come from the U.S. government. U.S. government customers have historically demonstrated a tendency to increase purchases in the third quarter of a calendar year in connection with the end of the U.S. government fiscal year and decrease purchases in the fourth quarter of a calendar year. We have experienced this form of seasonality in the past and anticipate to experience this in the future, as well. As with many companies that have a substantial presence in Europe, we also experience seasonality in our business in the third quarter of the calendar year due to the traditional slowdown of economic activity throughout Europe in the summer months. If as anticipated, our revenues reflect an increasing proportion of software licenses in the future, we may experience another form of seasonality typical of other software companies. Software customers have a tendency to delay purchases until the fourth quarter as driven by an annual budgetary process. This typically causes first quarter revenues to be lower than the previous fourth quarter revenues. Although we have not experienced such seasonality in the past, we may in the future.

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As a substantial proportion of our operating expenses are fixed, a small variation in the timing of recognition of revenue can cause significant variations in operating results from quarter to quarter.

Critical accounting policies

The discussion and analysis of our consolidated financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The preparation of our consolidated financial statements 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 consolidated financial statements and the reported amounts of revenue and expense during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, sales warranties and allowance for doubtful accounts, long-lived assets, goodwill and intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, the actual results could differ from those estimates.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue recognition

We derive our revenue primarily from:

Significant management judgments and estimates must be made and used in connection with the revenue recognized in any reporting period.

For all sales, we use a binding contract, purchase order or other form of documented agreement to evidence an arrangement with a customer. We do not include acceptance clauses for our shrink-wrapped software products such as ActivCard Gold. Acceptance clauses usually give the customer the right to accept or reject the software after we have shipped the product. However, we have provided certain customers with acceptance clauses for customized or significantly modified software products developed under product development agreements and, on occasion, for hardware products and client/server software products as well. In instances where an acceptance clause exists, we do not recognize revenues until the product is formally accepted by the customer in writing or the defined acceptance period has expired.

Revenues are derived primarily from the sale of software licenses, hardware and service agreements. We apply the provisions of Statement of Position 97-2 and related guidance. Revenues from software license agreements are generally recognized upon shipment, provided that evidence of an arrangement exists, the fee is fixed or determinable, no significant obligations remain and collection of the corresponding receivable is probable. In software arrangements that include hardware products, rights to multiple software products, maintenance and/or other services, we allocate the total arrangement fee among each deliverable, based on vendor-specific objective evidence of fair value of each element if vendor-specific objective evidence of each element exists. We determine vendor specific evidence of fair value of an element based on the price charged when the same element is sold separately. For an element not yet sold separately, vendor specific evidence of fair

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value of an element is established by management having the relevant authority as long as it is probable that the price, once established, will not change before separate introduction of the element in the marketplace. We define management having the relevant authority as any three of the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and the Vice President, Marketing. When arrangements contain multiple elements and vendor-specific objective evidence of fair value exists for all undelivered elements, we recognize revenue for the delivered elements based on the residual value method. For arrangements containing multiple elements wherein vendor specific objective evidence of fair value does not exist for all undelivered elements, revenue for the delivered and undelivered elements is deferred until vendor specific objective evidence of fair value exists or all elements have been delivered.

Revenue from the sale of hardware products, such as ActivCard tokens and ActivReader, is recognized upon shipment of the product, provided that no significant obligation remains and collection of the receivable is considered probable.

Post-contract customer support is recognized on a straight-line basis over the term of the contract.

Service revenues include revenues from training, installation or consulting. From time to time, we enter into agreements with customers that require significant production, modification or customization of software in addition to the provision of services. Where the services are essential to the functionality of the software element of the arrangement, separate accounting for the services is not permitted and contract accounting is applied to both the software and service elements. In these cases, revenue is recognized as the work is performed pursuant to the related contracts and the achievement of related milestones in accordance with the percentage of completion method based on input measures.

Service revenues are recognized separately from the software element when the services are performed if vendor-specific objective evidence of fair value exists to allocate the revenue to the various elements in a multi-element arrangement, the services are not essential to the functionality of any other element of the arrangement and the total price of the contract would vary with the inclusion or exclusion of the services.

Our normal payment terms are less than 60 days.

In certain specific and limited circumstances, we provide product return and price protection rights to certain distributors, resellers and end users. We generally recognize revenue from product sales upon shipment to resellers, distributors and other indirect channels, net of estimated returns or estimated future price changes. Our policy is to not ship product to a reseller or distributor unless the reseller or distributor has a history of selling our products or the end user is known and has been qualified by us. We have established a reasonable basis through historical experience for estimating future returns and price changes. Actual returns have not been material to date. Price protection rights typically expire after 30 days and have not been material to date.

Amounts billed in excess of revenue recognized are recorded as deferred revenue. Unbilled work-in-process is recorded as a receivable.

In September 2001, we licensed our authentication server software to VeriSign at or about the same time that we purchased software and services from VeriSign. This transaction was recorded at terms that we considered to be fair value. Although cash was exchanged in this transaction, we considered this a non-monetary transaction. For this transaction, we complied with Accounting Principles Board or APB Opinion No.29, “Accounting for Non-monetary Transactions”, and Emerging Issues Task Force or EITF issue No.01-02, “Interpretation of APB opinion No.29”, to determine whether the transaction was a monetary or non-monetary transaction. We recorded product revenues of $3.2 million in 2001 and billed $480 thousand in advance for maintenance and support for the twelve-month period commencing October 1, 2001. Software purchased from VeriSign in the amount of $3.0 million was capitalized as property and equipment and is being amortized on a straight-line basis over thirty-six months. In addition, we capitalized $908 thousand as prepaid expenses, which

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included maintenance and support, purchased digital certificates, license fees and prepaid training. The amounts included in prepaid expenses are charged to earnings as the services are provided or the certificates are consumed.

Sales warranties

Expenses associated with potential warranty claims are accrued at the time of sale, based on warranty terms and prior experience. We provide for the costs of warranty in excess of warranty coverage provided to us by the product assembly contractors. Our standard warranty period is ninety days for software products and one year for hardware products.

Allowance for doubtful accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to pay outstanding amounts. The provision is based on factors that include account aging, historical bad debt experience, customer creditworthiness and other known factors.

Inventories

Inventories are stated at the lower of cost or market, cost being determined on a first-in, first-out method. Write-downs for slow-moving and obsolete inventories are provided based on historical experience and current product demand.

Long-lived assets

In accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may be not recoverable. When the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount, an impairment loss would be measured based on future cash flows, discounted at our incremental borrowing rate, compared to the carrying amount. We adopted SFAS No. 144 on January 1, 2002 and on February 15, 2002, as a result of a change in corporate strategy, we executed a plan to dispose of the hosting operations of Authentic8 International. As a result, we recorded a charge to earnings in the amount of $15.6 million in 2002, which included a write-down of property and equipment of $645 thousand. No impairment charges have been recorded in any of the other periods presented. In the future, if any such impairment charges are required as a result of a change in circumstances, the resulting charge could be significant and could have a material adverse effect on our consolidated financial position and results of operations.

Purchase price allocations

In 2001, we completed the acquisition of three companies, all of which were accounted for using the purchase method of accounting. In January 2002, we established a wholly owned subsidiary in South Africa and acquired certain assets from two privately held companies based in South Africa. We allocated the purchase price to the assets acquired and liabilities assumed at the date of purchase based on their fair values. In order to determine fair values, we had to make assumptions regarding estimated future cash flows and make estimates based on other factors. In certain cases, an allocation was made to acquired in process research and development which was charged to operations, as the research and development did not have alternative future uses as of the date of the acquisition. The allocation of purchase price among long-lived assets, which are depreciated, in-process research and development, which is expensed at the time of acquisition and goodwill, which is not amortized starting January 1, 2002, but evaluated periodically for impairment, has a significant impact on both current and future operating results.

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Valuation of goodwill and other intangible assets

In assessing the recoverability of our goodwill and other intangibles, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges against these assets in the reporting period in which the impairment is determined. For identifiable long-lived assets, this evaluation includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over their estimated useful lives, we record an impairment charge in the amount by which the carrying value of the assets exceeds their fair value. Fair value for identifiable long-lived assets is generally determined based on discounted cash flows.

On February 15, 2002, as a result of changes in strategic plans, we executed a plan to dispose of the hosting operations of Authentic8 International. As a result of the changed circumstances, the estimates and assumptions for future cash flows from the hosting operation declined indicating that an impairment in the value of the related assets existed. Accordingly, we recorded a charge to earnings in the amount of $15.6 million in 2002, which included an impairment of the carrying value of goodwill and other intangibles of $15.0 million.

In December 2002, in connection with our annual budgetary planning process and business review, we assessed the estimated future cash flows from our other acquired intangible assets and concluded that the carrying value of certain of these assets exceeded their fair value. As a result, we recorded an impairment charge of $5.1 million during the fourth quarter ended December 31, 2002. In the future, any additional impairment charge could be significant and could have a material adverse effect on our consolidated financial position and results of operations. At December 31, 2002, we had $12.9 million of goodwill and other intangible assets, which accounted for 5% of our total assets.

In June 2001, the FASB issued SFAS No.142, “Goodwill and Other Intangible Assets”. SFAS No.142 provides that goodwill resulting from a business combination will no longer be amortized to earnings but rather will be reviewed periodically for impairment in value. The provisions of SFAS No.142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No.142 provided an exception to the prescribed date. Goodwill acquired after June 30, 2001 was subject to the non-amortization provisions. Accordingly, we amortized the goodwill resulting from acquisitions completed prior to June 30, 2001 on a straight-line basis over a five-year period from the acquisition dates to the end of the year. We did not amortize goodwill resulting from acquisitions completed subsequent to June 30, 2001. We adopted SFAS No.142 on January 1, 2002 and did not amortize any goodwill from the date of adoption. There was no impact from initial adoption of this standard on our consolidated financial position or results of operations. In December 2002, we performed an impairment test on the carrying value of goodwill and determined that no impairment existed. In the future, if any such impairment is determined to exist, the resulting charge could be significant and could have a material adverse effect on our consolidated financial position and results of operations.

Restructuring activities

We recorded a charge of $8.6 million in 2002 related to a restructuring and business realignment plan, which consisted primarily of a reduction-in-work force and facility vacancy costs. Accounting pronouncements for restructuring costs in effect at the time required us to record provisions and charges when we had a formal and committed plan. On February 5, 2002, we announced a restructuring and realignment of our business and cost structure. We were required to make significant estimates related to the subletting of facilities in Fremont, California and Melbourne, Australia. Estimates related to sublease income are based on assumptions regarding expected vacancy periods required to locate and contract with suitable sublessees and current sublease market rates. In December 2002, we revised our estimate of expected sublease income and recorded an additional charge to earnings of $620 thousand. If the assumptions for these estimates change in the future due to changes in the market, the ultimate restructuring expenses for these facilities could vary by material amounts. In addition, we

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had to record estimated expenses for severance and outplacement costs. Our policies, as supported by current authoritative guidance, require us to continually evaluate the adequacy of the remaining liabilities under our restructuring initiatives. As management continues to evaluate the business, there may be additional charges for new restructuring activities, as well as changes in estimates to amounts previously recorded.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated With Exit or Disposal Activities”, which addresses financial accounting and reporting for costs associated with exit or disposal activities. The provisions of SFAS No. 146 require that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than when an entity commits to an exit plan as previously required. The provisions of SFAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002. There will be no impact from initial adoption of this standard on our consolidated financial position or results of operations.

Income taxes

We have a history of operating losses. These losses generated a sizable net operating loss carry-forward in excess of $100 million as of December 31, 2002. Generally accepted accounting principles in the United States of America require that we record a valuation allowance against the deferred tax asset associated with this net operating loss carry-forward if it is “more likely than not” that we will not be able to utilize it to offset future taxes. Due to the size of the net operating loss carry-forward in relation to our history of unprofitable operations, we have not recognized any of this net deferred tax asset. We currently provide for income taxes only to the extent that we expect to pay cash taxes (primarily state taxes and minimum taxes). It is possible, however, that we could be profitable in the future at levels which cause management to conclude that it is more likely than not that we will realize all or a portion of the net operating loss carry-forward. Upon reaching such a conclusion, we would immediately record the estimated net realizable value of the deferred tax asset at that time and would then provide for income taxes at a rate equal to the relevant current local tax rates rather than the 0% rate currently being used. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the provision for income taxes to vary significantly from period to period, although our cash tax payments would remain unaffected until the benefit of the net operating loss carry-forward is utilized.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles in the United States of America, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto under “Item 8, Financial Statements and Supplementary Data” which contain accounting policies and other disclosures required by U.S. GAAP.

Recent acquisitions

In 2001, we acquired three companies, all of which were accounted for using the purchase method of accounting. In January 2002, we established a wholly owned subsidiary in South Africa and acquired certain assets from two privately held companies based in South Africa. The underlying assets purchased and liabilities assumed comprised a business and as such, we used the purchase method of accounting to allocate the purchase price to the assets acquired. The results of operations of the acquired businesses have been included in our consolidated statement of operations from their respective acquisition dates. We did not complete any acquisitions in 2000.

ActivCard Asia Pte. Ltd.

On March 26, 2001, we acquired the remaining 20% interest in ActivCard Asia Pte. Ltd. (“ActivCard Asia”) for $111 thousand. ActivCard Asia is now a wholly owned subsidiary.

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Safe Data System S.A.

On June 27, 2001, we acquired 100% of the outstanding shares of Safe Data System S.A. (“Safe Data”), a privately held developer of user authentication software based in Montpellier, France. We acquired Safe Data to replace its existing authentication server as well as to augment its engineering resources and customer base.

Authentic8 International Inc.

On April 10, 2001, we mutually agreed to terminate an initial agreement to combine with Authentic8 International Inc. (“Authentic8”), a privately held, Australian-based company offering an outsourced remote access authentication service for banks and service operators. In connection with this, we recorded a charge against earnings in the amount of $3.1 million, which consisted of $2.0 million in professional fees and $1.1 million in break-up fees. Subsequently, we acquired 100% of the outstanding shares of Authentic8 on September 7, 2001. We acquired Authentic8 to augment our technology and customer base as well as to acquire a managed authentication service model and obtain expertise associated with outsourcing a service.

American Biometric Company Ltd. (Ankari)

On November 13, 2001, we acquired 100% of the outstanding shares of American Biometric Company Ltd. (“Ankari”), a privately held company based in Ottawa, Canada. Ankari’s software framework provides organizations with the ability to verify network user access through the use of any combination of passwords, digital certificates, security tokens, smart cards and biometrics. We acquired Ankari to augment our technology, customer base and engineering resources.

ActivCard South Africa (Newshelf 650 Pty. Ltd)

In January 2002, we acquired certain assets from two privately held companies based in South Africa. The underlying assets purchased and liabilities assumed comprised a business that develops and markets biometric authentication systems and related software development kits. We acquired the assets to augment our technology and to establish a sales presence in South Africa.

Foreign currency

The consolidated financial statements are prepared in accordance with U.S. GAAP with the U.S. dollar as the reporting currency. In 2002, we established a presence in South Africa through the acquisition of ActivCard South Africa, and throughout 2001, we increased our presence in North America by investing in our U.S. subsidiary primarily by hiring employees engaged in sales, marketing and research and development activities and by acquiring Ankari, which was based in Canada. The acquisition of Authentic8 established a presence for our company in Australia, adding personnel, primarily in selling and managed services. In 2000, we also created a subsidiary in Japan and modestly expanded our presence in Singapore. For the year ended December 31, 2002, approximately one-half of our expenses were denominated in currencies other than the U.S. dollar. As such, our results are affected by year-over-year exchange rate fluctuations in foreign currencies relative to the U.S. dollar, but primarily in fluctuations in exchange rates between the U.S. dollar and the Euro. The effect on operating results from revenues and expenses denominated in currencies other than the U.S. dollar has not been material to date. In January and April 2001, we transferred to our U.S. subsidiary the majority of our U.S. dollar cash balances that were previously held in France, thereby substantially mitigating the effects on the results of operations that might be caused by exchange rate fluctuations between the Euro and the U.S. dollar. In September 2001, we implemented a foreign exchange hedging program to mitigate gains and losses resulting from exchange rate fluctuations on assets and liabilities held by ActivCard companies that were denominated in currencies other than the functional currency of the legal entity holding the related asset or liability. To achieve these objectives, we regularly enter into various short-term foreign currency forward contracts to offset these foreign exchange transaction gains and losses. At December 31, 2002, we did not have any foreign currency forward contracts outstanding.

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Results of operations

The following table sets forth the selected items from our consolidated statements of operations expressed as a percentage of total revenues for the periods presented:

Revenues

The increase in software and maintenance revenues of 78% in 2002 and 167% in 2001 reflects our continued focus on smart card related products, primarily software applications embedded on the smart card and client/server software to support multi-function capabilities including card issuance, provisioning, usage and management of digital identities. The increase in software and maintenance revenues in 2002 and 2001 was achieved primarily in the United States where we successfully marketed the ActivCard Gold client software, the ActivCard Identity Management System and ActivCard JavaCard Applets to the U.S. Department of Defense. The decline in hardware revenues of 7% in 2002 compared to 2001 reflected reduced demand from corporate and financial institutional customers for our token-based products in Europe, which did not carry over from 2001 when the same demand drove an increase in hardware revenues of 29% compared to 2000.

As a result of increased software license revenues, the amount of revenues from software maintenance and support contracts has also increased to 9% of total revenues in 2002 compared to 4% of total revenues in 2001.

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Revenues from North America accounted for $27.1 million, or 65% of revenues in 2002, an increase of 70% over the $15.9 million, or 51% of revenues in 2001. North American revenues in 2001 were 338% higher than 2000 revenues of $3.6 million, which represented 20% of revenues. Revenues from Europe accounted for $12.8 million or 31% of revenues in 2002, a decrease of 6% over the $13.7 million or 44% of revenues in 2001. European revenues in 2001 were at the same level as 2000 revenues of $13.7 million, which represented 76% of 2000 revenues. Revenues in North America consisted primarily of ActivCard Gold client software and ActivCard Identity Management System sales sold indirectly through various channel partners into the U.S. Department of Defense, while European revenues were primarily related to ActivCard Token and ActivPack authentication server sales into European financial institutions. Our customers have been deploying our solutions primarily to consolidate multiple security solutions and databases such as PKI, static passwords, building access and Symmetric Key Infrastructure solutions designed solely for remote network access login. European banks and financial institutions are using our company products to offer Internet and on-line banking capabilities to their customers.

Cost of revenues

Cost of revenues totaled $13.5 million in 2002, compared to $9.6 million for 2001. The 1% increase in cost of revenues as a percentage of sales in 2002 compared to 2001, reflects lower gross margins on software and maintenance as described below. The cost of software and maintenance revenues increased to $5.0 million in 2002, compared to $1.3 million in 2001. The increase in cost of software and maintenance revenues resulted from an increase in the software maintenance and support requirements for our large government deployments. The cost of hardware revenues increased slightly to $8.5 million in 2002, compared to $8.3 million for 2001. The increase in cost of hardware revenues resulted from increased volume of higher cost reader sales.

From 2000 to 2001, the 7% decrease in cost of revenues as a percentage of sales reflected a positive shift in the product mix in 2001, reflecting a higher proportion of revenues from the sale of software licenses and software products relative to 2000. The cost of software and maintenance revenues increased slightly to $1.3 million for the year ended December 31, 2001, compared to $1.2 million for the year ended December 31, 2000. The increase in cost of software and maintenance revenues resulted from an increased volume of software and maintenance revenues. Although software and maintenance revenues increased substantially from 2000 to 2001, the increase in the cost of software and maintenance revenues was comparatively less primarily because we commenced selling the ActivCard Gold client software in volume to the U.S. Department of Defense in 2001. The cost of hardware revenues increased to $8.3 million for the year ended December 31, 2001, compared to $5.8 million for the year ended December 31, 2000. The increase in cost of hardware revenues resulted from higher sales volume of hardware products. We increased investment in the infrastructure responsible for providing for and managing the supply of products for sale in 2000.

Included in cost of revenues are the costs associated with labor, manufacturing, delivery and other production and logistics costs. We employed 12 people in operations as of December 31, 2002 and 2001. Cost of revenues also includes the cost of staff dedicated to supporting customers on a post-sale basis including telephone support as well as providing software maintenance in the form of bug fixes and software updates. We employed 9 customer support people as of December 31, 2002 and 15 customer support people as of December 31, 2001.

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Gross margin

Gross margin totaled $28.4 million, $21.6 million and $11.1 million in 2002, 2001 and 2000, respectively.

The hardware gross margin percentage decreased 5% in 2002 to 43% from 48% in 2001 due to a negative shift in the product mix resulting in an increased proportion of hardware sales from lower margin reader sales. The software and maintenance gross margin percentage declined to 82% in 2002, a decrease of 10% from the gross margin percentage of 92% in 2001 due to increased costs of software maintenance and support activities for our large government deployments.

The hardware gross margin percentage for the year ended December 31, 2001 decreased 5% from 53% compared to the year ended December 31, 2000 due to lower average selling prices of token products caused by increased volume purchases from specific customers. The software and maintenance gross profit percentage for the year ended December 31, 2001 increased to 92% from 79% for the year ended December 31, 2000 as we commenced selling the ActivCard Gold client software in volume to the U.S. Department of Defense in June 2001.

Research and development expenses