ACTIVCARD CORP - 10-K Annual Report

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

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

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

The aggregate market value of the Common Stock held by non-affiliates of the registrant was $379,113,234 as of June 30, 2003 based on the closing price of the registrants Common Stock as reported on the Nasdaq National Market on such date. Shares of Common Stock held by officers, directors and holders of more than 10% of the outstanding Common Stock 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 shares of the Registrant’s Common Stock outstanding on February 27, 2004 was 42,114,646.

The information required by Part III of this Form 10-K, to the extent not set forth herein, is incorporated by reference from the issuer’s Proxy Statement to be filed in connection with the Annual Meeting of Stockholders to be held on May 26, 2004.

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 future 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 report.

We develop, market and support strong authentication and trusted 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. 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, IBM, 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.

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 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. We were incorporated in Delaware in August 2002 in connection with our change in domicile from France to Delaware. The financial statements set forth in this Annual Report on Form 10-K for periods preceding the change in domicile 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.

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.

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:

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 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:

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 6.7 million users worldwide. We also intend to market our product offerings to new customers by referencing our existing customer base.

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

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.

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.

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 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 Solo, a secure smart card reader that, when combined with a smart card, generates one-time passwords for strong two factor authentication to networks and confidential information for applications such as transaction verification. ActivReader Solo has been certified compliant with the standard secure electronic transmission protocol used by Europay, MasterCard and Visa International.

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.

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 identities. 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.

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, 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 100 selling partners in over 40 countries worldwide. These partners include IBM, MAXIMUS, Northrop Grumman, EDS and Unisys (worldwide), VeriSign (United States and Australia), Alternative Technology (United States), Allasso, Unipalm, and Risc (France, Italy, Spain, Netherlands, United Kingdom, Germany), Integralis (Germany, UK, France), Unit4 (Netherlands), Omnetica (United Kingdom, France), Telecom Systems and Econis (Switzerland), PT Inputronik (Indonesia), NCL Communications (Japan), Protect Data (Sweden, Norway, Denmark, Finland), Activ (Czech Republic), Logos (Croatia), Crea (Slovenia), SmartCard Ltd (Hungary), ATM (Poland), Probil (Turkey), and Nanoteq (South Africa).

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 Fremont, California; Centreville, Virginia; Suresnes, France; Ottawa, Canada; and Melbourne, Australia. 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 offer a technical service web site with controlled access through the Internet and 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.

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.

Northrop Grumman distributes our digital identity and authentication software and hardware products to government agencies through their SEWP (Scientific and Engineering Workstation Procurement) government procurement contract. Our subcontract agreement with Northrop Grumman expires in August 2004.

EDS integrates and supports our digital identity solutions for government ID projects. EDS has sold our products into some of the larger departments within the U.S. Department of Defense and we have an agreement with EDS to resell our professional services to one U.S. Department of Defense agency that expires in February 2007.

IBM promotes and resells our strong authentication and digital identity products through their customer base. We have had a non-development solutions agreement with IBM since June 2003.

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 smart 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.

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.

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.

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.

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 enhances 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.

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 $18.7 million in 2001, $20.2 million in 2002 and $18.6 million in 2003.

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 70 issued worldwide patents, 38 of which have been issued in the United States. We also have 149 pending patent applications worldwide, of which 74 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.

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:

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 been granted patents or have pending patent applications on these inventions in Europe, Canada, Taiwan, Singapore, Hong Kong and Japan.

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.

We have established relationships with hardware assemblers and multinational software reproducers. 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 Fremont, California and Suresnes, France. High capacity CD-ROM replication, full-service kit assembly, warehousing, and direct-to-user product fulfillment is outsourced in California.

Hardware. ActivCard hardware, including tokens, smart card readers, and the ActivReader Solo trusted terminal/smart card reader are assembled by our Hong Kong-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 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. 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 and smart card readers from third-party original equipment manufacturers.

Quality Control. We maintain strict internal and external quality control processes, which are performed during product design, production and acceptance. We contract with a third-party to ensure 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.

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:

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 principal 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.

On December 31, 2003, we had 324 employees, of whom 156 were engaged in research, development, quality assurance and third-line support, 109 were engaged in marketing, sales and customer support, 13 were engaged in operations, 32 were engaged in general administration and 14 were engaged in corporate and IT functions. As of December 31, 2003, 147 employees, including our executive officers, were located in North America, 138 were based in Europe and 39 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.

In February 2004 our Chief Executive Officer, George Garrick, resigned from the Company. As a result, the Board of Directors formed a special committee of the Board to assist our executive management team on both strategic and operational matters until a replacement Chief Executive Officer is appointed. We have engaged an executive recruiting firm to recruit a new Chief Executive Officer and a search is currently underway.

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. Additionally, our restructuring activities in 2002 and 2003, which consisted primarily of reductions in workforce, may make it more difficult to attract and retain talented employees. We are currently developing a plan to restructure operations. The plan being developed is primarily directed to enhancing and improving sales and marketing activities and rationalizing research and development projects and general and administrative functions. This plan, once completed and executed, will result in additional reductions in workforce and consolidation of geographic locations in 2004.

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.

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; 5,000 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 2010, January 2006 and November 2004, respectively. In February 2002 and June 2002, we vacated approximately 12,281 square feet and 11,700 square feet of leased facilities in Fremont, California, and Suresnes, France, respectively. We are currently seeking to sublet the vacated space in Fremont, California and have successfully sublet the vacated office space in Suresnes, France.

The Company has no material litigation currently ongoing. In the ordinary course of business, ActivCard Corp. and our subsidiaries 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. 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.

In December 2003 and March 2004, we notified Aspace Solutions Limited (“Aspace”) that Aspace may be in violation of one or more covenants in our senior convertible loan agreement dated July 23, 2003. We are working with Aspace to resolve the matter.

In December 2003, we settled our patent infringement dispute with Vasco Data Systems in the United States District Court, District of Delaware. In February 2004, we also settled the suit we had brought against certain former stockholders of Authentic8 International, Inc. relating to our acquisition of that company.

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

ActivCard Corp.’s common stock began trading on the Nasdaq National Market 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”. In connection with Nasdaq’s decision to close Nasdaq Europe, we voluntarily de-listed from Nasdaq Europe on September 11, 2003.

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

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 7 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.

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.

Our objective is to be a leading provider of secure digital identity and authentication systems and products for secure remote access, single sign-on and digital identity card solutions. Our scalable systems and strong authentication solutions are trusted by organizations—from enterprise to governments around the world. We develop, market and support digital identity systems that enable our customers to issue, use and maintain digital identities in a secure, manageable and reliable manner. We market our solutions to 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.

We have focused our 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 2002 and 2003, 54% and 41% of revenues were derived from our core smart card related software products, 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, software and maintenance and support revenues, expressed as a percentage of total revenues, were as follows:

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

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

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

North America accounts for the majority of our revenues, primarily from deployments of our smart card-based software products, such as ActivCard Gold and the ActivCard Identity Management System at the U.S. Department of Defense. Revenues in Europe are mainly derived from marketing our ActivCard Token products to European banks for secure network access and online banking applications.

We anticipate that the majority of our future revenue growth will be from marketing secure digital identity and authentication systems and products, comprising the ActivCard Identity Management System, ActivPack authentication server, 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. Historically, we have hedged our non-functional currency denominated assets and liabilities to mitigate the effects of exchange rate fluctuations on earnings.

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 typical in private industry. 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.

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. 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.

Throughout 2003, we continued to restructure our business to reduce operating costs by implementing a reduction in workforce that resulted in the termination of 17 employees. As a result, we recorded restructuring and business realignment costs of $1.5 million, which consisted of severance and other termination costs. We expect to continue to restructure our operations in fiscal 2004 and that these restructuring efforts may result in additional restructuring and business realignment costs, which could be significant, in future periods.

In July 2003, we acquired a 38% interest in ASPACE Solutions Limited (“Aspace”), a developer of secure multi-channel data management systems based in London, England for £1.0 million or $1.6 million and we also provided Aspace with a two-year, senior convertible loan in the amount of £2.5 million or $4.1 million. In December 2003, we provided Aspace with an additional two-year loan facility in the amount of £1.0 million or $1.7 million. In connection with the additional loan, we received shares and warrants convertible into newly issued shares of Aspace. We exercised our warrant conversion rights in December 2003 increasing our ownership to 49% of the outstanding common shares of Aspace.

Aspace has incurred losses to date and we anticipate continuing losses from Aspace over the next twelve months. We believe that the other shareholders in Aspace cannot bear their share of losses to fund ongoing operations and anticipates that future Aspace losses will ultimately be borne by us. In this context, the authoritative accounting guidance requires that we record 100% of the net losses incurred by Aspace despite holding less than a controlling interest. For the year ended December 31, 2003, we recorded $2.4 million of losses incurred by Aspace from July 30, 2003 to December 31, 2003.

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:

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 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. 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 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. 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.

We normally sell our products to customers with payment terms that are less than 60 days.

In certain specific and limited circumstances, we provide product return and price protection rights to certain distributors and resellers. 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 and the end user is known or 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 in the accompanying consolidated balance sheets. Unbilled work-in-process is recorded as a receivable in the accompanying consolidated balance sheets.

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 we consider to be fair value. Although cash was exchanged in this transaction, we considered this as a nonmonetary transaction. For this transaction, we complied with Accounting Principles Board (“APB”) Opinion No. 29, “Accounting for Nonmonetary Transactions”, and Emerging Issues Task Force (“EITF”) issue No. 01-02, “Interpretation of APB opinion No. 29”, to determine whether the transaction was a monetary or nonmonetary 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. In addition, we capitalized $908 thousand as prepaid expenses, which included maintenance and support, PKI digital certificates,

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

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 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.

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. In June 2003, we commenced a follow-on registered exchange offer to acquire the minority interest in ActivCard S.A. not owned by ActivCard Corp. The follow-on exchange offer closed in July 2003 with ActivCard Corp. issuing 1,808,075 shares of its common stock to acquire approximately an additional 4.6% of the outstanding securities of ActivCard S.A. We allocated the purchase prices 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 but evaluated periodically for impairment, has a significant impact on both current and future operating results.

We review the valuation of goodwill in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets.” Under the provisions of SFAS No. 142, goodwill is required to be tested for impairment annually in lieu of being amortized. The annual impairment test date is December 1. Furthermore, goodwill is required to be tested for impairment on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred. An impairment loss shall be recognized to the extent that the carrying amount of goodwill exceeds its implied fair value. 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.

We review the valuation of long-lived assets, including property and equipment, under the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” We are required to assess the recoverability of long-lived assets on an interim basis whenever events and circumstances indicate that the carrying value may not be recoverable. This evaluation includes an analysis of estimated expected future undiscounted net cash flows 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. The hosting operations were disposed in February 2003.

In December 2002 and 2003, we performed impairment tests on the carrying value of goodwill and determined that no impairment existed.

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. In June 2003, due to changes in our strategic plans that affected the use of acquired technologies and expected revenues from certain acquired contracts, we identified indicators of additional impairment of our other acquired intangible assets. As a result, we recorded impairment charges of $5.1 million and $758 thousand in the years ended December 31, 2002 and 2003, respectively.

In June 2003, we terminated certain non-core activities that resulted in charges to earnings for asset write-downs of $4.2 million. The actions taken included: discontinuance of our biometric hardware product line in favor of reselling similar products manufactured by third parties; termination of a service offering whereby we would have hosted PKI digital certificate issuance; and consolidation of overlapping product offerings resulting in the replacement of certain third-party software code. As a result of these decisions, certain assets relating to these non-core activities were impaired. The assets written down were biometric hardware inventories, PKI digital certificate inventories, prepaid software royalties, prepaid software maintenance and software licenses.

At December 31, 2003, we had $17.1 million of goodwill and other intangible assets, which accounted for 6% of our total assets. In the future, if any additional 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.

We recorded charges of $8.6 million and $1.5 million in 2002 and 2003, respectively, related to restructuring plans, which consisted primarily of reductions-in-work force and facility vacancy costs. We exepect to incurr additional restructuring costs in 2004 as we continue to implement our restructuring initiatives. Accounting pronouncements in effect for restructuring activities initiated after December 31, 2002 required us to record a liability and charge when the liability was incurred rather than when we formally committed to the restructuring plan as previously required. These new provisions required us to measure the liability at fair value.

In 2002, 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 and 2003, we revised our estimate of expected sublease income and recorded additional charges to earnings of $620 thousand and $111 thousand, respectively. 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. 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.

We have a history of operating losses. These losses generated a net operating loss carry-forward in excess of $100 million as of December 31, 2003. Generally accepted accounting principles in the United States of America require that we record a valuation allowance against the deferred tax asset associated with our 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 low 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.

The consolidated financial statements are prepared in accordance with U.S. GAAP with the U.S. dollar as the reporting currency. We have established operations in geographic locations throughout the world including Canada, France, South Africa, India, and Australia in addition to our operations in the United States. For the year ended December 31, 2003, more than 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 by fluctuations in exchange rates between the U.S. dollar and the Euro. 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. Historically, we have entered into various short-term foreign currency forward contracts to offset these foreign exchange transaction gains and losses. In January 2004, we decided to re-evaluate the ongoing costs of our hedging programs and have not entered into any new foreign currency forward contracts.

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:

The increase in hardware revenues of 15% in 2003 compared to 2002 was the result of increased demand for our token-based products from European financial institutions and for smart card readers from U.S. government agencies and North American corporate enterprises. 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.

The 34% decrease in software revenues in 2003 compared to the prior year was the result of decreased unit sales of our ActivCard Gold client software products for maturing smart card based digital identification deployments by U.S. Department of Defense agencies. These large scale deployments at U.S. Department of Defense agencies began in the second half of 2001 and accelerated in 2002 resulting in a 68% increase in software revenues in 2002 compared to 2001.

The increase in maintenance and support revenues of 59% in 2003 and 190% in 2002 was the result of growth in the installed base of our ActivCard Gold client software primarily at U.S. Department of Defense agencies.

North American revenues accounted for $21.9 million or 57% of total revenues in 2003, a decrease of 19% over the $27.1 million, or 65% of total revenues in 2002. North American revenues in 2002 were 70% higher than 2001 revenues of $15.9 million or 51% of total revenues in 2001. 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. Revenues from Europe accounted for $14.6 million or 38% of total revenues in 2003, an increase of 14% over revenues of $12.8 million or 31% of total revenues in 2002. Revenues from Europe in 2002 were 6% lower than 2001 revenues of $13.7 million or 44% of revenues in 2001. 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.

Total cost of hardware revenues increased 33% in 2003 compared to 2002 as a result of increased volumes of higher cost reader sales. The increase in cost of hardware revenues of 2% in 2002 compared to 2001 resulted from increased volume of higher cost reader sales.

Total cost of software revenues increased 88% in 2003 compared to 2002 primarily as a result of our decisions in June 2003 to terminate certain non-core activities resulting in charges to cost of software and maintenance revenues of $3.3 million for asset write-downs during 2003. These decisions also resulted in charges to cost of hardware revenues of $0.9 million. The actions taken included: discontinuance of our biometric hardware product line in favor of reselling similar products manufactured by third parties; termination of a service offering whereby we would have hosted PKI digital certificate issuance; and consolidation of overlapping product offerings resulting in the replacement of certain third-party software code. As a result of these decisions, certain assets relating to these non-core activities were impaired. The assets written down were biometric hardware inventories, PKI digital certificate inventories, prepaid software royalties, prepaid software maintenance and software licenses. The cost of software revenues increased 296% in 2002 compared to 2001 as a result of increased engineering labor costs for custom software development related to deployments by the U.S. Department of Defense.

The cost of maintenance and support revenues increased 84% in 2003 and 286% in 2002, reflecting the increased cost of expanding software maintenance and support requirements for our large government deployments.

Included in cost of revenues are the costs associated with labor, manufacturing, delivery and other production and logistics costs. We employed 13 people in operations as of December 31, 2003 and 12 people as of December 31, 2002. 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 12 customer support people as of December 31, 2003 and 9 customer support people as of December 31, 2002.

Gross margin totaled $17.7 million, $28.4 million and $21.6 million in 2003, 2002 and 2001, respectively.

The hardware gross margin percentage declined 9% and 5% in 2003 and 2002, respectively, primarily as a result of an increased proportion of hardware sales derived from lower margin smart card reader sales.

The software gross margin percentage decreased 34% to 48% in 2003 from 82% in 2002. Charges to cost of software revenues associated with the termination of non-core activities described above accounted for 15% of the decrease while the balance of the decrease relates primarily to decreased unit sales of our ActivCard Gold client software products for maturing smart card-based digital identification deployments by U.S. Department of Defense agencies. The software gross margin percentage declined to 82% in 2002, a decrease of 10% from the gross margin percentage of 92% in 2001 due to increased engineering labor costs for custom software development related to deployments by the U.S. Department of Defense.

The maintenance and support gross margin declined 3% and 5% in 2003 and 2002, respectively, due to the increased cost of expanding software maintenance and support requirements for our large government deployments.

Research and development expenses consist primarily of salaries, costs of components used in research and development activities and related overhead costs. In 2003, research and development expenses decreased 8% compared to 2002 pursuant to our restructuring and business realignment activities executed during 2002 that included reductions in headcount and relocation of certain development activities to lower cost locations. Research and development expenses increased 8% in 2002 compared to 2001. The increase in expenditures related primarily to additional personnel assumed from the acquisition of Safe Data in June 2001 and Ankari in November 2001.

The majority of the research and development expenses incurred related to the development of the ActivCard Identity Management System, primarily for U.S. government agencies, as well as the introduction of new versions of ActivCard Gold, ActivCard Trinity and ActivPack products. We are also developing a converged product line that integrates our client software, single sign-on, authentication and provisioning software into a single unified platform that will be released commercially in the first quarter of 2004.

In connection with the purchase price allocation of the ActivCard S.A. minority interest acquired as part of the follow-on exchange offer completed in July 2003, the following amounts were assigned to research and development assets (in thousands):

Acquired research and development assets were valued based on discounted estimated future cash flows on a project-by-project basis over periods ranging three to seven years. The discount rates used ranged from 14% to 18% for developed and core technology and 28% for in process research and development. The research and development assets recorded in the purchase of the ActivCard S.A. minority interest were smart card related software applications and client/server software to support multi-function capabilities including card issuance, provisioning and management of digital identities.

The portion of the purchase price of the acquired assets that related to acquired research and development assets that had no alternative future use amounted to $306 thousand and was charged to operations as expense in the third quarter of 2003.

In connection with the purchase of certain assets from two privately held companies based in South Africa in January 2002, the portion of the purchase price that was attributed to research and development assets was as follows (in thousands):

The values attributed to acquired in-process research and development assets were based on discounted estimated future cash flows on a project-by-project basis over periods ranging over four years for developed technologies and five years for core technologies and in process research and development. The discount rates used ranged from 20% to 25% for developed and core technology and 30% for in process research and development.

The nature of the research and development assets purchased from the two privately held South African companies related to biometric authentication systems and related software development kits. An initial limited version of the biometric authentication system allows developers and solution providers to offer enhanced fingerprint authentication. At the time of asset purchase, the product was released to a limited and controlled group of customers. The full-featured product was released to the general marketplace in April 2002 and generated revenues starting in the quarter ended June 30, 2002. No material additional development was planned. The cost to complete the development work was less than $25 thousand and related to completion of functionality and features.

The portion of the purchase price of the acquired assets that related to acquired research and development assets that had no alternative future use amounted to $68 thousand and was charged to operations as expense in the first quarter of 2002.

In connection with the acquisitions of Safe Data, Authentic8 and Ankari in 2001, the portion of the purchase price that was attributed to research and development assets was as follows (in thousands):

The values attributed to acquired in process research and development assets were based on discounted estimated future cash flows on a project-by-project basis over periods ranging from three to seven years for developed and core technologies and five to seven years for in process research and development. The discount rates used ranged from 19% to 45% for developed and core technology and 24% to 50% for in process research and development.

The nature of the research and development assets acquired from Safe Data on June 27, 2001, related to the development of an authentication server. An authentication server is software that resides on a server that is designed to authenticate a user accessing a network by matching a password that is generated by a personal security device, such as a smart card or token, with the algorithm stored in its database. At the acquisition date, the status of development and the complexity of the work completed were estimated to be at the early stages of development. Accordingly, additional research and development was anticipated prior to release of the products under development. As of December 31, 2001, the product was complete, had been released and generated revenue in the third and fourth quarters of 2001. The cost to complete the project was less than $100 thousand and related to the completion of development, integration with existing ActivCard products, such as the ActivCard token, testing and technical documentation.

The nature of the research and development assets acquired from Authentic8 on September 11, 2001, related to the development of version 1.0 of Authentic8 client/server product. This development was required to enable Authentic8 to offer a fully outsourced public key infrastructure or PKI based remote access authentication service. At the acquisition date, the status of development and the complexity of the work completed were estimated to be at later stages of development. Accordingly, additional research and development was anticipated prior to commercial launch of the service. The product under development was estimated to be approximately three months from completion and was expected to generate material revenues in December 2001. The cost to complete the product under development was estimated to be less than $200 thousand and related to development of software code, integration with other products required to offer a complete server offer, testing and documentation.

The nature of the research and development assets acquired from Ankari on November 13, 2001, related to the development of client/server authentication software that support a broader range of personal security devices including biometrics. Ankari also markets authentication hardware in the form of fingerprint readers or biometric authentication as well as smart card readers. At the acquisition date, the status of development and the complexity of the work completed were estimated to be at the early stages of development. Accordingly, additional research and development was anticipated prior to release of the products under development. Version 4.2 of the client/server authentication software, which incorporated a number of new functionalities into the Trinity product, was completed, made available for general release and generated revenues in the fourth quarter of 2002. The cost to complete the project was approximately $2.0 million and related to the completion of development, integration with existing ActivCard products, such as the ActivCard token and smart card client software, testing and technical documentation.

Had any of these in-process research and development project been completed in a less timely manner, we would have experienced lower revenues, delays in receiving customer orders, loss of revenue opportunities and increased research and development expenses, among other things.

The portion of the purchase price of the acquired companies that related to acquired research and development assets that had no alternative future use amounted to $2.7 million and was charged to operations as expense in 2001.

We employed 156 and 137 people in research and development at December 31, 2003 and 2002, respectively.

Sales and marketing expenses consist primarily of salaries and other payroll expenses such as commissions, travel expenses of sales and marketing personnel, and costs associated with marketing programs and promotions.

Selling and marketing expenses increased 2% in 2003 compared to the prior year as a result of increased costs associated with pre-sales and support efforts for large corporate and government deployments. Selling and marketing expenses decreased 14% in 2002 compared to 2001 as a result of headcount reductions implemented as part of our restructuring and business realignment plan and reduced marketing activities.

We employed 109 and 90 people in sales and marketing at December 31, 2003 and 2002, respectively.

General and administrative expenses consist primarily of personnel costs for administration, accounting and finance, human resources and legal as well as professional fees related to legal, audit, accounting, transfer agent fees and stock exchange listing fees. In 2003, general and administrative expenses increased 43% from the prior year primarily as a result of increased professional fees incurred to defend our intellectual property, pursue potential business acquisitions and implement new regulatory reporting and compliance regulations. General and administrative expenses decreased 3% in 2002 compared to 2001 primarily due to the elimination of certain positions and the replacement of certain executive-level positions with lower cost personnel. The reduction in general and administrative expenses was somewhat offset by an increase in professional fees such as legal and audit related to the defense of our intellectual property and the implementation of new accounting pronouncements.

We employed 32 people in general and administrative functions and 14 personnel in corporate and IT functions on December 31, 2003 compared to 27 people in general and administrative functions and 16 personnel in corporate and IT functions on December 31, 2002.

The amortization of goodwill and acquired intangibles resulted from the acquisitions of ActivCard Asia, Safe Data, Authentic8, Ankari, the assets acquired from two privately-held companies based in South Africa, and the ActivCard S.A. minority interest. The amortization of acquired intangible assets decreased 74% in 2003 compared to 2002 as a result of impairment write-downs of $758 thousand and $5.1 million recorded in the second quarter of 2003 and the fourth quarter of 2002, respectively, to adjust the carrying value of acquired intangible assets to their estimated fair value as of the respective reporting dates. The amortization of goodwill related to the acquisitions of ActivCard Asia and Safe Data, both of which occurred prior to June 30, 2001, totaled $68 thousand in 2001. Effective January 1, 2002, goodwill is no longer amortized and, as such, there was no amortization expense related to goodwill in 2002 or 2003. The amortization of other intangibles consisted of the amortization of developed and core technology, agreements, contracts, trade names and trademarks.

In December 2002, in connection with our annual budgetary planning process and business review, we identified indicators of possible impairment of our other acquired intangible assets. These indicators included changes to our strategic plans that affected the use of acquired developed and core technologies and expected revenues from certain acquired contracts and strategic agreements. In June 2003, we identified indicators of additional impairment of our other acquired intangible assets. These indicators were caused by changes to our strategic plans that affected the use of acquired technologies and expected revenues from certain acquired contracts. Asset impairment tests were performed comparing the expected aggregate undiscounted cash flows to the carrying amounts of the acquired intangible assets. Based on the results of these tests, we determined that our other acquired intangible assets were impaired. The fair value of these acquired intangible assets was then determined using the discounted cash flow method. As a result, we recorded impairment write-downs of $758 thousand and $5.1 million in 2003 and 2002, respectively. The other intangible assets determined to be impaired consisted of developed and core technology, agreements, contracts, and trade names and trademarks.

Other charges for the respective comparative periods consisted of the following (in thousands):

Acquired in-process research and development represents the fair value of product that was at a stage of development that requires further research and development to determine technological feasibility and commercial viability. Acquired research and development was $306 thousand in 2003 and related to the acquisition of the ActivCard S.A. minority interest. Acquired in process research and development was $68 thousand in 2002 and related to the acquisition of ActivCard South Africa. Acquired in process research and development was $2.7 million in 2001 and related to the acquisitions of Safe Data, Authentic8 and Ankari.

Acquisition termination charges of $3.1 million represent charges incurred for the termination of a share purchase agreement to acquire Authentic8 in April 2001. The charges consisted primarily of professional fees of $2.0 million and an agreement termination fee of $1.1 million.

In 2001, we paid $728 thousand in compensation related to the termination of our former chief executive officer. The amounts paid were in accordance with an employment contract and statutory requirements under French law.

In 2001, we recorded $201 thousand for the settlement of litigation. The litigation related to a former minority shareholder of ActivCard Europe S.A. (formerly Telecash S.A.) as well as a second dispute for investment banking fees on a private financing completed in February 2000.

In 2002, we commenced consolidation of certain operations in order to enhance operational efficiency and reduce expenses and recorded restructuring and business realignment costs of $8.6 million. Restructuring and business realignment expenses consist of severance and other costs associated with the reduction of employee headcount of $2.6 million, 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. The severance costs were for 90 employees, of which 36 were employed in sales and marketing, 42 were employed in research and development, 7 were employed in general and administrative activities, 3 were employed in manufacturing and logistics and 2 were employed in corporate functions.

In 2003, we took further measures to restructure our business and reduce our operating costs by implementing a further reduction in workforce and recorded restructuring charges of $1.4 million. This charge consisted of severance and other termination costs for 17 employees, of whom 9 were employed in sales and marketing, 7 were employed in research and development and 1 was employed in manufacturing and logistics. We also recorded a restructuring charge of $111 thousand for a decrease in our estimate of expected sublease revenue associated with facility exit costs recorded in 2002. We are currently developing a plan to restructure operations. The plan being developed is primarily directed to enhancing and improving sales and marketing activities and rationalizing research and development projects and general and administrative functions. This plan, once completed and executed, will result in additional reductions in workforce and consolidation of geographic locations in 2004.

Components of restructuring and business realignment accruals, which are presented on the condensed consolidated balance sheet and in the condensed consolidated statements of operations for the years ended December 31, 2002 and 2003 were as follows (in thousands):

Remaining cash expenditures to complete the facility exit activities will be made over the seven-year period ending February 2011. We expect to make remaining cash payments to complete the workforce reduction by March 31, 2004.

In 2002 and 2003, we incurred charges of $1.0 million and $1.1 million, respectively, related to the change in domicile of the publicly listed company in the ActivCard group from the Republic of France to the United States, which was completed in February 2003. The charges consisted primarily of share cancellation expenses and legal, audit and other professional fees associated with the regulatory filings prepared in connection with the exchange offer and filed with the SEC and the Belgian Banking and Finance Commission.

Interest expense decreased 91% and 86% in 2003 and 2002, respectively, compared to the prior years as loans and capital lease obligations assumed on the acquisition of Safe Date in 2001 were repaid in 2002 and 2003.

The decrease in interest income of 18% from 2002 to 2003 was the result of lower interest rates in effect during 2003 compared to 2002 combined with lower average cash balances during the year. The decrease in interest income from 2001 to 2002 of 61% also related to a decrease in interest rates and average cash balances from the prior year. We consumed cash due to operating losses and the completion of three business acquisitions during the second half of 2001. We had cash and short-term investments of $228.7 million at December 31, 2003 and $248.4 million at December 31, 2002 and 2001. We earned an average yield from interest income and capital gains of 1.79% during 2003 on average cash balances and short-term investments compared to 2.10% in 2002 and 4.75% in 2001.

Foreign exchange losses decreased 74% to a loss of $120 thousand in 2003 and foreign exchange gains decreased 113% to a loss of $458 thousand in 2002. In September 2001, we implemented a foreign currency hedge program to mitigate the effect of exchange rate fluctuations on non-functional currency denominated assets and liabilities held by ActivCard legal entities. The average exchange rate of the Euro relative to the U.S. dollar for the year ended December 31, 2003 was 1.13. The average exchange rate of the Euro relative to the U.S. dollar for the year ended December 31, 2002 was 0.95.

Income tax expenses in all years represent minimum taxes payable in certain jurisdictions. The increase in income tax expense in 2003 over 2002 is mainly due to minimum taxes in the state of Delaware incurred as a result of the change in domicile from the Republic of France to the state of Delaware.

Minority interest of $744 thousand in 2003 represents approximately 5.2% of the consolidated net loss of ActivCard S.A. from February 3, 2003 to July 17, 2003 and approximately 0.6% of the consolidated net loss of ActivCard S.A. subsequently. In February of 2003, we completed the change in domicile of the publicly listed company in the ActivCard group, formerly ActivCard S.A. from the Republic of France to the United States. In July 2003, we completed a follow-on exchange offer in which we acquired approximately an additional 4.6% of the outstanding securities of ActivCard S.A. The minority interest in ActivCard S.A. is approximately 0.6% representing outstanding common shares and American Depositary Shares of ActivCard S.A. that were not exchanged as of December 31, 2003.

In July 2003, we acquired a 38% interest in ASPACE Solutions Limited (“Aspace”), a developer of secure multi-channel data management systems based in London, England. We acquired 38,140 common shares of Aspace from existing shareholders for £954 thousand (£25 per share) or $1.5 million. In connection with the acquisition of common shares, we also provided Aspace with a two-year, senior convertible loan in the amount of £2.5 million or $4.1 million, which bears interest at a rate of 6% per annum. If all or part of the senior convertible loan is outstanding on the two-year anniversary date, we have the right to convert the loan balance any time thereafter, into common shares of Aspace at a price of £25 per share.

In December 2003, we provided Aspace with an additional two-year loan facility in the amount of £1.0 million or $1.7 million, which bears interest at a rate of 6% per annum and is repayable on November 30, 2005. In connection with the additional loan, we received shares and warrants convertible into 21,245 newly issued shares of Aspace at a price of £0.01 per share. We exercised our warrant conversion rights in December 2003 increasing our ownership to 59,385 common shares or 49% of the outstanding common shares of Aspace. Aspace currently has 121,245 shares outstanding.

Aspace has incurred losses to date and we anticipate continuing losses from Aspace over the next twelve months. We believe that the other shareholders in Aspace cannot bear their share of losses incurred. In this context, the authoritative accounting guidance requires that we record 100% of the net losses incurred by Aspace despite holding less than a controlling interest. For the year ended December 31, 2003, we recorded $2.4 million of losses incurred by Aspace from July 30, 2003 to December 31, 2003.

On February 15, 2002, we executed a plan to dispose of the hosting operations of Authentic8. The assets and liabilities related to the hosting operations were classified as assets and liabilities held for sale on the consolidated balance sheet at December 31, 2002 and the charge to earnings classified as a loss from discontinued operations on the consolidated statement of operations for the year ended December 31, 2002.

On February 12, 2003, the Company entered into an agreement to dispose of the assets and certain liabilities of the hosting operations of Authentic8. The results of operations of the hosting activities to March 14, 2003, the effective date of the agreement, have been included in the loss from discontinued operations in the condensed consolidated statement of operations.

The loss from discontinued operations was comprised of the following (in thousands):

As of December 31, 2003, we had cash and equivalents and short-term investments of $228.7 million, a decrease of $19.6 million from December 31, 2002. During 2003, we consumed $13.5 million of cash from continuing operations primarily due to a net loss from continuing operations in the period of $29.7 million. Included in the loss from continuing operations were non-cash items totaling $10.4 million. We consumed $9.0 million of cash from continuing operations in 2002 primarily from a net loss from continuing operations of $28.7 million offset by non-cash items of $13.6 million. As of December 31, 2002, we had cash and equivalents of $248.4 million, a decrease of $62 thousand from December 31, 2001.

Accounts receivable, net of allowances, decreased to $3.4 million as of December 31, 2003 from $9.2 million as of December 31, 2002. Accounts receivable, net of allowances were $8.3 million as of December 31, 2001. Days sales outstanding, which is a measure of the average collection period of trade accounts receivable, improved to 45 days at December 31, 2003 from 69 days as of December 31, 2002. The decline in days sales outstanding was the result of improved linearity of monthly shipments in the fourth quarter of 2003 compared to the fourth quarter of 2002 resulting in proportionately lower shipments in the last month of the quarter. Days sales outstanding as of December 31, 2001 was 83 days. The credit terms extended to our customers are typically less than 60 days, which has not changed during these periods. We anticipate that days sales outstanding will return to our historical trend of approximately 70 days, which we believe is consistent with other companies in our industry.

Investing activities in 2003 consisted primarily of investments in short-term securities, investments in and loans to Aspace and capital expenditures. Purchases of short-term investments, net of proceeds from sales and maturities of short-term investments, totaled $107.0 million for the year ended December 31, 2003 as we invested excess cash and equivalents in U.S. government and government agency securities. During 2003, we also agreed to make investments in and loans to Aspace totaling $8.2 million. Aspace has been incurring losses to date and we anticipate continuing losses from Aspace over the next twelve months. We believe that the other shareholders in Aspace cannot bear their share of losses to fund ongoing operations and anticipate that future Aspace losses may ultimately be borne by ActivCard. Although we have no contractual obligation to do so, we may provide financing to Aspace in the future.

Investing activities consisted primarily of investments in short-term securities, acquisitions and capital expenditures in 2002. Purchases of short-term investments, net of proceeds from sales and maturities of short-term investments, totaled $89.5 million for the year ended December 31, 2002 as we invested excess cash and equivalents in U.S. government and government agency securities. During 2002, we also acquired certain assets and assumed certain liabilities of two privately held companies based in South Africa totaling $1.2 million including acquisition costs and recovered $1.8 million from closing balance sheet adjustments from the purchase of Safe Data and Authentic8.

Financing activities for the year ended December 31, 2003 and 2002 consisted primarily of proceeds from the issuance of common shares resulting from the exercise of warrants and options of $3.9 million and $5.8 million, respectively.

At December 31, 2003, we had $4.9 million of long-term liabilities compared to long-term liabilities of $5.0 million at December 31, 2002. Long-term liabilities consist of the long term portion of restructuring accruals for facility exit costs and deferred rent obligations on leased facilities.

Our future capital requirements, the timing and amount of expenditures, and the adequacy of funds available to us will depend on our success in developing and selling new and existing products. Based on our current plans, we believe that existing cash balances and cash flows generated by operations will be adequate to satisfy our capital requirements at least through 2004.

The following summarizes our contractual obligations at December 31, 2003, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

In June 2002, the Financial Accounting Standards Board (“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. SFAS 146 also requires that such a liability be measured at its fair value and subsequent changes to the liability be measured using the credit-adjusted risk-free rate used when the liability was initially recorded. We adopted the provisions of SFAS 146 for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have a material impact on our results of operations or financial position.

In November 2002, the EITF reached a consensus on Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into in fiscal periods commencing after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material impact on our results of operations or financial position.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148 at December 31, 2002. We have not yet determined the impact, if any, that the transition provisions of SFAS No. 148 may have on our results of operations or financial position.

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” and a revised interpretation of FIN 46, (FIN 46R), in December 2003. FIN 46 provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as “variable interest entities” (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate a VIE. This new requirement for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. FIN 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. For VIEs created after January 31, 2003, FIN 46R is effective immediately. We will apply FIN 46R for all new VIEs created before January 31, 2003 no later than the quarter ending March 31, 2004. We have not yet determined the impact, if any, that the provisions of FIN 46R may have on our results of operations or financial position.

In May 2003, the EITF reached a consensus on Issue No. 03-5 “Applicability of AICPA Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.” The FASB ratified this consensus in August 2003. The EITF affirmed that SOP 97-2 applies to non-software deliverables, such as hardware and services, in an arrangement if the software is essential to the functionality of the non-software deliverables. The adoption of EITF Issue No. 03-5 did not have a material impact on our results of operations or financial position.

In November 2003, the EITF reached a consensus on certain disclosure provisions under Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The disclosure provisions indicate that certain quantitative and qualitative disclosures are required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS Nos. 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The EITF has not reached a consensus on the proposed models for evaluating impairment of equity securities and debt securities. The consensus on the required quantitative and qualitative disclosures is effective for fiscal years ending after December 15, 2003. The adoption of the disclosure provisions of this Issue during the fourth quarter of 2003 did not have a material impact on our results of operations or financial position.

We have a history of losses and we may experience losses in the foreseeable future.

We have not achieved profitability on an operating basis and we may continue to incur operating losses in the foreseeable future. We incurred losses from operations of $32.0 million in 2003, $33.3 million in 2002 and $32.9 million in 2001. As of December 31, 2003, our accumulated deficit was $139.4 million, which represents our net losses since we began our operations. Even with our sizable cash balances, we may not become profitable or be able to significantly increase our revenue.

We will need to achieve significant incremental revenue growth and contain costs to achieve profitability. Even if we do achieve profitability, we may be unable to sustain profitability on a quarterly or annual basis in the future. It is possible that our revenues will grow more slowly than we anticipate or that operating expenses will exceed our expectations.

Our cost-reduction initiatives may not result in the anticipated savings or more efficient operations and may harm our long-term viability.

In connection with our effort to streamline operations, improve efficiency and reduce costs, we restructured our organization in 2002 and 2003, with substantial reductions in our workforce, vacated premises and reduced operations in some locations. We expect that we will continue our cost-reduction initiatives in fiscal 2004 and may incur substantial costs, including severance and other employee–related costs. These restructuring efforts are disruptive to operations and may not generate the anticipated savings in operational costs.

We are currently developing a plan to restructure operations. The plan being developed is primarily directed to enhancing and improving sales and marketing activities and rationalizing research and development projects and general and administrative functions. This plan, once completed and executed, will result in additional reductions in workforce and consolidation of geographic locations in 2004.

Additionally, our restructuring plan may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce. Although we believe that it is necessary to reduce the size and cost of our operations to improve our financial results, a reduction in our operations may make it more difficult to develop and market new products and to compete successfully with other companies in our industry. In addition, many of the employees who were terminated possessed specific knowledge or expertise that may prove to have been important to our operations. In that case, their absence may create significant difficulties. This personnel reduction may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us to incur significant expense.

We have experienced significant turnover in management and this may make it more difficult for the Company to execute on its business plan.

In February 2004, we announced the departure of our chief executive officer, who had joined in October 2003. Since that time, we have eliminated or consolidated the positions of several other senior-level officers and employees in connection with our restructuring initiatives. The remaining members of our management team have assumed many of the duties of these positions. Additionally, recent turnover in our management team may make it more difficult for us to attract and retain skilled employees in the future.

We have recorded significant write-downs in recent periods for impairment of assets and may have similar write-downs in future periods.

We recorded an impairment write-down of $758 thousand in the second quarter of 2003 and $5.1 million in the fourth quarter of 2002 to adjust the carrying value of acquired intangible assets to their estimated fair value. The impaired assets consisted of developed and core technology, agreements, contracts, and trade names and trademarks. Additionally, we terminated certain non-core activities in 2003, including our biometric hardware product line, hosting of PKI digital certificate issuance and overlapping product offerings. As a result of these decisions, we recorded charges to earnings of $4.2 million in 2003, which included impairment in value of software licenses included in property and equipment of $1.7 million.

We may terminate additional non-core activities in future periods or determine that our investment in Aspace Solutions Limited, other intangible assets or goodwill have been impaired. Any additional impairment charges that result could be significant and could have a material adverse effect on our consolidated financial position and results of operations. At December 31, 2003, we had $17.1 million of goodwill and other intangible assets, which accounted for 6% of our total assets.

Our industry is characterized by rapid technological change and we must continually improve our products to remain competitive.

The market for network security products is characterized by rapid technological advances, changes in customer requirements, evolving industry standards and frequent new product introductions and enhancements. If we do not continually modify and adapt our products and improve the performance features and reliability of our products in response to advances and changes in technology and standards, our business could be adversely affected and our products and technology could become obsolete or less marketable. Moreover, if new Internet, networking or telecommunications technologies or standards become widely adopted, or if other technological changes occur, we may need to adapt our

products. Our future operating results will depend upon our ability, on a timely basis, to enhance our current products and to develop and introduce new products that address the increasingly sophisticated needs of the marketplace and that keep pace with technological developments, new competitive product offerings and emerging industry standards. The process of developing our products and services is extremely complex and requires significant ongoing development efforts.

Results vary significantly from quarter-to-quarter and it is difficult to forecast future results.

Our operating results are difficult to forecast and may continue to fluctuate. As a result, period-to-period comparisons of our operating results are not necessarily meaningful. Factors that influence our operating results include:

Our expense levels are based, in part, on our expectations of future revenues and if such expectations are not met, our operating results will be adversely affected. Further, net income (loss) may be disproportionately affected by a reduction in revenues because of the relatively small amount of our expenses that vary with our revenues.

We have a 49% voting control interest in Aspace Solutions Ltd. To date, Aspace’s product is unproven in the marketplace, achieving only modest revenues. Further, Aspace has a history of losses and may not have adequate capital to grow its business. We have no contractual obligation to continue to fund Aspace, although we may do so in the future. Should Aspace fail to execute on its business plan, our operating results and financial condition could be negatively affected.

Despite only owning 49% of the voting control of Aspace, current authoritative accounting guidelines require us to record 100% of Aspace’s losses in our results of operations. Should Aspace continue to experience losses, our operating results and financial condition would be negatively affected at least to the extent of our investment.

We derive revenue from only a limited number of products and we do not have a diversified product base.

Substantially all of our revenues are derived from the sale of our digital identity systems and products. We anticipate that substantially all of the growth in our revenue, if any, will also be derived from these sources. If for any reason our sale of these products is impeded, and we have not diversified our product offerings, our business and results from operations could be harmed. We do not expect to diversify our product offerings in the foreseeable future and may actually reduce our product offerings as part of our restructuring initiatives so that we focus on just our core products. By limiting our product offerings in the future, we will likely increase the risks associated with not having a diversified product base.

Our customer base is highly concentrated and the loss of any one of these customers could adversely affect our business.

Historically, we have experienced a concentration of revenues through certain of our channel partners to customers. In 2003 and 2002, there was a high concentration of revenues through a number of system integrators to the U.S. Department of Defense. Many of our contracts with our significant channel partners are short-term. If any of these channel partners did not renew their contract upon expiration, or if there was a substantial reduction in sales to any of our significant customers, it could adversely affect our business and operating results.

In 2001, three customers accounted for 41% of revenues. In 2002, one customer accounted for 26% of revenues. In 2003, three customers accounted for 49% of revenues. Our customers consist primarily of system integrators, resellers, distributors and OEMs. We ship product to the U.S. Department of Defense exclusively through system integrators. In the year ended December 31, 2003 and 2002, we shipped product to many departments within the U.S. Department of Defense through system integrators such as Northrop Grumman. Our subcontract agreement with Northrop Grumman expires in August 2004. We cannot be certain the subcontract agreement with Northrop Grumman will be renewed or extended.

In the aggregate, the U.S. Department of Defense, as an end-user, accounted for approximately 39% of our consolidated revenues in the year ended December 31, 2003 and approximately 47% in the year ended December 31, 2002. Two departments within the U.S. Department of Defense, each accounted for 10% of consolidated revenues during those periods. We expect to continue to depend upon a small number of large customers for a substantial portion of our revenue.

We have a long and often complicated sales cycle for individual orders, which can result in significant revenue fluctuations from quarter to quarter.

The sales cycle for our products, which is the period of time between the identification of a potential customer and completion of the sale, is typically long and subject to a number of significant risks over which we have little control. As our operating expenses are based on anticipated revenue levels, a small fluctuation in the timing of sales can cause our operating results to vary significantly from period to period. If revenue falls significantly below anticipated levels, our business would be seriously harmed.

A typical sales cycle is often six to nine months in the case of an enterprise customer, and more than twelve months in the case of a network service provider customer or government entity.

Purchasing decisions for our products and systems may be subject to delay due to many factors that are not within our control, such as:

Furthermore, the implementation process is subject to delays resulting from network administrative concerns associated with incorporating new technologies into existing networks, deployment of a new network system or preservation of existing network infrastructure and data migration to the new system. Full deployment of our technology and products for such networks, servers or other host systems is usually scheduled to occur over a two-to-three-year period and the licensing of digital identity systems and products, including client and server software, smart cards, readers, tokens and the recognition of maintenance revenues would also occur over this period.

The market for our products is still developing and if the industry adopts standards or a platform different from our platform, then our competitive position would be negatively affected.

The market for digital identity products is still emerging and is also experiencing consolidation. The evolution of the market is in a constant state of flux that may result in the development of different network computing platforms and industry standards that are not compatible with our current products or technologies.

We believe that smart cards are an emerging platform for providing digital identity for network applications and services. Our business model is premised on the smart card becoming a common access platform for network computing in the future. Further, we have focused on developing our products for particular operating systems related to smart card deployment and use. Should platforms other than the smart card emerge as a preferred platform or should operating systems other than the specific systems we have focused on emerge as preferred operating systems, our current product offerings could be at a disadvantage to competitors who have been focusing on alternative platforms and operating systems. If this were to occur, our future growth and operating results could suffer.

In addition, the digital identity market lacks industry-wide standards. While we are actively engaged in discussions with industry peers to define what standards should be, it is possible that any standards eventually adopted could prove disadvantageous to or incompatible with our business model and product lines.

The nature of our bidding process and competitive pressures may, in the future, force us to sell products at a loss.

We engage in competitive bidding practices for some of our contracts that in the future could result in our costs exceeding our revenues for some contracts. We generate a portion of our revenue from contracts and purchase orders awarded through competitive bidding processes. Our bids will not always be accepted or, if accepted, awarded contracts may not generate enough revenue to be profitable. The competitive bidding process is typically lengthy and often results in the expenditure of financial, engineering and other resources early in the process and also in connection with bids that are not accepted. Additionally, inherent in the competitive bidding process is the risk that our costs may exceed projected costs upon which a submitted bid or contract price is based.

Our international operations subject us to risks associated with operating in foreign markets, including fluctuations in currency exchange rates that could adversely affect our results from operations and financial condition. International sales are a substantial portion of our business. A severe economic decline in one of our major foreign markets could make it difficult for customers from those countries to pay us on a timely basis. Any such failure to pay, or deferral of payment, could

adversely affect our results of operations and financial condition. In 2001, 2002 and 2003, markets outside of North America accounted for 49%, 35% and 43% of consolidated revenues, respectively.

We face a number of risks inherent in doing business in international markets, including among others:

While we prepare our financial statements in U.S. dollars, we have historically incurred a substantial portion of our expenses in Euros. We expect that a significant portion of our expenses will continue to be incurred in Euros and, to a lesser extent, in other non-U.S. foreign currencies. Fluctuations in the value of the Euro and other currencies relative to the U.S. dollar have caused and will continue to cause dollar-translated amounts to vary from one period to another. Due to the constantly changing currency exposures and the substantial volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations upon future operating results.

Our ability to remain competitive depends in part on attracting, hiring and retaining qualified technical personnel.

Our future success depends in part on the availability of qualified technical personnel, including personnel trained in software and hardware applications within specialized fields. As a result, we may not be able to successfully attract or retain skilled technical employees, which may impede our ability to develop, install, implement and otherwise service our software and hardware systems and to efficiently conduct our operations.

The information technology and network security industries are characterized by a high level of employee mobility and the market for technical personnel remains extremely competitive in certain regions. This competition means there are fewer highly qualified employees available to hire, the costs of hiring and retaining such personnel are high and they may not remain with our company once hired. Furthermore, there is continuing pressure to provide technical employees with stock options and other equity interests in our company, which may dilute our earnings per share.

Additions of new personnel and departures of existing personnel, particularly in key positions, can be disruptive, might lead to additional departures of existing personnel and could have a material adverse effect on our business, operating results and financial condition. The addition and assimilation of new personnel may be made more difficult by the fact that our research and development personnel are located in France, the United States, and Canada and our sales and marketing activities are located on three continents, thus requiring the coordination of organizations separated by geography and time zones, and the interaction of personnel with disparate business backgrounds, languages and cultures.

It is difficult to integrate acquired companies, products and technologies into our operations and our inability to do so could greatly lessen the value of any such acquisitions.

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. In 2001, we acquired Safe Data System S.A. in Montpellier, France, Authentic8 International Inc. in Melbourne, Australia and American Biometric Co. Ltd. (Ankari) in Ottawa, Canada. We may make additional strategic acquisitions of companies, products or technologies in the future in order to implement our business strategy. If we are unable to successfully integrate acquired businesses, products or technologies with our existing operations, we may not receive the intended benefits of such acquisitions. For example, in the first quarter of 2002, we decided to dispose of certain of the operations of Authentic8. As a result of this decision, we recorded a $16.8 million charge to earnings in year ended December 31, 2002 associated with the impairment of goodwill and other intangibles, write-down of property and equipment and loss from discontinued operations. Additionally, as we recently experienced relating to our acquisition of Authentic8, following the consummation of an acquisition, disputes may arise regarding representations and warranties, indemnity, earn-out and other provisions in the acquisition agreement. For the foregoing reasons, acquisitions may subject us to unanticipated liabilities or risks, disrupt our operations and divert management’s attention from day-to-day operations.

To date, we have primarily used cash to finance our business acquisitions. We may incur debt or issue equity securities to finance future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our shareholders. In addition, our profitability may suffer due to acquisition-related expenses and the amortization of acquired intangible assets.

We depend on a limited number of manufacturers and suppliers and any disruption of our supply chain could adversely affect the results of operations and could impact customer relations.

We depend upon a small number of companies for the manufacture of our products and the loss of any one of them could materially harm our business. We source from three Hong Kong-based companies, for the manufacture and assembly of ActivCard tokens and readers. We also purchase PCMCIA and USB smart card readers and smart cards from various third-parties for distribution to our end-user customers. We place purchase orders with these manufacturers, the terms of which are negotiated on an order-by-order basis. The reproduction of CDs for our software products is performed in California and in France. These are currently our sole sources for the manufacture and assembly of these products. A reduction or interruption in supply and the failure to identify and establish relationships with additional manufacturers and assemblers would adversely affect our results of operations and could impact customer relations.

Certain of our subcontractors have manufacturing facilities located in a special economic zone in the Guandong and Shenzhen Provinces in the People’s Republic of China. The Chinese government has exercised, and continues to exercise, substantial control over many sectors of the Chinese economy, including manufacturing. Consequently, changes in policy by the Chinese government could adversely affect our ability to source ActivCard tokens in China. The preferential tax treatment granted to enterprises located in these special economic zones could also be withdrawn, which could adversely affect the cost of manufacturing in China.

Although most of the parts and components used in the manufacture of our products are readily available from a number of suppliers, certain components are currently available only from a single source or from limited sources. Our inability to obtain sufficient source components, or to obtain or develop alternative sources at competitive prices and quality, could result in delays in product shipments or increase our material costs, either of which would adversely affect our financial condition or results of operations. In particular, the micro-controller chips contained in the older ActivCard Plus tokens are currently purchased from a sole source supplier, which produces the chips in South Korea. This supplier may not be able to furnish enough chips to meet our demand or we may not be able to continue to purchase chips of acceptable quality from this supplier at commercially acceptable prices. We believe that if this supplier were to discontinue the manufacture of the chips or to become unwilling or unable to meet our future requirements, we would be able to procure chips of acceptable quality from another supplier, and our contractual relationship with this supplier would not restrict our ability to do so. We could also redesign our ActivCard Plus tokens for a different microprocessor. However, delay or failure to identify additional suppliers at commercially acceptable prices or redesign the circuits could adversely affect our results of operations.

We rely on strategic relationships with other companies to develop and market our products. If we are unable to enter into any such relationships, or if we lose an existing relationship, our business could be harmed.

Our success depends on establishing and maintaining strategic relationships with other companies to develop, market and distribute our technology and products and, in some cases, to incorporate our technology into their products. Part of our business strategy has been to enter into strategic alliances and other cooperative arrangements with other companies in the industry. We are currently involved in cooperative efforts to incorporate our products into products of others, to jointly engage in research and development efforts and to jointly engage in marketing efforts and reseller arrangements. None of these relationships is exclusive, and some of our strategic partners also have cooperative relationships with certain of our competitors.

If we are unable to enter into cooperative arrangements in the future or if we lose any of our current strategic or cooperative relationships, our business could be harmed. We do not control the time and resources devoted to such activities by parties with whom we have relationships. In addition, we may not have the resources available to satisfy our commitments, which may adversely affect these relationships. These relationships may not continue, may not be commercially successful, or may require the expenditure of significant financial, personnel and administrative resources from time to time. Further, certain of our products and services compete with the products and services of our strategic partners. For example, Schlumberger distributes software for logical security applications using smart cards in addition to the smart card products that they license from our company. This competition may adversely affect our relationships with our strategic partners, which could adversely affect our business.

The nature of our operations makes us particularly susceptible to power outages, computer viruses, acts of terrorism and natural disasters.

Our operations are vulnerable to damage or interruption from computer viruses, human error, natural disasters, telecommunication failures, power outages, intentional acts of vandalism or terrorism and similar events. In particular, our U.S. headquarters are located in the San Francisco Bay area, which is known for seismic activity. We have not established a formal disaster recovery plan, and our back-up operations and business interruption insurance may not be adequate to compensate us for losses that occur. A significant business interruption would result in losses or damages incurred and would harm our business.

Legislative actions, higher insurance cost and potential new accounting pronouncements are likely to impact our future financial position and results of operations.

There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and there may potentially be new accounting pronouncements or additional regulatory rulings, which will have an impact on our future financial position and results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes as well as proposed legislative initiatives following the Enron bankruptcy are likely to increase general and administrative costs, particularly for a relatively small company such as ours. In addition, insurers are likely to increase premiums as a result of high claims rates over the past year, which we expect will increase our premiums for our various insurance policies. Further, proposed initiatives are expected to result in changes in certain accounting rules, including legislative and other proposals to account for employee stock options as a compensation expense. These and other potential changes could materially increase the expenses we report under generally accepted accounting principles and adversely affect our operating results.

We may be subject to liability claims brought by our customers alleging flaws in our products. If any such claims were to arise, they may be costly to defend and our reputation could be damaged.

Our sales agreements typically contain provisions designed to limit our exposure to potential product liability or related claims. Products as complex as those we offer may contain undetected errors or “bugs” or result in failures when first introduced or when new versions are released. The occurrence of these errors could result in adverse publicity, delay in product introduction, diversion of resources to remedy defects, loss of or a delay in market acceptance or claims by customers against our company, or could cause us to incur additional costs, any of which could adversely affect our business. Despite our product testing efforts and testing by current and potential customers, it is possible that errors will be found in products or enhancements after commencement of commercial shipments. We do not maintain insurance to mitigate losses caused by product defects.

Our products can be used to prevent unauthorized access to and attacks on critical enterprise information. As our customers rely on our products for critical security applications, we may be exposed to potential liability claims for damage caused to an enterprise as a result of an actual or perceived failure of our products. An actual or perceived breach of enterprise network or data security systems of one of our customers, regardless of whether the breach is attributable to our products or solutions, could adversely affect the market’s perception of our products and solutions and therefore our business. Furthermore, the nature of many of our professional services exposes us to a variety of risks. Many of our professional service engagements involve projects that are critical to the operations of the customers’ businesses. Our failure or inability to meet a customer’s expectations in the performance of our services or products, or to do so in the time frame required by the customer, regardless of our responsibility for the failure, could:

In addition, as a provider of professional services, a portion of our business involves employing people and placing them in the workplace of other businesses. Therefore, we are also exposed to liability with respect to actions of our employees while on assignment, such as damages caused by employee errors and omissions, misuse of customer proprietary information, misappropriation of funds, discrimination and harassment, theft of customer property, other criminal activity or torts and other claims.

We currently carry general liability insurance, errors and omissions insurance and insurance to guard against losses caused by employee dishonesty. We believe that this insurance is comparable to other similar companies in our industry. However, that insurance may not continue to be available to us on reasonable terms or in sufficient amounts to cover one or more large claims, or the insurer may disclaim coverage as to any future claim. We do not maintain insurance coverage for employee errors or security breaches, nor do we maintain specific insurance coverage for any interruptions in our business

operations. The successful assertion of one or more large claims against us that exceed available insurance coverage, or changes in our insurance policies, including premium increases or the imposition of large deductibles or co-insurance requirements, could adversely affect our business.

Our operating results could suffer if we are subjected to a protracted intellectual property infringement claim or one with a significant damages award.

We may face claims of infringement on proprietary rights of others that could subject us to costly litigation and possible restriction on the use of such proprietary rights. There is a risk that our products infringe on the proprietary rights of third parties. While we do not believe that our products infringe on proprietary rights of third parties, infringement or invalidity claims may nevertheless be asserted or prosecuted against us and our products may be found to have infringed the rights of third parties. Such claims are costly to defend and could subject us to substantial litigation costs. If any claims or actions are asserted against us, we may be required to modify our products or may be forced to obtain a license for such intellectual property rights in a timely manner. We may not be able to modify our products or obtain a license on commercially reasonable terms, or at all.

The threat of new terrorist attacks and the continued weakness in the global economy may cause our company to fail to meet expectations, which could negatively impact the price of our stock.

Our operating results can vary significantly based upon the impact of changes in global and domestic economic and political conditions. Capital investment by businesses, particularly investments in new technology, has been experiencing substantial weakness. The threat of new terrorist attacks and the United States’ continued involvement in Iraq have contributed to continuing economic and political uncertainty that could result in a further decline in new technology investments. These uncertainties could cause customers to defer or reconsider purchasing our products or services if they experience a downturn in their business or if there is a further downturn in the general economy. Such events could have a material adverse effect on our business.

Demand for our products depends, in part, on the continued growth of the Internet and other communications networks.

If the use of the Internet and other communications networks does not continue to grow, demand for our products may not increase. Successful implementation of our strategy depends in large part on the continued growth in the use of the Internet and other communications networks based on internetworking protocols. If the use of these networks does not continue to grow, or if it grows more slowly than we expect, the demand for our products may not increase. As certain types of network transactions and applications, such as electronic commerce, are still evolving, we cannot predict the size of the market and its sustainable growth rate. To date, many businesses and consumers have been deterred from using these networks for a number of reasons, including, but not limited to:

The adoption of the Internet and other communication networks based on internet protocols will require a broad acceptance of new methods of conducting business and exchanging information. Companies and government agencies that already have invested substantial resources in other methods of conducting business may be reluctant to adopt new methods. Also, persons with established patterns of purchasing goods and services and effecting payments through traditional means may be reluctant to change.

If the security codes in our software were to be broken, our products may be rendered less effective and our reputation and operating results could be adversely affected.

We employ cryptographic technology in our authentication products that use complex mathematical formulations to establish network security systems. Many of our products are based on cryptographic technology. With cryptographic technology, a user is given a key that is required to encrypt and decode messages. The security afforded by this technology depends on the integrity of a user’s key and in part on the application of algorithms, which are advanced mathematical factoring equations. These codes may eventually be broken or become subject to government regulation regarding their use, which would render our technology and products less effective. The occurrence of any one of the following could result in a decline in demand for our technology and products:

U.S. and French export laws may limit our ability to sell certain of our products internationally. These restrictions may reduce potential revenue and create a competitive advantage for companies not subject to these laws.

For the years ended December 31, 2001, 2002 and 2003, international sales, defined as sales in Europe and Asia, were 49%, 35% and 43% of consolidated revenues, respectively.

Government regulation of technology exports could limit our ability to market our products and to compete effectively worldwide. Our international sales and operations may be subject to the following risks:

While we believe our technology and products are designed to meet the regulatory standards of many foreign markets, any inability to obtain foreign regulatory approvals on a timely basis could have a material adverse effect on our results of operations and financial condition.

Certain of our products are subject to export controls under U.S. and French laws, and we believe that we have obtained all necessary export approvals when required. However, the list of products and countries for which export approval is required, and the regulatory policies with respect thereto, may be revised from time to time. Our failure to obtain required approvals under these regulations could adversely affect our ability to sell in certain parts of the world. For example, because of the U.S. governmental controls on the exportation of encryption technology, we have been unable to export some of our products with the most advanced information security encryption technology without providing encryption keys for access by governmental authorities. As a result, non-U.S. competitors facing less stringent controls on their products may be able to compete more effectively than we can in the global information security market. Recent political events such as the terrorist attacks in the U.S. may lead to greater governmental regulation of these products and further restrictions on the export of strong encryption technologies. These factors may have a material adverse effect on our results of operations and financial condition.

Due to the increasing popularity of the Internet and internetworking protocol-based communication networks, it is possible that laws and regulations may be enacted covering issues such as user privacy, pricing, content and quality of

products and services. The increased attention focused upon these issues as a result of the adoption of additional laws and regulations may reduce the rate of growth of these networks, which in turn could result in decreased demand for our technology.

We believe that we are exposed to minimal market risks. We do not hold or issue derivatives, derivative commodity instruments or other financial instruments for trading purposes.

We are exposed to currency exchange fluctuations as we sell our products internationally. We manage the sensitivity of our international sales by denominating substantially all transactions in U.S. dollars.

In the years ended December 31, 2002 and 2003, nearly all of our revenues were invoiced in U.S. dollars. Although we purchase many of our components in U.S. dollars, approximately half of our cost of revenues and operating expenses are denominated in other currencies.

In the year ended December 31, 2003, the net foreign exchange loss was $120 thousand. In fiscal 2002, the net foreign exchange loss was $458 thousand.

In September 2001, we implemented a foreign exchange hedging program to mitigate transaction 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. Historically, we entered into various short-term foreign currency forward contracts that we account for as fair value hedging instruments to offset these foreign exchange transaction gains and losses. In January 2004, we decided to re-evaluate the ongoing costs of our hedging programs and have not entered into any new foreign currency forward contracts.

At December 31, 2003, ActivCard Inc., our U.S. subsidiary, had entered into forward contracts to buy (sell) foreign currency, with settlement dates on January 7, 2004, with the following notional amounts:

We are exposed to interest rate risk as a result of our significant cash and equivalent holdings. The interest rate risk that we may be able to obtain on investment securities will depend on market conditions at that time and may differ from the rates we have secured in the past.

On December 31, 2003, we held $33.6 million of cash and equivalents and $195.1 million in short-term investments. Our cash and equivalents consist primarily of money-market funds and auction rate securities and our short-term investments are primarily comprised of government and government agency securities. We currently have the ability and intention to hold our fixed investments until maturity, and therefore, we would not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates. As of December 31, 2003, money-market fund rates yielded approximately 0.98%, auction rate securities yielded approximately 1.21% and our short-term investments were earning yields ranging from 1.07% to 3.40%. The maturity dates ranged from 30 days to three years. Due to the low current market yields and the relatively short-term nature of our investments, a hypothetical 10% increase in market rates would not have a material effect on the fair value of our portfolio. Assuming no change to cash and equivalent balances throughout the year, a notional 10% decline in interest rates would have the effect of reducing interest income by approximately $420 thousand per annum.

Inflation has not had a material impact on our revenues, operating loss and net loss during any of our three most recent fiscal years. However, to the extent inflationary pressures affect short-term interest rates, a significant portion of our investment returns may be affected, as may be the interest rates we charge to our customers.

We have audited the accompanying consolidated balance sheets of ActivCard Corp. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated 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, such consolidated financial statements present fairly, in all material respects, the financial position of ActivCard Corp. and subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

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 as a société anonyme, or limited liability corporation, under the laws of the Republic of France. In 2003 ActivCard Corp. completed registered public exchange offers in which holders of ActivCard S.A. securities exchanged 41,730,958 common shares and American depositary shares (“ADS”) of ActivCard S.A. for 41,635,741 common shares of ActivCard Corp. Following completion of the exchange offers, ActivCard Corp. holds approximately 99.4% of the outstanding securities of ActivCard S.A. The common shares and ADS’s of ActivCard S.A. not exchanged have been recorded as a minority interest on the consolidated balance sheet. These consolidated financial statements present the financial position and results of operations and cash flows for ActivCard S.A. for those periods preceding the change in domicile. Unless otherwise indicated, references to “ActivCard” and the “Company” refer to the consolidated group of ActivCard companies.

The Company develops and markets digital identity solutions that enable customers to securely issue, use and maintain digital identities. The Company’s solutions provide customers with the ability to authenticate a user to a network through a variety of personal devices as well as the ability to manage credentials remotely post-issuance. The Company markets its solutions to governments, enterprises and financial institutions directly and indirectly through resellers, distributors, original equipment manufacturers and system integrators.

The market for security products and services is dynamic and can be affected by a variety of factors. For example, management believes that changes in any of the following areas could have a significant negative effect on the future consolidated cash flows, results of operations and financial position: regulatory changes; fundamental changes in the technologies underlying security products and services; market acceptance of the Company’s solutions; development of strategic partners and sales channels; litigation or other claims against the Company; hiring, training and retention of key employees; successful and timely completion of development efforts; and new product introductions by competitors.

Revenues are derived primarily from the sale of software licenses, hardware and service agreements. The Company applies 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, the Company allocates 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. The Company determines 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 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. When arrangements contain multiple elements and vendor specific objective evidence of fair value exists for all undelivered elements, the Company recognizes 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. The Company does not include acceptance clauses for its shrink-wrapped software products such as ActivCard Gold or Trinity client software. Acceptance clauses usually give the customer the right to accept or reject the software after the Company has delivered the product. However, the Company has 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, the Company does not recognize revenue until the product is formally accepted by the customer in writing or the defined acceptance period has expired.

Revenue from the sale of hardware 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. The Company enters 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.

The Company normally sells its products to customers with payment terms that are less than 60 days.

In certain specific and limited circumstances, the Company provides product return and price protection rights to certain distributors and resellers. The Company generally recognizes revenue from product sales upon shipment to resellers, distributors and other indirect channels, net of estimated returns or estimated future price changes. The Company’s policy is to not ship product to a reseller or distributor unless the reseller or distributor has a history of selling the Company’s products and the end user is known or has been qualified by the Company. The Company has 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.

In September 2001, the Company licensed its authentication server software to VeriSign at or about the same time that it purchased software and services from VeriSign. This transaction was recorded at terms that the Company considers to be fair value. Although cash was exchanged in this transaction, the Company considered this as a nonmonetary transaction. For this transaction, the Company complied with Accounting Principles Board (“APB”) Opinion No. 29, “Accounting for Nonmonetary Transactions”, and Emerging Issues Task Force (“EITF”) issue No. 01-02, “Interpretation of APB opinion No. 29”, to determine whether the transaction was a monetary or nonmonetary transaction. The Company recorded product revenues of $3,200 in 2001 and billed $480 in advance for maintenance and support for the twelve-month period commencing October 1, 2001. Software purchased from VeriSign in the amount of $3,033 was capitalized as property and equipment. In addition, the Company capitalized $908 as prepaid expenses, which included maintenance and support, PKI digital certificates, license fees and prepaid training.

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of the Company’s 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.

Research and development costs are expensed as incurred. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, the Company capitalizes eligible software costs upon achievement of technological feasibility subject to net realizable value considerations. To date, the period between technological feasibility of a solution and the general availability of such software is short. Accordingly, the Company has not capitalized any costs and charged all such costs to research and development expenses.

In October 1995, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123, “Accounting for Stock Based compensation”, which recommends that the compensation cost for stock-based plans be measured using a fair value based method. The Company calculates the compensation cost for its stock option plans in compliance with the provisions of APB Opinion No. 25, which provides that no compensation costs be recorded if the exercise price of the options granted is equal to the fair market value of the Company’s stock as at the date of grant.

In accordance with APB Opinion No. 25, the Company allocates to deferred stock compensation, the fair value of restricted stock when granted to employees of acquired companies if they remain as employees of the Company subsequent to the acquisition date. The Company amortizes the deferred stock compensation to expense using the straight-line method over the vesting period, which is three years.

Pro forma information regarding net loss and loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options and warrants under the fair value method of SFAS 123. For purposes of pro forma disclosures, the estimated fair value of the options granted is amortized to expense over the options’ vesting period. The Company’s pro forma information follows (in thousands except for net loss per share information):

The fair value for these options and warrants was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions

The reporting currency of the Company and its subsidiaries is the U.S. dollar. All of the companies within the ActivCard Group use their local currency as their functional currency with the exception of ActivCard Ireland Ltd., which uses the U.S. dollar as its functional currency. For those entities using their non-U.S. dollar currency as their functional currency, assets and liabilities are translated into the U.S. dollar at exchange rates in effect at the balance sheet date and revenues and expenses are translated at weighted average exchange rates during the year. Translation adjustments arising upon the consolidation of non-U.S. dollar financial statements are accumulated in shareholders’ equity as a translation adjustment within other comprehensive income.

Transactions involving a currency other than the functional currency generate a gain or loss from the fluctuation of this currency relative to the functional currency and are recorded in the statement of operations during the respective period. The Company enters into and designates foreign currency forward exchange contracts to establish fair value hedges to mitigate these foreign transaction gains and losses.

As required, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, on January 1, 2001. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. SFAS 133, as amended, requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting.

In accordance with SFAS No. 109, “Accounting for Income Taxes”, the Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences, utilizing enacted tax rates, of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets are recognized for the estimated future tax effects of deductible temporary differences and net operating loss carry forwards and research and development tax credits. The Company has provided a valuation allowance for the entire calculated deferred income tax asset.

Basic earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of shares outstanding plus dilutive potential common share and equivalents outstanding assuming conversion of convertible loans and the exercise of options, rights and warrants. Dilutive options, rights and warrants did not have any effect on the computation of diluted loss per share in any of the periods presented since they were anti-dilutive.

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources and is presented in the Consolidated Statements of Shareholders’ Equity.

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company classifies investments, based on the nature of the securities and the intent and investment goal of the Company, as trading securities, available-for-sale securities or held-to-maturity securities.

The fair value of certain of the Company’s short-term financial instruments, including cash and equivalents, accounts receivable, accounts payable and accrued liabilities approximate their carrying values due to their short maturities.

Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and equivalents, short-term investments, accounts receivable and forward contracts used in hedging activities. The Company maintains its cash and equivalents with high credit quality financial institutions and short-term investments are placed in U.S. government and government agency securities. The Company sells the majority of its products and services to a limited number of customers in North America and Europe with an increasing proportion of revenues coming from the U.S. government, primarily the U.S. Department of Defense. If the financial condition or results of operations of these customers deteriorate substantially, the Company’s operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. The Company does not generally require collateral and maintains reserves for estimated credit losses on customer accounts when considered necessary. The Company is exposed to nonperformance by counterparties to foreign currency forward contracts used in hedging activities. These counterparties are large international financial institutions and to date, no such counterparty has failed to meet its financial obligations to the Company. Management does not believe there is a significant risk of nonperformance by these counterparties because the positions with and the credit ratings of such counterparties are continuously monitored. However, there can be no assurance that there will be no significant nonperformance by these counterparties and that this would not materially adversely affect the Company’s business, financial condition, and results of operations.

Short-term investments consist of investments acquired with maturities exceeding three months but less than four years. While the Company intends to hold debt securities to maturity, consistent with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the Company has classified all debt securities that have readily determinable fair values as available-for-sale, as the sale of such securities may be required prior to maturity to implement management strategies. Such securities are reported at fair value, with unrealized gains or losses excluded from earnings and included in other comprehensive income (loss), net of applicable taxes. The cost of securities sold is based on the specific identification method.

Inventory consists of finished goods and components and is valued at the lower of cost (first-in, first-out method) or market.

The Company evaluates its 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 the Company’s incremental borrowing rate, compared to the carrying amount.

Depreciation and amortization are provided using the straight-line method over the estimated useful lives of three to five years. Assets under capital leases are amortized over the shorter of the asset life or the lease term. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the improvement.

Goodwill represents the excess of the purchase price of net tangible and intangible assets acquired in business combinations over their estimated fair value. Other intangibles include the fair value of agreements and contracts, developed technology and trademarks acquired in business combinations. For the acquisitions that were completed before June 30, 2001, goodwill was amortized on a straight-line basis over five years. For the acquisitions completed subsequent to June 30, 2001, goodwill is not amortized in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” but is assessed at least annually for impairment. The annual impairment assessment date is December 1. Other finite life intangible assets acquired from business combinations are recorded at their fair value on the date of acquisition and are amortized on a straight-line basis over one to six years, which approximates their estimated useful lives.

Patents and patent rights are amortized over the shorter of their economic useful life, which does not exceed three years or their legal life.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements, reported amounts of revenues and expenses during the reporting period and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Estimates are used for, but not limited to, the provision for returns and doubtful accounts, the provision for obsolete and excess inventories, valuation of goodwill and intangible assets, depreciation and amortization, taxes and contingencies. Actual results could differ from those estimates.

The Company has one operating segment, Digital Identity Solutions. Accordingly, the Company discloses segment information by geography only.

Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported net loss or shareholders’ equity.

In June 2002, the Financial Accounting Standards Board (“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. SFAS 146 also requires that such a liability be measured at its fair value and subsequent changes to the liability be measured using the credit-adjusted risk-free rate used when the liability was initially recorded. The Company adopted the provisions of SFAS 146 for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have a material impact on the Company’s results of operations or financial position.

In November 2002, the EITF reached a consensus on Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables.” The EITF concluded that revenue arrangements with multiple elements should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, if there is objective and reliable evidence of the fair value of the undelivered elements, and as long as there are no rights of return or additional performance guarantees by the Company. The provisions of EITF Issue No. 00-21 are applicable to agreements entered into in fiscal periods commencing after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material impact on the Company’s results of operations or financial position.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The Company adopted the disclosure requirements of FIN 45 in the fourth quarter of fiscal 2002 (see Note 17 concerning the reserve for warranty costs). The recognition and measurement provisions apply to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a material impact on the Company’s results of operations or financial position.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” The statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148 at December 31, 2002. The Company has not yet determined the impact, if any, that the transition provisions of SFAS No. 148 may have on its results of operations or financial position.

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” and a revised interpretation of FIN 46, (FIN 46R), in December 2003. FIN 46 provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as “variable interest entities” (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate a VIE. This new requirement for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. FIN 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. For VIEs created after January 31, 2003, FIN 46R is effective immediately. The Company will apply FIN 46R for all new VIEs created before January 31, 2003 no later than the quarter ending March 31, 2004. The Company has not yet determined the impact, if any, that the provisions of FIN 46R may have on its results of operations or financial position.

In 2001, the Company acquired three companies, all of which were accounted for using the purchase method of accounting.

In January 2002, the Company 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, the Company used the purchase method of accounting to allocate the purchase price to the assets acquired.

On June 9, 2003 the Company commenced a follow-on registered exchange offer to acquire the minority interest in ActivCard S.A. not owned by ActivCard Corp. The follow-on exchange offer closed on July 17, 2003 with ActivCard Corp. issuing 1,808,075 shares of its common stock to acquire approximately an additional 4.6% of the outstanding securities of ActivCard S.A. The acquisition of the ActivCard S.A. 4.6% minority interest was accounted for using the purchase method of accounting.

The results of operations of the acquired businesses have been included in the Company’s consolidated statement of operations from their respective acquisition dates.

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

On June 27, 2001, the Company 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. The Company acquired Safe Data to replace its existing authentication server as well as to augment its engineering resources and customer base.

On April 10, 2001, Authentic8 International Inc. (“Authentic8”), a privately held, Australian-based company offering an outsourced remote access authentication service for banks and service operators, and the Company mutually agreed to terminate an initial agreement to combine. In connection with this, the Company recorded a charge against earnings in the amount of $3,149, which consisted of $1,999 in professional fees and $1,150 in break-up fees.

On September 7, 2001, the Company acquired 100% of the outstanding shares of Authentic8. The Company acquired Authentic8 to augment its technology and customer base as well as to acquire a managed authentication service model and obtain expertise associated with outsourcing a service (see Note 7 concerning the disposal of the hosting operations of Authentic8).

On November 13, 2001, the Company 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. The Company acquired Ankari to augment its technology, customer base and engineering resources.

In January 2002, the Company 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 that develops and markets biometric authentication systems and related software development kits. The Company acquired the assets to augment its technology and to establish a sales presence in South Africa.

The fair values of the assets acquired and liabilities assumed for the respective acquisitions at date of purchase were as follows:

In connection with the purchase price allocation, the following amounts were charged to earnings:

The value assigned to acquired in process research and development was based on estimated future cash flows over periods ranging from three to seven years and was discounted at the rates indicated above.

At December 31, 2002, other acquired intangibles were comprised of the following:

At December 31, 2003, other acquired intangibles were comprised of the following:

Amortization expense for goodwill was $68 in 2001. Amortization of other intangibles assets was $706 in 2001, $2,073 in 2002 and $540 in 2003.

In connection with the Company’s annual budgetary planning process and business review in December 2002, management identified indicators of possible impairment of the Company’s other acquired intangible assets. These indicators included changes to the Company’s strategic plans that affected the use of acquired developed and core technologies and expected revenues from certain acquired contracts and strategic agreements. In June 2003, management identified indicators of additional impairment of the Company’s other acquired intangible assets. These indicators were caused by changes to the Company’s strategic plans that affected the use of acquired technologies and expected revenues from certain acquired contracts. Asset impairment tests were performed comparing the expected aggregate undiscounted cash flows to the carrying amounts of the acquired intangible assets. Based on the results of these tests, the Company determined that its other acquired intangible assets were impaired. The fair value of these acquired intangible assets was then determined using the discounted cash flow method. As a result, the Company recorded impairment write-downs of $5,090 and $758 during the years ended December 31, 2002 and 2003, respectively. The other intangible assets determined to be impaired consisted of developed and core technology, agreements, contracts, and trade names and trademarks.

Estimated amortization of other acquired intangibles in each of the next five years is as follows:

Supplemental information on a pro forma basis, as if all acquisitions were completed at the beginning of the periods presented, is as follows:

The pro forma supplemental information is based on estimates and assumptions, which the Company believes are reasonable. However, this pro forma information is not necessarily indicative of the results that would have occurred had the acquisitions been completed at the beginning of these periods nor is it indicative of results that may occur in the future. This pro forma supplemental information is based on the respective historical financial statements of the respective companies and does not reflect any benefits from cost saving or synergies that may have been achieved from the combined company.

In July 2003, the Company acquired a 38% interest in ASPACE Solutions Limited (“Aspace”), a developer of secure multi-channel data management systems based in London, England. The Company purchased 38,140 common shares of Aspace from existing shareholders for £954 (£25 per share) or $1,552. In connection with the acquisition of common shares, the Company also provided Aspace with a two-year, senior convertible loan in the amount of £2,500 or $4,067, which bears interest at a rate of 6% per annum. If all or part of the senior convertible loan is outstanding on the two-year anniversary date or if the senior convertible loan covenants are breached, the Company has the right to convert the loan balance any time thereafter, into common shares of Aspace at a price of £25 per share.

In December 2003, the Company provided Aspace with an additional two-year loan facility in the amount of £1,000 or $1,727, which bears interest at a rate of 6% per annum and is repayable on November 30, 2005. In connection with the additional loan, the Company received shares and warrants convertible into 21,245 newly issued shares of Aspace at a price of £0.01 per share. The Company exercised its warrant conversion rights in December 2003 increasing its ownership to 59,385 common shares or 49% of the outstanding common shares of Aspace. Aspace currently has 121,245 shares outstanding. In the event that the senior convertible loan, excluding accrued interest, is converted into common shares, an additional 100,000 new common shares of Aspace would be issued to the Company thereby increasing its ownership to approximately 72% of the voting control.

Aspace has incurred losses to date and ActivCard management anticipates continuing losses from Aspace over the next twelve months. ActivCard management believes that the other shareholders in Aspace cannot bear their share of losses incurred. In this context, the authoritative accounting guidance requires that the Company record 100% of the net losses incurred by Aspace despite holding less than a controlling interest. For the year ended December 31, 2003, the Company recorded $2,394 of losses incurred by Aspace from July 30, 2003 to December 31, 2003.

At December 31, 2003 the Company’s investment in Aspace consisted of the following:

In June 2003, the Company terminated certain non-core activities that resulted in charges to earnings for asset write-downs of $4,165. The actions taken included: discontinuance of the Company’s biometric hardware product line in favor of reselling similar products manufactured by third parties; termination of a service offering whereby the Company would have hosted PKI digital certificate issuance; and consolidation of overlapping product offerings resulting in the replacement of certain third-party software code. As a result of these decisions, certain assets relating to these non-core activities were impaired. The assets written down were biometric hardware inventories, PKI digital certificate inventories, prepaid software royalties, prepaid software maintenance and software licenses. The charges for the asset write-downs are included in cost of revenues in the condensed consolidated statements of operations for the year ended December 31, 2003.

In 2002, the Company commenced restructuring its business to enhance operational efficiency and reduce expenses. This restructuring and business realignment plan included a worldwide reduction in workforce across all functions of 90 employees, a reduction in excess facilities and other direct costs. Of the terminated employees, 36 were employed in sales and marketing, 42 were employed in research and development, 7 were employed in general and administrative, 3 were employed in manufacturing and logistics and 2 were employed in corporate functions. The charge for excess facilities was comprised primarily of future minimum lease payments payable over a nine-year period ending February 2011, net of estimated sublease income of $626. Sublease income was estimated assuming current market lease rates and after estimated vacancy periods. Charges for the reduction in workforce consisted mainly of severance, outplacement and other termination costs.

In 2003, the Company took further measures to restructure its business and reduce its operating costs by implementing a reduction in workforce that resulted in the termination of 17 employees. Of the terminated employees, 9 were employed in sales and marketing, 7 were employed in research and development and 1 was employed in manufacturing and logistics. Charges for the reduction in workforce consist of severance, outplacement and other termination costs.

Remaining cash expenditures to complete the facility exit activities will be made over the seven-year period ending February 2011. The Company expects to make remaining cash payments to complete the workforce reduction by March 31, 2004.

On February 15, 2002, the Company executed its plan to dispose of the hosting operations of Authentic8. As a result of this decision, the results of operations of the hosting activities, an impairment of goodwill and other acquired intangible assets and a write-down of fixed assets have been included in loss from discontinued operations in the consolidated statement of operations for the year ended December 31, 2002. The Company determined the fair value of the reporting unit by discounting estimated future cash flows to assess whether there was impairment in the carrying value of the goodwill and other intangibles. The assets and liabilities related to the hosting operations have been classified as assets and liabilities held for sale on the consolidated balance sheet at December 31, 2002.

On February 12, 2003, the Company entered into an agreement with VeriSign for the disposition of the assets and certain liabilities of the hosting operations of Authentic8. The results of operations of the hosting activities to March 14, 2003, the effective date of the agreement with VeriSign, have been included in the loss from discontinued operations in the consolidated statement of operations for the year ended December 31, 2003.

The assets and liabilities held for sale and loss from discontinued operations related to the planned disposal of the hosting operations of the former Authentic8 International, Inc. were comprised of the following:

The contractual maturities of available-for-sale debt securities as of December 31, 2003 were as follows:

The contractual maturities of available-for-sale debt securities as of December 31, 2002 were as follows:

Foreign exchange gains and losses reported on the consolidated statements of operations resulted from the translation of assets and liabilities denominated in a non-functional currency into the functional currency of the legal entity that held the asset and/or liability. The Company utilizes a foreign exchange hedging program to mitigate transaction gains and losses resulting from such 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 this objective, the Company regularly enters into various short-term foreign currency forward contracts that the Company accounts for as fair value hedging instruments to offset these foreign exchange transaction gains and losses.

Foreign exchange gains and losses attributable to fair value hedging instruments reduce the foreign exchange gains and losses in the consolidated statements of operations. For the year ended December 31, 2001, foreign exchange losses from the fair value hedges were $363; for the year ended December 31, 2002, foreign exchange gains from the fair value hedges were $752; and for the year ended December 31, 2003 foreign exchange losses from the fair value hedges were $301.

At December 31, 2003, ActivCard Inc., the Company’s U.S. subsidiary, had entered into forward contracts to buy (sell) foreign currency, with settlement dates on January 7, 2004, with the following notional amounts:

Customers that accounted for 10% or more of accounts receivable were as follows:

On October 22, 2001, the Board of Directors of the U.S. subsidiary of the Company approved a full recourse loan to an executive officer of the Company in the amount of $2,700. The loan earned interest at a rate of 3.5% per annum and was due October 21, 2002. The loan was secured with 867,800 shares of ActivCard S.A. held by the executive officer. The loan and accrued interest were repaid in full on November 13, 2002.

During the years ended December 31, 2002 and 2003, the Company had purchases of approximately $2,464 and $2,914, respectively, from SCM Microsystems, Inc. (“SCM”), a manufacturer of smart card readers. As of December 31, 2002, the amount owing to SCM was $634. No balance was owed to SCM at December 31, 2003. Although SCM is not a single-source supplier to the Company of specific products, the companies shared the services of Steven Humphreys. Mr. Humphreys was the Chairman and Chief Executive Officer of ActivCard until September 30, 2003 and is the non-executive Chairman of SCM’s Board of Directors. Mr. Humphreys was not compensated for the transactions between the two companies.

Other long-term assets consist primarily of security deposits for leased facilities of $846 and $793 at December 31, 2002 and 2003, respectively.

Other long-term liabilities consist of deferred rent expense of $525 and $1,056 at December 31, 2002 and 2003, respectively.

The Company has entered into non-cancelable operating leases for office space and equipment with original terms that range between 3 and 10 years.

Certain commitments under non-cancelable operating leases are included in the charge for restructuring and business realignment expenses (Note 6).

Rental expense for all operating leases amounted to $3,291, $3,058 and $3,169 during 2001, 2002 and 2003, respectively.

In June 2001, the Company issued 250,000 common shares in connection with the acquisition of Safe Data. In July 2003, the Company issued 1,808,075 common shares in connection with the acquisition of a 4.6% minority interest of ActivCard S.A.

The rights and preferences of the common shareholders, as provided under the Company’s bylaws are as follows:

In 1996 and 1998, the shareholders of the Company authorized the issuance of share purchase rights to existing bond and warrant holders in conjunction with the issuance of common shares during these periods in accordance with the statutory anti-dilution laws of France.

The following is a summary of the Company’s outstanding share warrant plans with the corresponding number of underlying common shares issuable upon exercise:

During the years 1995 to 2002, inclusive, the shareholders of the Company authorized the creation of share warrant plans for the purpose of granting warrants to certain executive officers and to members of the Company’s Board of Directors. The activity for each of the last three years and terms of the plans are summarized as follows:

The director share warrant plans vest over four years. The term of the warrants is five years.

In October 1999, the Company issued convertible securities, consisting of $6.0 million principal amount of non-interest bearing bonds and 1,200,000 warrants to purchase an aggregate of 1,200,000 shares at an exercise price of $5.00 per share. Warrants could be exercised between April 15, 2000 and April 15, 2002. During 2000, 395,300 warrants related to this debt offering were exercised. During 2001, 92,000 warrants related to this debt offering were exercised. During 2002, 705,600 warrants related to this debt offering were exercised and the remaining 7,100 warrants were forfeited.

In August 2002, the shareholders of the Company authorized the creation of a stock option plan granting the Board of Directors of the Company the authority to issue options to employees to subscribe for a maximum of 8,600,000 common shares. This plan provides for a four-year vesting period and may be exercised no later than ten years after date of grant. The option plan prohibits residents of France employed by the Company from selling their shares prior to the fifth anniversary from the date of grant. The Board of Directors establishes the exercise price as the closing price quoted on Nasdaq on the date of grant. For option plans of years prior to 2002, the Board of Directors established the exercise price as the weighted average closing price quoted on Nasdaq Europe during the twenty trading days prior to the date of grant. The Company calculates the compensation cost for its stock option plans in compliance with the provisions of APB Opinion No. 25 which provides that compensation cost has to be recorded if the exercise price of the options granted is lower than the fair market value of the Company’s stock as at the date of grant. In 2001, the Company granted 2,394,500 options with a weighted average exercise price of $8.80 at less than fair value. The options granted at less than fair value had a weighted average fair value of $10.43, where fair value was determined to be the closing share price on the date of grant. Amortization of deferred stock compensation was $446, $965 and $750 in 2001, 2002 and 2003, respectively.

In September 2003, the Board of Directors authorized the issuance of two stock options to the Company’s Chief Executive Officer to subscribe for a maximum of 1,860,000 common shares. The first option to subscribe for a maximum of 690,000 common shares vests and becomes exercisable with respect to one-third of the underlying shares on each of the fifth, sixth and seventh anniversaries of the grant date, or earlier upon the Company’s common stock trading at certain predetermined prices. The second option to subscribe for a maximum of 1,170,000 common shares vests and becomes exercisable with respect to one quarter of the underlying shares on the first anniversary of the grant date and then with respect to 2.0833% of the underlying shares each month thereafter. Both options expire September 17, 2013. In February 2004, the Chief Executive Officer resigned and these options were forfeited.

A summary of the Company’s employee stock option plan activity and related information for the years ended December 31, follows:

As of December 31, 2003, 1,942,448 options were available for new grant. As of December 31, 2003, outstanding stock options granted to employees subject to French regulation and U.S. regulation were 1,389,268 and 6,989,553, respectively.

The summary of stock options and Director’s share warrants outstanding and exercisable as of December 31, 2003 was as follows:

Income tax expense of $22, $69 and $238 during the years ended December 31, 2001, 2002 and 2003 consisted of minimum taxes in certain jurisdictions.

As of December 31, 2002 and 2003, significant components of the Company’s net deferred income tax assets were as follows:

Due to the history of losses and uncertainty surrounding the realization of net deferred tax assets, the Company has provided a valuation allowance for the entire amounts. The valuation allowance will be reduced at such time as management believes it is more likely than not that the deferred tax assets will be realized.

As of December 31, 2003, the Company’s approximate net operating loss carry-forwards and their corresponding expirations were as follows:

These net operating loss carry-forwards can only be used by the legal entity generating the operating losses.

The following is a reconciliation of the numerator and denominator used to determine basic and diluted loss per share:

No amounts have been presented for diluted earnings per share for the periods where the effect of including the weighted average number of common shares available under share options, reserved rights and warrants after applying the treasury stock method is anti-dilutive. Weighted average common share equivalents excluded in 2001, 2002 and 2003 were 2,128,766; 949,690; and 1,035,872; respectively.

French law requires payment of a lump sum retirement indemnity to all employees based upon years of service and compensation at retirement. Benefits do not vest prior to retirement. There is no formal plan and no funding of the obligation is required. The Company’s obligation is not material to its consolidated financial condition or results of operations for the years ended December 31, 2001, 2002 and 2003.

The U.S. subsidiary has a 401(k) profit sharing plan for its full-time employees who have attained the age of 21 years and have been employed with the Company for at least six months. Eligible employees may make voluntary contributions to the plan up to a fixed dollar amount specified by U.S. law. The Company is not required to make contributions and, to December 31, 2003, no contributions have been made.

In October 2001, the Company implemented a non-qualified deferred compensation plan which allows eligible U.S. employees to elect to defer for personal tax purposes, on an annual basis, up to 90% of their base salary, commissions and/or bonus. Amounts deferred are invested by the Company in investment embedded funds within a variable life insurance policy. The employee designates the investment of amounts withheld and is entitled to receive the amounts deferred, net of investment gains and losses, upon termination, retirement, death, disability or, under certain circumstances, based on pre-scheduled withdrawals. Amounts withheld and deferred for eligible employees under the Company’s deferred compensation plan were $193 in 2001, $345 in 2002, and $232 in 2003. Amounts withheld and deferred are included in operating expenses as salary expense in the period withheld. As at December 31, 2003, total assets related to the plan amounted to $551 and were classified as restricted investments in the consolidated balance sheet. The Company also recorded a corresponding liability of $551.

The Company has one operating segment: Digital Identity Solutions. Accordingly, the Company is disclosing segmented information by geographic area only. Transfers between geographic areas are eliminated in the consolidated financial statements. The following is a summary of operations by geographic region for the years ended December 31, 2001, 2002 and 2003:

From time to time, the Company has been named as a defendant in legal actions arising from its normal business activities, which it believes will not have a material adverse effect on it or its business.

The Company enters into standard indemnification agreements with many of its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third-party to the extent any such claim alleges that an ActivCard product infringes a U.S. patent, copyright or trademark, or violates any other proprietary rights of that third-party. It is not possible to estimate the maximum potential amount of future payments the Company could be required to make under these indemnification agreements. To date, the Company has not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. No liability for these indemnification agreements has been recorded at December 31, 2003 or 2002.

As permitted under Delaware law, the Company has agreements indemnifying its executive officers and directors for certain events and occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is not estimable. The Company maintains directors and officers liability insurance designed to enable it to recover a portion of any future amounts paid. No liability for these indemnification agreements has been recorded at December 31, 2003 or 2002.

The Company’s President (principal executive officer) and Chief Financial Officer (principal financial officer), carried out an evaluation of the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15(d)-15(e)), as of the end of the period covered by this report. Based on their evaluation, these officers have concluded that the Company’s disclosure controls and procedures were effective to ensure that material information required to be disclosed in the Company’s reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the periods specified in the Securities and Exchange Commission rules and forms.

There were no significant changes in the Company’s internal controls over financial reporting that occurred during the most recent quarter that has materially affected or is reasonably likely to materially affect the Company’s internal controls over financial reporting.

The information required by this item is included under “Proposal No. 1: Election of Directors,” “Other Information—Executive Officers” and “Compliance with Section 16(a) of the Exchange Act” in our Proxy Statement, to be filed in connection with our 2004 Annual Meeting of Shareholders, and is incorporated herein by reference.

We have adopted a code of ethics for directors, officers (including our principal executive officer, principal financial officer and principal accounting officer or controller) and employees. This code of ethics is available on our website at www.activcard.com and any waivers from or amendments to the code of ethics will be posted on our website.

The information required by this item is included under the caption “Executive Compensation” in our Proxy Statement, to be filed in connection with our 2004 Annual Meeting of Stockholders, and is incorporated herein by reference.

The information required by this item is included under the caption “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement, to be filed in connection with our 2004 Annual Meeting of Stockholders, and is incorporated herein by reference.

The information required by this item is included under the caption “Certain Relationships and Related Transactions” in our Proxy Statement, to be filed in connection with our 2004 Annual Meeting of Stockholders, and is incorporated herein by reference.

The information required by this item is included under the caption “Principal Accountant Fees and Services” in our Proxy Statement, to be filed in connection with our 2004 Annual Meeting of Stockholders, and is incorporated herein by reference.

On October 30, 2003, the registrant furnished the SEC with a Current Report on Form 8-K to report the issuance of a press release announcing the registrant’s results of operations for the quarter ended September 30, 2003.

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Fremont, State of California on this 12th day of March, 2004.


ACTIVCARD CORP.

By:		/s/ YVES AUDEBERT
		Vice Chairman of the Board of Directors and President

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Yves Audebert and Blair W. Geddes, and each of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the following persons on behalf of the Registrant in the capacities and on the date indicated.


	PART I

Item 1	Business	2
Item 2	Properties	3
Item 3	Legal Proceedings	4
Item 4	Submission of Matters to a Vote of Security Holders	5

	PART II

Item 5	Market for Registrant’s Common Stock and Related Stockholder Matters	13
Item 6	Selected Financial Data	14
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 7A	Quantitative and Qualitative Disclosures about Market Risk	41
Item 8	Financial Statements and Supplementary Data	42
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	74
Item 9a	Controls and Procedures	74

	PART III

Item 10	Directors and Executive Officers of the Registrant	74
Item 11	Executive Compensation	74
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	74
Item 13	Certain Relationships and Related Transactions	74
Item 14	Principal Accountant Fees and Services	74

	PART IV

Item 15	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	75


	Nasdaq National Market
	High		Low
ActivCard S.A.
Fiscal year ended December 31, 2002
First Quarter	$	9.52	$	6.46
Second Quarter		7.99		5.75
Third Quarter		6.75		6.00
Fourth Quarter		9.20		6.60
ActivCard Corp.
Fiscal year ended December 31, 2003
First Quarter	$	9.86	$	7.05
Second Quarter		11.60		9.20
Third Quarter		9.94		7.80
Fourth Quarter		9.69		7.75


	Fiscal Year Ended December 31,
	1999			2000			2001			2002			2003
	(in thousands, except share and per share data)
Consolidated Statement of Operations Data:
Revenue	$	10,262		$	18,081		$	31,176		$	41,840		$	38,262
Cost of revenue		5,337			6,991			9,587			13,485			20,604

Gross margin		4,925			11,090			21,589			28,355			17,658

Operating expenses
Research and development		5,233			8,097			18,715			20,165			18,600
Sales and marketing		9,829			15,657			23,847			20,432			20,763
General and administrative		2,565			3,344			4,411			4,270			6,091
Amortization of goodwill and acquired intangible assets		—			—			774			2,073			540
Write-down of other intangible assets		—			—			—			5,090			758
Other charges		3,038			—			6,779			9,655			2,870

Total operating expenses		20,665			27,098			54,526			61,685			49,622

Loss from operations		(15,740	)		(16,008	)		(32,937	)		(33,330	)		(31,964	)
Interest expense		(743	)		(16	)		(81	)		(11	)		(1	)
Interest income		294			15,669			13,269			5,209			4,264
Foreign exchange gain (loss)		262			14,429			3,491			(458	)		(120	)

(Loss) income from continuing operations before income taxes, minority interest and equity in net loss of Aspace Solutions Limited		(15,927	)		14,074			(16,258	)		(28,590	)		(27,821	)
Income tax benefit (expense)		15			(1	)		(22	)		(69	)		(238	)
Minority interest		—			—			—			—			744
Equity in net loss of Aspace Solutions Limited		—			—			—			—			(2,394	)

(Loss) income from continuing operations		(15,912	)		14,073			(16,280	)		(28,659	)		(29,709	)
Loss from discontinued operations		—			—			(429	)		(16,834	)		(70	)

Net (loss) income	$	(15,912	)	$	14,073		$	(16,709	)	$	(45,493	)	$	(29,779	)

(Loss) earnings per common share:
Basic from continuing operations	$	(0.55	)	$	0.37		$	(0.41	)	$	(0.69	)	$	(0.72	)
Basic from discontinued operations		—			—			(0.01	)		(0.41	)		—

	$	(0.55	)	$	0.37		$	(0.42	)	$	(1.10	)	$	(0.72	)

Diluted from continuing operations	$	(0.55	)	$	0.34		$	(0.41	)	$	(0.69	)	$	(0.72	)
Diluted from discontinued operations		—			—			(0.01	)		(0.41	)		—

	$	(0.55	)	$	0.34		$	(0.42	)	$	(1.10	)	$	(0.72	)

Weighted average number of common shares outstanding:
Basic		29,114,715			37,897,417			40,062,018			41,212,326			41,120,305
Diluted		29,114,715			42,215,045			40,062,018			41,212,326			41,120,305
Other charges were comprised of:
Acquired in process research and development	$	—		$	—		$	2,701		$	68		$	306
Acquisition termination charges		—			—			3,149			—			—
Restructuring and business realignment expenses		—			—			—			8,586			1,497
Re-incorporation costs		—			—			—			1,001			1,067
Severance paid to former CEO		—			—			728			—			—
Settlement of litigation		3,038			—			201			—			—

	$	3,038		$	—		$	6,779		$	9,655		$	2,870


	At December 31,
	1999		2000		2001		2002		2003
	(in thousands)
Balance Sheet Data:
Cash and short term investments	$	8,790	$	309,850	$	248,444	$	248,382	$	228,734
Total current assets		14,398		323,424		283,885		264,862		238,296
Total assets		16,434		326,335		311,448		286,392		267,101
Total current liabilities		5,953		11,464		13,328		15,629		15,094
Total long-term liabilities		258		108		560		4,954		4,915
Convertible bonds		9,259		—		—		—		—
Minority interest		—		—		—		—		1,513
Common shares		36,339		43,503		43,951		45,117		42
Additional paid-in capital		34,483		341,853		349,963		354,400		397,962
Shareholders’ equity		992		314,763		297,560		265,809		245,579


	Year ended December 31,
	2001		2002		2003
Percentage of revenue
Revenue	100.0	%	100.0	%	100.0	%
Cost of revenue	30.8		32.2		53.8

Gross profit	69.2		67.8		46.2

Operating expenses
Research and development	60.0		48.2		48.6
Sales and marketing	76.5		48.8		54.3
General and administrative	14.1		10.2		15.9
Other operating expenses	24.2		40.3		10.9

Total operating expenses	174.8		147.5		129.7

Loss from operations	(105.6	)	(79.7	)	(83.5	)
Non-operating income	53.5		11.3		10.8
Income tax expense	—		(0.1	)	(0.5	)
Minority interest	—		—		1.9
Equity in net loss of Aspace Solutions Limited	—		—		(6.3	)

Loss from continuing operations	(52.1	)	(68.5	)	(77.6	)
Loss from discontinued operations	(1.4	)	(40.2	)	(0.2	)

Net loss income	(53.5	)%	(108.7	)%	(77.8	)%


	Year ended December 31,						% Change in
	2001		2002		2003		2002		2003
	(in thousands)
Hardware revenues	$	16,022	$	14,844	$	17,045	-7	%	+15	%
Software revenues		13,850		23,215		15,218	+68	%	-34	%
Maintenance and support revenues		1,304		3,781		5,999	+190	%	+59	%

	$	31,176	$	41,840	$	38,262	+34	%	-9	%


Developed and core technology	$	742
Acquired in process research and development		306

Acquired research and development assets	$	1,048


	Safe Data		Authentic8		Ankari		Total
Developed and core technology	$	2,300	$	1,900	$	4,300		8,500
In process research and development		101		300		2,300		2,701

Acquired research and development assets	$	2,401	$	2,200	$	6,600	$	11,201


	2002 Restructuring						2003 Restructuring Workforce Reduction			Total
	Facility Exit Costs			Workforce Reduction			2003 Restructuring Workforce Reduction			Total
Accrual balance at January 1, 2002	$	—		$	—		$	—		$	—
Provisions for restructuring and business realignment costs		5,423			2,706			—			8,129
Adjustments to accruals for changes in estimates		569			(112	)		—			457
Payments		(701	)		(1,658	)		—			(2,359	)
Non-cash charges		(214	)		(717	)		—			(931	)

Accrual balance at December 31, 2002		5,077			219			—			5,296
Provisions for restructuring and business realignment costs		111			—			1,347			1,458
Adjustments to accruals for changes in estimates		—			42			(3	)		39
Payments		(681	)		(261	)		(580	)		(1,522	)
Non-cash charges		—			—			(520	)		(520	)

Accrual balance at December 31, 2003		4,507			—			244			4,751
Less current portion		648			—			244			892

Long term portion	$	3,859		$	—		$	—		$	3,859

Estimated remaining cash expenditures	$	4,507		$	—		$	244		$	4,751


Contractual cash obligations	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
Operating leases (1)	$	20,670	$	3,401	$	6,283	$	5,214	$	5,772
Long-term debt		1,056		56		137		369		494

Total	$	21,726	$	3,457	$	6,420	$	5,583	$	6,266


Amount		Currency
(13,702)		Euro
6,325		Canadian dollar
8,231		Australian dollar
3,709		British pound
5,351		Indian rupee
114,968		Japanese Yen
7,167		Singapore dollar
2,900		South African rand


	As at December 31,
	2002			2003
ASSETS
Current assets
Cash and equivalents	$	158,880		$	33,599
Short-term investments		89,502			195,135
Accounts receivable (net of allowance for doubtful accounts of $525 in 2002 and $42 in 2003)		9,192			3,364
Other receivables		1,579			2,372
Inventories		3,488			2,744
Assets held for sale		262			—
Other current assets		1,959			1,082

Total current assets		264,862			238,296
Restricted investments		432			551
Property and equipment		7,313			4,498
Investment in Aspace Solutions Limited		—			5,816
Goodwill		10,600			15,322
Other intangible assets		2,311			1,825
Other long-term assets		874			793

	$	286,392		$	267,101

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Accounts payable and accrued liabilities	$	10,493		$	11,179
Current portion of restructuring and business realignment accruals		867			892
Income taxes payable		—			148
Deferred revenue		3,997			2,875
Liabilities held for sale		250			—
Current portion of long-term debt		15			—
Current portion of obligations under capital lease		7			—

Total current liabilities		15,629			15,094

Long-term portion of restructuring and business realignment accruals		4,429			3,859
Other long-term liabilities		525			1,056

Total long-term liabilities		4,954			4,915

Minority interest		—			1,513

Commitments and contingencies (Notes 19 and 25)
Shareholders’ equity
Preferred shares, $0.001 par value, none issued		—			—
Common shares, €1.00 nominal value, 41,690 shares issued and outstanding at December 31, 2002; $0.001 par value, 42,115 shares issued and outstanding at December 31, 2003		45,117			42
Additional paid-in capital		354,400			397,962
Accumulated other comprehensive loss		(14,817	)		(12,816	)
Deferred stock compensation		(3,122	)		(211	)
Accumulated deficit		(115,769	)		(139,398	)

Total shareholders’ equity		265,809			245,579

	$	286,392		$	267,101


	Common shares					Additional paid-in capital			Accumulated other comprehensive loss			Deferred stock compensation			Accumulated deficit			Shareholders’ equity			Total Comprehensive Loss
	Shares		Amount			Additional paid-in capital			Accumulated other comprehensive loss			Deferred stock compensation			Accumulated deficit			Shareholders’ equity			Total Comprehensive Loss
Balance January 1, 2001	39,899,926		$	43,503		$	341,853		$	(17,026	)	$	—		$	(53,567	)	$	314,763
Shares issued for acquisition	250,000			215			2,981			—			(1,963	)		—			1,233
Exercise of warrants	92,000			82			378			—			—			—			460
Exercise of options	162,440			151			488			—			—			—			639
Deferred stock compensation, net of cancellations	—			—			4,263			—			(4,263	)		—			—
Amortization of deferred stock compensation	—			—			—			—			785			—			785
Comprehensive loss:
Net loss	—			—			—			—			—			(16,709	)		(16,709	)	$	(16,709	)
Foreign currency translation	—			—			—			(3,611	)		—			—			(3,611	)		(3,611	)

Total comprehensive loss	—			—			—			—			—			—			—		$	(20,320	)

Balance December 31, 2001	40,404,366			43,951			349,963			(20,637	)		(5,441	)		(70,276	)		297,560
Exercise of warrants	744,100			660			3,083			—			—			—			3,743
Exercise of rights	13,660			14			16												30
Exercise of options	528,032			492			1,586			—			—			—			2,078
Deferred stock compensation, net of cancellations	—			—			(248	)		—			248			—			—
Amortization of deferred stock compensation	—			—			—			—			2,071			—			2,071
Comprehensive loss:
Net loss	—			—			—			—			—			(45,493	)		(45,493	)	$	(45,493	)
Unrealized gains on short term investments										700									700			700
Foreign currency translation	—			—			—			5,120			—			—			5,120			5,120

Total comprehensive loss	—			—			—			—			—			—			—		$	(39,673	)

Balance December 31, 2002	41,690,158			45,117			354,400			(14,817	)		(3,122	)		(115,769	)		265,809
Minority interest arising in connection with re-incorporation	(2,165,532	)		(45,441	)		24,755			749			155			6,150			(13,632	)
Acquisition of ActivCard S.A. minority interest	1,808,075			2			16,635			—			—			—			16,637
Exercise of warrants	251,250			—			1,592			—			—			—			1,592
Exercise of rights	28,800			—			36			—			—			—			36
Exercise of options	501,895			364			1,988			—			—			—			2,352
Deferred stock compensation, cancellations	—			—			(1,484	)		—			1,484			—			—
Amortization of deferred stock compensation	—			—			—			—			1,335			—			1,335
Minority interest	—			—			40			(19	)		(63	)		—			(42	)
Comprehensive loss:
Net loss	—			—			—			—			—			(29,779	)		(29,779	)	$	(29,779	)
Unrealized losses on short term investments										(435	)								(435	)		(435	)
Foreign currency translation	—			—			—			1,706			—			—			1,706			1,706

Total comprehensive loss	—			—			—			—			—			—			—		$	(28,508	)

Balance December 31, 2003	42,114,646		$	42		$	397,962		$	(12,816	)	$	(211	)	$	(139,398	)	$	245,579


	ActivCard Asia		Safe Data(1)		Authentic8		Ankari		ActivCard South Africa		ActivCard S.A. Minority Interest		Total
Cash consideration	$	111	$	1,762	$	13,412	$	18,000	$	1,150	$	—	$	34,435
Share consideration		—		3,142		—		—		—		16,637		19,779
Acquisition costs		—		116		973		362		20		395		1,866

	$	111	$	5,020	$	14,385	$	18,362	$	1,170	$	17,032	$	56,080


	Discount Rates		Year ended December 31,
	Discount Rates		2001		2002		2003
In process research and development:
Safe Data	50	%	$	101	$	—	$	—
Authentic8	24	%		300		—		—
Ankari	50	%		2,300		—		—
ActivCard South Africa	30	%		—		68		—
ActivCard S.A. minority interest	28	%		—		—		306

			$	2,701	$	68	$	306


	Developed and Core Technology			Agreements and Contracts			Trade Names and Trademarks			Total
Additions from acquisitions:
Safe Data	$	2,470			—			—			2,470
Ankari		4,569			425			212			5,206

		7,039			425			212			7,676

Accumulated amortization:
Safe Data		(1,940	)		—			—			(1,940	)
Ankari		(3,573	)		(195	)		(80	)		(3,848	)

		(5,513	)		(195	)		(80	)		(5,788	)

	$	1,526		$	230		$	132		$	1,888

Weighted average useful life		5 years			3 years			6 years


Loan advances and equity investments	$	8,210
Equity in net losses of Aspace		(2,394	)

	$	5,816


	2002 Restructuring						2003 Restructuring Workforce Reduction			Total
	Facility Exit Costs			Workforce Reduction			2003 Restructuring Workforce Reduction			Total
Accrual balance at January 1, 2002	$	—		$	—		$	—		$	—
Provisions for restructuring and business realignment costs		5,423			2,706			—			8,129
Adjustments to accruals for changes in estimates		569			(112	)		—			457
Payments		(701	)		(1,658	)		—			(2,359	)
Non-cash charges		(214	)		(717	)		—			(931	)

Accrual balance at December 31, 2002		5,077			219			—			5,296
Provisions for restructuring and business realignment costs		111			—			1,347			1,458
Adjustments to accruals for changes in estimates		—			42			(3	)		39
Payments		(681	)		(261	)		(580	)		(1,522	)
Non-cash charges		—			—			(520	)		(520	)

Accrual balance at December 31, 2003		4,507			—			244			4,751
Less current portion		648			—			244			892

Long term portion	$	3,859		$	—		$	—		$	3,859

Estimated remaining cash expenditures	$	4,507		$	—		$	244		$	4,751


	December 31
	2002		2003
Assets held for sale consist of:
Current assets	$	262	$	—

Liabilities held for sale consist of:
Trade accounts payable	$	27	$	—
Accrued payroll and benefits		58		—
Other accrued liabilities		30		—
Deferred revenue		135		—

	$	250	$	—


	December 31, 2003
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
U.S. government and agency securities	$	194,870	$	436	$	171	$	195,135


	December 31, 2003
	Amortized Cost		Estimated Fair Value
Within one year	$	22,602	$	22,701
Between one year and three years		172,268		172,434

	$	194,870	$	195,135


	December 31, 2002
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
U.S. government and agency securities	$	88,802	$	703	$	3	$	89,502


	2002			2003
Accounts receivable	$	9,717		$	3,406
Less allowance for doubtful accounts		(525	)		(42	)

	$	9,192		$	3,364


	2002		2003
Customer B	11	%	—
Customer D	40	%	—
Customer E	—		11	%
Customer F	—		11	%

	51	%	22	%


	2002		2003
Value-added tax recoverable	$	455	$	911
Interest receivable		857		1,289
Other		267		172

	$	1,579	$	2,372


	2002		2003
Components	$	911	$	660
Finished goods		2,577		2,084

	$	3,488	$	2,744


	2002			2003
Computers and equipment	$	10,372		$	9,129
Furniture and fixtures		1,761			2,031
Leasehold improvements		1,494			1,554

Property and equipment at cost		13,627			12,714
Less accumulated amortization		(6,314	)		(8,216	)

Property and equipment, net	$	7,313		$	4,498


	2002		2003
Acquired intangible assets from business combinations		1,888		1,463
Licenses and patents		423		362

	$	2,311	$	1,825


	2002			2003
Sales warranty allowance balance at January 1	$	65		$	43
Warranty costs incurred		(52	)		(73	)
Additions related to current period sales		59			198
Adjustments to accruals related to prior period sales		(29	)		80

Sales warranty allowance balance at December 31	$	43		$	248


Year ending December 31,	Operating Leases
2004	$	3,401
2005		3,336
2006		2,947
2007		2,590
2008		2,624
Thereafter		5,772

Total minimum lease payments	$	20,670


	ActivCard S.A.		ActivCard Corp 2003
	2001	2002	ActivCard Corp 2003
Preferred shares:
Authorized	—	—	10,000,000
Issued and outstanding	—	—	—

Common shares:
Authorized	49,639,114	49,853,746	75,000,000
Issued and outstanding	40,404,366	41,690,158	42,114,646


	Options and Warrants outstanding				Options and Warrants exercisable
Range of exercise prices	Number outstanding	Weighted average remaining life (years)	Weighted average exercise price		Number exercisable	Weighted average exercise price
$ 1.67-$ 2.23	131,927	2.01	$	1.88	131,927	$	1.88
$ 4.03-$ 5.00	1,072,073	1.65		4.49	1,072,073		4.49
$ 6.60-$ 7.96	3,661,711	8.61		7.55	253,237		7.10
$ 8.04-$ 9.99	2,525,846	7.29		8.67	1,016,854		8.20
$10.89-$15.09	396,828	4.37		12.13	237,912		12.28
$17.77-$23.37	825,063	3.59		19.93	710,296		19.92
$25.41-$32.80	202,333	3.54		28.60	176,923		29.00
$71.03-$73.63	14,000	1.90		71.77	11,249		71.90

Total	8,830,321	6.50	$	9.36	3,610,471	$	10.58


	2002			2003
Net operating loss carry-forwards	$	35,143		$	45,248
Research and development tax credits		1,498			1,513
Research and development capitalized for tax purposes		101			—
Timing differences in depreciation and amortization periods		754			174
Non-deductible accruals and reserves		3,665			3,054

Net deferred tax assets		41,161			49,989
Valuation allowance		(41,161	)		(49,989	)

Net deferred tax assets	$	—		$	—


	Amount		Expiration
United States—Federal	$	38,100	2010 to 2024
United States—State		22,200	2005 to 2015
France		67,800	no expiration
Canada		7,500	2006 to 2011
Singapore		4,400	no expiration
Australia		4,200	no expiration


	Europe			North America			Asia Pacific			Total
2001
Net revenues	$	13,681		$	15,888		$	1,607		$	31,176
Loss from operations		(13,937	)		(17,859	)		(1,141	)		(32,937	)
Goodwill		456			8,154			94			8,704
Long lived assets		4,697			14,099			63			18,859
Total assets		24,202			269,976			17,270			311,448
Capital expenditures		1,431			7,119			32			8,582
Depreciation and amortization		1,458			1,238			284			2,980

2002
Net revenues	$	12,819		$	27,074		$	1,947		$	41,840
Loss from operations		(12,988	)		(17,913	)		(2,429	)		(33,330	)
Goodwill		1,795			8,698			107			10,600
Long lived assets		2,921			7,883			126			10,930
Total assets		23,311			260,908			2,173			286,392
Capital expenditures		1,037			596			77			1,710
Depreciation and amortization		938			2,491			74			3,503

2003
Net revenues	$	14,648		$	21,855		$	1,759		$	38,262
Loss from operations		(11,222	)		(19,487	)		(1,255	)		(31,964	)
Goodwill		1,795			13,420			107			15,322
Long lived assets		8,517			4,719			247			13,483
Total assets		19,364			245,452			2,285			267,101
Capital expenditures		773			484			217			1,474
Depreciation and amortization		1,079			1,820			111			3,010