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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
Commission file No. 0-11447
DATAKEY, INC.
(Name of small business issuer in its charter)
MINNESOTA 41-1291472
(State of incorporation or organization) (I.R.S. Employer Identification No.)
407 WEST TRAVELERS TRAIL, BURNSVILLE, MINNESOTA 55337
(Address of principal executive offices)
Issuer's telephone number, including area code: (612) 890-6850 Securities
registered pursuant to Section 12(b) of the Act:NONE Securities registered
pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.05 PER
SHARE (Title of Class)
Check whether the Issuer (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 Issuer was required to file such
reports) and (2) has been subject to such filing requirements for the last 90
days. YES X NO
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Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained herein and no disclosure will be contained, to the best
of Issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
Issuer's revenues for its most recent fiscal year: $7,219,308.
The aggregate market value of the voting stock (Common Stock) held by non-
affiliates was approximately $8,125,468 based upon the closing sale price of the
Issuer's Common Stock on March 22, 1996.
As of March 22, 1996, there were 2,835,736 shares of the Issuer's Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive Proxy Statement for its Annual Meeting of
Shareholders to be held on June 5, 1996 are incorporated by reference pursuant
to Rule 12b-23 into Items 9, 10 and 11 of Part III.
Transitional Small Business Disclosure Format (check one) YES NO X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Datakey, Inc. (the "Company") was incorporated under the laws of the State
of Minnesota in 1976 under the name "The Systems Group, Inc." In 1980, the
Company changed its name to Datakey, Inc. The Company designs, manufactures and
markets portable memory-based systems, subsystems and custom-designed components
for security-driven markets. The Company's proprietary memory keys, cards and
custom-shaped tokens serve as a convenient way to carry electronic information
and are packaged to survive in portable environments. Datakey products enhance
security and simplify equipment use for a wide range of applications by
automating critical identification, data collection and control functions.
The Company's first portable information system, consisting of an
electronic key and support electronics, was introduced in 1981 for applications
requiring convenient storage, transportation and management of information. The
Company's current system utilizes semiconductor technology to provide a storage
device more versatile than conventional portable information products such as
keys, badges and magnetic stripe cards. The Company's current product line of
portable data carriers and associated interface products provide up to 1,024,000
bits of data storage which are used in a wide range of applications including
communications security, computer security, facility security, vending and
process control.
Each of the Company's personal portable information systems consists of one
or more portable data carriers, access devices and, for certain models,
interface modules containing microprocessors. These components, together with
the user's processor-based equipment, function as an integrated system allowing
instantaneous processing of personalized data carried within a portable data
carrier. Through the incorporation of advanced semiconductor memory technology,
the Company's portable data carrier is able to store and carry substantial
amounts of information. When the portable data carrier is used in conjunction
with the other components of the Company's system, information can be
selectively altered, added to or erased, as required, to effectively and
reliably manage or control a particular activity or transaction.
GOVERNMENT CONTRACTS
Since October 1986, the Company has received a total of six contracts from
the U.S. Government to supply components for the secure telephone program.
These contracts have lasted for periods ranging from 12 to 24 months. The most
recent contract, received in November 1993, was for the 12-month period ended
September 30, 1994 and annual options for the years ended September 30, 1995 and
September 30, 1996. The 1995 option was not exercised, and the Company does not
currently expect the 1996 option to be exercised. Although Datakey has
exclusive rights, along with its sole licensee, to provide secure telephone keys
and receptacles, purchases by the government ceased after 1994.
Shipments under the government secure telephone contracts, other orders
related to the secure telephone program, and orders obtained from other
government agencies and government contractors accounted for revenues (and
percent of total revenues) of approximately $993,000 (14%) in 1995, $1,146,000
(20%) in 1994, and $3,108,000 (51%) in 1993. The continuing decline reflects
the Company's transition toward an increased commercial business and a decreased
government business. See "Research and Development" and "Marketing".
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CURRENT PRODUCTS
PORTABLE DATA CARRIER DEVICES. Portable data carriers are electronic
memory devices which store information. They have a plastic exterior, are in
the forms of keys, cards, or custom shaped tokens and most encapsulate
semiconductor memory. Certain devices have been designed to store information
which may be retrieved, altered, erased or updated; while other devices have
been designed to store one-time programmable information which may be retrieved
but not altered or updated. The storage capacities of the Company's portable
memory devices range from 1,000 bits (150 alphanumeric characters) to 1,024,000
bits. The portable data carriers are priced generally between $2 and $100 per
unit, depending on capacities and quantities purchased.
ACCESS DEVICE. The access device is the element into which a portable data
carrier is inserted to provide the interconnection between the portable data
carrier and the electronic interface circuitry or the host processor-based
equipment. It is through this physical interconnection that the data contained
in the portable data carrier's memory is transmitted to the electronic interface
or to the host interface. Several models of the access device have been
developed to handle the Company's different portable data carriers. The access
devices are priced generally between $15 and $120 per unit, depending on models
and quantities purchased.
INTERFACE. The interface is the electronics control module between the
access device and a customer's processor-based equipment. This module is used
with the Company's serial communication key and contains all the necessary
electronics to control information within the key and to coordinate the
information requests of the host equipment. This communication process is
managed by the system's firmware, which is a software program existing within
the interface. For some applications, this firmware structures, secures and
verifies the information within the portable device, and may allow separate
groups or files of data to reside in a single portable device and be secure from
access except by equipment authorized to manage a particular group or file of
data. The interface is priced between $70 and $120 per unit, depending on
models and quantities purchased.
SUPPORT SYSTEMS. The Company also sells several support systems. Certain
systems assist customers in the evaluation, integration and support of the
Company's portable information systems. Other systems are used to write data on
the portable data carriers. The support systems are priced between $170 and
$350 per unit, depending on type of system and quantities purchased.
CUSTOM DESIGN SERVICES. The Company also offers custom design services on
a contract basis to commercial and government customers in support of the
manufacturing of unique portable data carriers, in forms not currently offered
by the Company.
RESEARCH AND DEVELOPMENT
During 1995, the Company continued the development of portable data
carriers to expand its line of standard products as well as newly designed
custom products. The Company also continued the development of its token-based
information security products.
As the need for computer security products continues to grow, the Company
is planning a major thrust into token-based computer information security
systems. The Company's SignaSURE line of information security products is
designed to provide electronic authentication and digital signature required for
electronically generated documents on computer networks. Follow on products,
which are currently in development, will provide a more complete security
solution for Datakey's customers.
The technology involved in portable information systems in undergoing rapid
expansion and advancement which could result in the development of new products
and systems which may make the Company's present portable information products
obsolete. As a result, the Company must continue to improve its present
portable information products in order to remain competitive.
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In 1995, 1994, and 1993, research and development expenses were $704,000,
$771,000 and $928,000 respectively. The Company expects that research and
development expenses in 1996 will be significantly higher than in 1995.
MANUFACTURING
The Company's in-house manufacturing capabilities include microelectronic
assembly, plastic injection molding, automated surface mount assembly, and
general electronic assembly. The Company also utilizes independent
subcontractors from time to time to perform certain manufacturing functions.
The Company provides a 90-day warranty on domestic sales, a 180-day warranty on
sales to its international distributors to cover the longer shelf life of the
Company's products, and a 180-day warranty on sales to the government.
In an effort to more efficiently produce products, to reduce product costs,
and to increase its manufacturing flexibility, the Company intends to continue
to improve certain manufacturing processes and add capital equipment to its
manufacturing operations. While the Company believes that these steps will
provide a greater level of control over, and flexibility in, its manufacturing
processes, there are no assurances that the Company's ability to produce
products and to meet required delivery schedules will be sufficiently improved
to meet the demands created by increased sales and more complex manufacturing
processes.
SOURCES OF SUPPLY
The Company has several qualified sources from which to purchase printed
circuit boards and electronic components for most of its standard portable data
carriers. The components for the Company's products are, in general, available
from multiple suppliers. Some of the plastic components are molded on the
Company's in-house molding equipment or suppliers' molding equipment using
Company-owned tooling.
The Company purchases integrated circuits through nationwide multivendor
distributors. If, for any reason, the Company would have to cancel or reduce a
particular integrated circuit order, it might thereafter have to pay a higher
price for the integrated circuits. Since general economic conditions have an
effect on the supply and cost of integrated circuits, there is no guarantee that
the Company will be able to obtain adequate quantities of integrated circuits to
meet all of its production needs during periods of short supply.
SIGNIFICANT CUSTOMER
While the Company sells its products to a number of commercial original
equipment manufacturers (OEMs) and government customers, a major portion of its
1993 and 1994 revenues were derived from sales to the U.S. Government and
related parties involved in the secure telephone program (see Government
Contracts). Sales to the U.S. Government and government agencies represented
only about 14% of revenue in 1995, and very little revenue is expected from the
secure telephone program in 1996.
MARKETING
GENERAL. While there appears to be a broad range of applications and
potential customers for portable data carriers, no single application group has
evidenced strong, long-term growth potential. The diversity of potential
applications has made it difficult for the Company to focus its limited
marketing resources. In 1993, commercial sales increased 16% to $2,966,000 from
those of 1992, and in 1994 increased 57% from 1993 to $4,669,000. In 1995,
commercial sales increased 33% to $6,205,000. The
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Company believes that commercial sales may increase again in 1996. There is no
assurance, however, that the Company will be able to maintain this sales
momentum in future years.
COMMERCIAL MARKET. To date, most applications in the commercial market
have used the Data Key for electronic security and equipment control
applications. The Company is seeking to develop other long-term business in
this market. The Company markets its products to both domestic and
international customers using the following channels.
DOMESTIC. The Company markets its portable information products
domestically through a combination of direct and indirect sales personnel. In
addition, it utilizes advertising, trade shows and direct mail to reach its
buying audience. In 1995, 1994, and 1993, sales to domestic customers, and the
corresponding percentage of total revenue, were approximately $4,319,000 (60%),
$2,953,000 (50%) and $1,841,000 (30%), respectively.
INTERNATIONAL. The Company presently markets its portable information
products internationally through an independent sales agent in the United
Kingdom and agents and/or distributors in Columbia, Japan, Australia, Belgium,
the Netherlands and Germany. The Company has customers in other countries who
are handled on a direct basis from the Company's headquarters in the United
States. The Company intends to expand into other international market areas in
the future. In 1995, 1994 and 1993, sales to international customers, and the
corresponding percentage of total revenue, were approximately $1,907,000 (26%),
$1,716,000 (29%) and $1,125,000 (18%), respectively.
GOVERNMENT MARKET. The Company markets its products to government agencies
primarily through its personnel and through a consultant and a sales
representative in Washington, D.C., who are retained to identify new government
programs which may be appropriate for the Company's products. The Company's
primary activity in this segment has been in the marketing of its portable data
and access devices to government agencies for use in various secure information
systems and in the development of custom designed portable data devices for
other government programs.
BACKLOG
As of March 3, 1996, the Company had an order backlog totaling
approximately $2,854,000, compared to $3,332,000 a year ago. Although the
orders contain scheduled shipment dates, they may be accelerated, delayed or
canceled at the customer's request. The Company does not believe that the
current backlog is necessarily indicative of future backlog levels.
COMPETITION
The Company's primary competition is presently, and is expected to remain,
conventional portable information systems, such as keys and cards, and more
advanced portable information systems including those in the familiar credit
card format, such as "smart cards", Personal Computer Memory Card Industry
Association (PCMCIA) cards, magnetic stripe cards, bar-code cards and laser
technology cards. The Company's products, when used as a portable data base,
may also compete with centralized data base systems. Many of the manufacturers
of these portable information devices and systems are large, well-established
companies.
A number of European and Japanese firms continue to develop and refine the
smart card technologies. Some of these companies have established branch
offices in the United States to explore the United States market. To date, the
smart card has been used primarily in Europe, where it has been implemented in
prepaid telephone systems. In the United States, smart cards are currently
being used mainly in field trial environments. Although the Company does not
have complete information about the status of these trials, the Company believes
that, in time, the smart card will be successfully developed and
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could become a competitor, especially in those markets which have a history of
using a card or a preference for card-type devices.
Memory cards, such as PCMCIA standard cards, are functionally equivalent to
the Company's portable data carriers in that they utilize semiconductor memory
in card-shaped devices made of plastic. Memory cards generally have larger
memory capacities than the devices currently offered by the Company and
incorporate volatile, battery-backed memory elements. More recently,
nonvolatile (principally "Flash Memory") memory elements which do not require
battery backup have become more prominent. They are used in such applications
as laser printer fonts, instrumentation, electronic lettering machines and
fax/modems, and are also used as replacements or "add ons" to diskettes and hard
drives for data storage in certain desktop, notebook and smaller portable
computers.
Magnetic stripe cards are relatively inexpensive and are used extensively
in the access control industry and in the banking and credit card industries.
These markets are not priority markets for the Company's portable information
devices. Magnetic stripe cards are not conveniently updatable, have limited
storage capacity and generally have a useful life of one or two years. As a
result, the Company believes its products are technologically superior and may
be more cost-effective for applications requiring more complex technologies.
Another technology utilizes a strip of reflective material which is
laminated into a card. Information is inscribed on this material through use of
a laser beam. Since these cards can contain several million bits of
information, the Company believes that this technology will be a competitor in
portable information markets where very large information storage capacities are
required and instantaneous management of information is not essential.
The Company's ability to compete in the portable information market will
depend primarily on its ability to demonstrate superior product performance at
cost-effective prices and on the enhanced features of its system which make it
more effective than competing systems.
Datakey currently offers token-based (smart card, smart key and PCMCIA
card) information security products which are primarily utilized in encryption
for electronic mail privacy and digital signatures for electronic document
authentication. The Company is presently undertaking a significant product
development effort to expand the applications and ease-of-use of its products
and systems.
Competition in the information security business is varied with companies
offering hardware solutions, software solutions and combinations of hardware and
software solutions. Many of the competitors in this business are established
companies with more resources than Datakey. Although the Company feels it has
unique ideas and products for this marketplace, there is no assurance that
Datakey will be successful.
PATENTS AND TRADEMARKS
The Company has been granted several patents by the United States Patent
and Trademark Office relative to the Data Key, its key interface and its overall
portable information device technology. The Company has sought and will, when
appropriate, continue to seek patent protection in several foreign countries.
The federal registration of the Datakey trademark was approved in 1985. The
Company also has patents in application or in the filing process. In an
industry characterized by rapid technological change, the Company believes that
the knowledge, experience and creativity of its employees will prove to be more
important than patent protection.
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EMPLOYEES
The Company presently employs 44 full-time employees, 17 of whom are
involved in manufacturing, 4 in materials handling, 3 in quality assurance, 9 in
engineering, 5 in marketing/sales and 6 in general and administrative areas. In
addition, the Company uses contract labor during peak production times. The
Company's employees are not subject to a collective bargaining agreement, and
the Company believes that its employee relations are good.
CAUTIONARY STATEMENTS
As provided for under the Private Securities Litigation Reform Act of 1995,
the Company wishes to caution investors that the following important factors,
among others, in some cases have affected and in the future could affect the
Company's actual results of operations and cause such results to differ
materially from those anticipated in forward-looking statements made in this
document and elsewhere by or on behalf of the Company:
UNCERTAINTY OF MARKET ACCEPTANCE OF NEW PRODUCTS
The Company is currently developing new data security products, some of
which it expects to introduce by the end of 1996. There can be no assurance
that the Company will be successful in capturing a significant portion of this
emerging market. In addition, no operating history exists from which investors
might judge the Company's ability to market at a profit such new products. The
ability of the Company to achieve acceptable growth will be highly dependent on
market acceptance of these products and the success of its distribution
arrangements.
NEW PRODUCT DEVELOPMENT
Substantial additional development work is required for the introduction of
the Company's planned new information security products. The Company expects
extensive software development and staffing expenses to contribute to an overall
research and development expense figure for 1996 substantially in excess of that
for previous years. No assurance can be given that the Company's timetable for
these development plans will be achieved or that development efforts will be
successful.
DEPENDENCE ON KEY PERSONNEL
The Company is highly dependent on a limited number of key management and
technical personnel, including John H. Underwood, who has served as the
Company's Chief Executive Officer since June 1983, and Alan G. Shuler who has
been the Vice President and Chief Financial Officer since June 1992. Early in
1995, the Company hired Carl P. Boecher as Vice President of Marketing and
Sales. More recently, Jim Foley joined the Company as Vice President of
Engineering, and Paul Onnen accepted the position of Director of Data Security
Architecture. The loss of key personnel, especially while working to add a new
product line, could have an adverse effect on the Company's business, financial
condition and results of operations.
FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced a steady decline in government contract
business and the related secure telephone program. Commercial sales, however,
have grown. During the past two years, Datakey has marketed secure
microprocessor-based tokens in the smart card format, its patented key shaped
format, and recently, the PCMCIA format, along with a file based software
package for encrypting and digitally signing electronic documents in the
emerging information data security market. The information data security market
is a rapidly developing and changing market, but to date the Company has not
achieved the
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sales levels on its current product offerings. In addition, the Company plans
to spend substantially more for research and development of such new products.
Therefore, the Company believes that its results of operations may fluctuate as
a result of the new product mix and the timing of releases of new products and
product upgrades. As a result of its product development expenditures, the
Company will have significant losses in 1996, and it may have losses in 1997.
COMPETITION
Both the Company's core business, consisting of portable memory-based
systems, subsystems and custom-designed components for security-driven markets,
and the information data security market are highly competitive. The
information data security market is rapidly developing. There can be no
assurance that the Company will be able to effectively compete within such
markets, and that others will not enter these markets. Competition in the sale
of information data security products occurs principally on the basis of price
and functionality. Many of the manufacturers of portable information devices
and systems are large, well-established companies.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's corporate offices and manufacturing facility, located at 407
West Travelers Trail, Burnsville, Minnesota, consists of 18,488 square feet.
Approximately one-half of the space is used for manufacturing and warehousing,
and the balance for present and future office space. All of this space is
rented under a lease which extends through June 1997. The annual rent expense
for the space currently occupied is $97,000 for 1996, plus a portion of the
operating expenses and real estate taxes.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending to which the Company is a
party or of which any of its property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of fiscal year 1995.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the NASDAQ National Market System
under the symbol DKEY. The high and low sale prices for the common stock by
quarter as reported by NASDAQ are set forth in the following table for 1995 and
1994.
On March 15, 1996, the Company had approximately 1,350 shareholders,
including approximately 1,000 beneficial owners. The Company has never paid
dividends and does not plan to in the foreseeable future.
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<TABLE>
<CAPTION>
SALE PRICES
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High Low
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<S> <C> <C>
1995
1st Quarter . . . . . . . . . . $4 $2 7/8
2nd Quarter . . . . . . . . . . $4 1/8 $3 1/2
3rd Quarter . . . . . . . . . . $4 1/4 $2 1/2
4th Quarter . . . . . . . . . . $8 3/4 $3 3/8
1994
1st Quarter . . . . . . . . . . $4 1/8 $3 3/8
2nd Quarter . . . . . . . . . . $3 5/8 $2 1/2
3rd Quarter . . . . . . . . . . $3 1/2 $2 1/4
4th Quarter . . . . . . . . . . $4 $2 3/4
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
RESULTS OF OPERATIONS
The table below summarizes changes in selected operating indicators,
showing certain income and expense items as a percentage of total revenue for
each of the past three years.
Inflation has not been a significant factor in Datakey's operations to
date.
<TABLE>
<CAPTION>
Percentage of Total Revenue
Year Ended December 31, 1995 1994 1993
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<S> <C> <C> <C>
REVENUE
Net Sales . . . . . . . . . . . . . . 100% 99% 99%
Other operating revenue . . . . . . . --- 1 1
-----------------------
Total revenue . . . . . . . . . . . . 100 100 100
COST AND EXPENSES
Cost of goods sold. . . . . . . . . . 67% 70% 61%
Research and development. . . . . . . 10 13 15
Marketing and sales . . . . . . . . . 15 17 17
General and administrative. . . . . . 9 10 17
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Total cost and expense. . . . . . . . 101 110 110
Nonoperating income . . . . . . . . . 5 5 4
Income (loss) before income taxes . . 4 (5) (6)
Income taxes (benefit). . . . . . . . 2 (2) (3)
-----------------------
Net Income (loss) . . . . . . . . . . 2 (3) (3)
-----------------------
</TABLE>
COMPARISON OF 1995 WITH 1994
TOTAL REVENUE: Total revenue was $7,219,000 in 1995, an increase of 23
percent from $5,874,000 in 1994. The increase is principally due to a
substantial increase in commercial revenue offset, in part, by a decline in
government revenue. Commercial sales increased 33% to $6,205,000 in 1995 from
$4,669,000 in 1994. Commercial sales as a percentage of total revenue were 86
percent in 1995 versus 79 percent in 1994. The increase in commercial sales is
attributed to increased business with existing customers as well as sales,
generally small initially, to several new customers. The decline in government
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revenue resulted from a discontinuation of purchases by the U.S. Government of
keys for the secure telephone program. The Company expects commercial sales and
total sales to increase in 1996, but at a lower percentage of increase than in
1995.
GROSS MARGINS: The gross profit margin on net sales increased to 33
percent in 1995 from 29 percent in 1994. This increase in gross profit
percentage was achieved primarily by improvements in manufacturing productivity
and the increase in revenue over which the fixed factory overhead is absorbed.
Although the Company is operating in a highly competitive commercial market with
profit margins generally lower than were achieved in the past, improvements in
manufacturing processes and product purchase prices along with increased revenue
result in improved margins. The Company expects gross margins to continue to
improve gradually as sales volumes increase and manufacturing efficiencies
improve.
RESEARCH AND DEVELOPMENT: Research and development expenses decreased 9
percent to $704,000 from $771,000 in 1994 and also decreased as a percentage of
revenue to 10 percent in 1995 from 13 percent in 1994. The decrease in 1995 was
primarily related to a reduction in travel and project supplies expense.
Research and development expenses are expected to be significantly higher
in 1996 as a result of the Company's decision to substantially accelerate the
product development process for data security products. Although the amount of
research and development spending in 1996 cannot be specified, the total is
likely to be three to four times the 1995 level.
MARKETING AND SALES, GENERAL AND ADMINISTRATIVE: Marketing and sales
expenses increased 16 percent to $1,124,000 in 1995 from $971,000 in 1994. The
1995 increase is principally due to commissions payable on the higher level of
revenue and an increase in travel and promotional expenses. Marketing and sales
expense declined as a percentage of revenue to 15 percent in 1995 from 17
percent in 1994.
General and administrative expenses increased 14 percent to $670,000 in
1995 from $590,000 in 1994. This increase is related to increased data
processing support costs for a more complex computer system as well as general
increases in a variety of administrative costs necessary to support the growth
in the Company. General and administrative expenses as a percentage of revenue
declined to 9 percent in 1995 from 10 percent in 1994.
Sales and marketing expense is expected to increase by 10 to 20 percent in
1996, to promote and sell the advanced data security products under development.
Although little revenue is expected from the sale of these products during 1996,
a major product introduction is planned.
General and administrative expenses in 1996 are expected to increase at
approximately the rate of increase in revenue.
INTEREST INCOME: Interest income increased 34 percent to $381,000 in 1995
from $285,000 in 1994. The increase was due to an increased market interest
rate for the Company's interest bearing investments as well as an increase in
the average balance of these investments. Interest income in 1996 is expected
to be lower as the Company intends to use cash to fund increased product
development and promotional activities as well as an increased level of capital
spending to support the accelerated development of advanced data security
products.
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COMPARISON OF 1994 WITH 1993
TOTAL REVENUE: Total revenue was $5,874,000 in 1994, a decrease of 5
percent from $6,151,000 in 1993. The decrease in revenue was due to a sharp
decline in shipments to government agencies and contractors.
Sales to government agencies and contractors declined 63 percent to
$1,146,000 in 1994 from $3,108,000 in 1993. Commercial sales increased 57
percent to $4,669,000 in 1994, from $2,966,000 in 1993. Commercial sales as a
percentage of revenues were 79 percent in 1994 versus 48 percent in 1993.
GROSS MARGINS: The gross profit margin on net sales decreased to 29
percent in 1994 from 38 percent in 1993. This decrease in gross profit
percentage was primarily due to a shift from sales of mature government
products, which generally carry higher gross margins, to commercial products
carrying lower gross margins. Additionally, competitive price pressure in
government as well as commercial products have resulted in lower unit price
without corresponding reductions in unit product cost.
RESEARCH AND DEVELOPMENT: Research and development expenses decreased 17
percent to $771,000 in 1994 from $928,000 in 1993, and also decreased as a
percentage of revenue to 13 percent in 1994 from 15 percent in 1993. The
decrease in dollars and percentage of revenue was due to lower personnel costs
in 1994.
MARKETING AND SALES, GENERAL AND ADMINISTRATIVE: Marketing and sales
expenses declined 7 percent to $971,000 in 1994 from $1,045,000 in 1993 but
remained at 17 percent of revenue. The overall decline in marketing and sales
expense resulted primarily from reducing advertising and promotion expenditures.
General and administration expenses decreased 43 percent to $590,000 in
1994 from $1,028,000 in 1993. The large decrease in 1994 was primarily due to
unusually large expenditures in 1993 to improve the management information
system and to document manufacturing processes as well as $217,000 in expenses
related to acquisition search work and merger discussions with Sheldahl, Inc.
which were abandoned in December 1993. The remainder of the expense reduction
was achieved in lower personnel costs and other operating expenses in light of
lower revenue and lower gross product margins.
INTEREST INCOME: Interest income increased 16 percent to $285,000 in 1994
from $246,000 in 1993 as a result of a higher effective yield rate earned on the
Company's cash, cash equivalents and investment in held-to-maturity/marketable
debt securities. This increased earnings rate was offset partially by reduced
interest-bearing investments due to purchases of equipment and tooling and an
increase in inventory.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities provided $938,000 of cash in 1995 and
used $316,000 of cash in 1994. The cash provided in 1995 was primarily the
result of net income of $176,000 together with non-cash depreciation and
amortization charges totaling $595,000 during the year. Trade receivables as of
December 31, 1995 were $1,055,075 compared to $1,191,000 as of December 31,
1994. The decline in receivables as of year end 1995 was due to a lower level
of shipments in December 1995 than was reported in 1994. Inventory decreased
$126,000 to $1,223,000 as of December 31, 1995 compared to $1,349,000 as of
December 31, 1994. The inventory declined in 1995 in spite of an increase in
revenue resulting from improved inventory management procedures. The Company
expects inventory to remain at approximately the current level in 1996. The
Company invested $318,000 in the purchase of equipment and maintenance of
patents in 1995 compared to $668,000 in 1994. Cash, cash equivalents and
investments in held-to-maturity/marketable debt securities as of December 31,
1995 were $6,967,000 compared to $6,366,000 as of December 31, 1994.
11
<PAGE>
Datakey's balance sheet continues to reflect a strong financial position,
with $8,645,000 in working capital and a current assets to current liabilities
ratio of 11.7 to 1 as of December 31, 1995. The Company expects its 1996
investments in capital equipment and tooling to be approximately double its
capital investments in 1995. The Company's working capital and investments are
sufficient to fund its planned operations and continued research and development
activities in 1996.
OUTLOOK FOR 1996
The Company expects to report a loss in 1996 due to a substantial increase
in expenditures on product development and promotion. Although increased
revenue and profitability is expected in the core business, this increased
spending to develop and promote the data security business will likely lead to a
loss for the year.
ITEM 7. FINANCIAL STATEMENTS
The information required by Item 7 is enclosed as Exhibit 13.1 of this
report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by Item 9 regarding the Company's directors and
executive officers is incorporated by reference to the Company's proxy statement
for its 1996 Annual Meeting of Shareholders under the captions "Determination of
Number and Election of Directors" and "Executive Officers of the Company." The
Company's proxy statement will be filed pursuant to Rule 14a-3 within 120 days
after the close of the fiscal year for which this report is filed.
The information relating to compliance with Section 16(a) of the Exchange
Act is incorporated by reference to the Company's proxy statement for its 1996
Annual Meeting of Shareholders under the caption "Compliance With Section 16(a)
of the Exchange Act."
ITEM 10. EXECUTIVE COMPENSATION
The information required by Item 10 is incorporated by reference to the
Company's proxy statement for its 1996 Annual Meeting of Shareholders under the
caption "Executive Compensation."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 11 is incorporated by reference to the
Company's proxy statement for its 1996 Annual Meeting of Shareholders under the
caption "Security Ownership of Management and Certain Beneficial Owners."
12
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are included in this report: See "Exhibit
Index" immediately following the signature page of this Form 10-KSB.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended December 31, 1995.
13
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Issuer has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1996 DATAKEY, INC.
BY: /s/ John H. Underwood
---------------------
John H. Underwood
Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Company, in the
capacities, and on the dates, indicated:
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints John H.
Underwood and Alan G. Shuler as his true and lawful attorneys-in-fact and
agents, each acting alone, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities, to sign any
or all amendments to this Annual Report on Form 10-KSB and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, acting alone, full power and authority to do and perform each and every
act and thing requisite and necessary to be done in and about the premises, as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming said attorneys-in-fact and agents, acting alone, or his
substitute or substitutes, may lawfully do or cause to be done by virtue
thereof.
SIGNATURES TITLES DATE
/s/ John H. Underwood Chief Executive Officer and March 27, 1996
- --------------------- Director (Principal Executive
John H. Underwood Officer)
/s/ Alan G. Shuler Vice President and Chief March 27, 1996
- ------------------ Financial Officer (Principal
Alan G. Shuler Financial Officer)
/s/ Thomas R. King Director and Secretary March 27, 1996
- ------------------
Thomas R. King
/s/ Terrence W. Glarner Director March 27, 1996
- -----------------------
Terrence W. Glarner
/s/ Gary R. Holland Chairman of the Board of March 27, 1996
- ------------------- Directors
Gary R. Holland
/s/ Eugene W. Courtney Director March 27, 1996
- ----------------------
Eugene W. Courtney
14
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description Incorporation by Reference to
- ---- ----------- -----------------------------
<S> <C> <C>
3.1 Restated Articles of Incorporation, as Exhibit 3.1 to Form 10-K for
amended fiscal year ended December 31, 1987
3.2 Bylaws, as Amended Exhibit 3.2 to form 10-K for
fiscal year ended December 31,
1988
10.1 Agreement between National Security Exhibit 10.5 to Form 10-K for
Agency and Datakey, Inc. dated fiscal year ended December 31
September 30, 1986, as amended on 1986
October 16, 1986*
10.2 Amendments dated May 8, 1987, May Exhibit 10.6 to Form 10-K for
29, 1987, June 30, 1987, and February fiscal year ended December 31,
17, 1988, to Agreement between National 1987
Security Agency and Datakey, Inc. dated
September 30, 1986
10.3 1987 Datakey, Inc. Stock Option Plan** Exhibit 10.7 to Form 10-K for
fiscal year ended December 31,
1987
10.4 Amendment dated March 15, 1991 to Exhibit 10.5 to Form 10-K for
1987 Datakey, Inc. Stock Option Plan** fiscal year ended December 31,
1991
10.5 License Agreement between CTS Exhibit 10.8 to Form 10-K for
Corporation and Datakey, Inc. dated fiscal year ended December 31,
March 9, 1988 1987
10.6 Employment Agreement between John H. Exhibit 10.6 to Form 10-KSB for
Underwood and Datakey, Inc. dated fiscal year ended December 31,
January 4, 1994** 1993
10.7 Agreement between Maryland Exhibit 10.9 to Form 10-K for
Procurement Office and Datakey, Inc. fiscal year ended December 31,
dated September 24, 1988 as amended on 1988
September 26, 1988, November 7, 1988,
November 9, 1988, and December 19,
1988
15
<PAGE>
Exhibit
No. Description Incorporation by Reference to
- ------- ----------- -----------------------------
10.8 Agreement between Maryland Exhibit 10.10 to Form 10-K for
Procurement Office and Datakey, Inc. fiscal year ended December 31,
dated October 2, 1989 as amended on 1989
November 8, 1989
10.9 Agreement between Maryland Exhibit 10.10 to Form 10-K for
Procurement Office and Datakey, Inc. fiscal year ended December 31,
dated September 28, 1990 as amended on 1991
October 29, 1990, February 22, 1991,
and May 15, 1991
10.10 Lease between Datakey, Inc. and Kraus- Exhibit 10.12 to Form 10-K for
Anderson, Inc. dated June 3, 1987, as fiscal year ended December 31,
amended on February 10, 1988, 1991
December 23, 1988, February 13, 1992,
and on April 1, 1992
10.11 Agreement between National Institute of Exhibit 10.12 to Form 10-KSB
Standards & Technology Acquisition of for fiscal year ended December
Assistance Division and Datakey, Inc. 31, 1992
dated June 2, 1992, as amended on
June 3, 1992*
10.12 Agreement between Maryland Exhibit 10.13 to Form 10-KSB
Procurement Office and Datakey, Inc. for fiscal year ended December
dated July 29, 1992,* as amended on 31, 1992
October 13, 1992
10.13 Agreement between Maryland Exhibit 10.15 to Form 10-KSB
Procurement Office and Datakey, Inc. for fiscal year ended December
dated November 16, 1993* 31, 1993
10.14 Manufacturing Agreement between Exhibit 10.16 to Form 10-KSB
Duncan Industries and Datakey, Inc. for fiscal year ended December
dated August 27, 1993 31, 1993
10.15 Employment Agreement between John H. Exhibit 10 to Form 10-QSB for
Underwood and Datakey, Inc. dated fiscal quarter ended October 1,
July 1, 1994** 1994
10.16 Employment Agreement between Alan G. Exhibit 10 to Form 10-QSB for
Shuler and Datakey, Inc. dated fiscal quarter ended July 1, 1995
January 1, 1995**
16
<PAGE>
Exhibit
No. Description Incorporation by Reference to
- ------- ----------- -----------------------------
10.17 Employment Agreement between Carl P. Exhibit 10.17 to Form 10-KSB
Boecher and Datakey, Inc. dated for fiscal year ended December 31,
January 9, 1995** 1994
10.18 Employment Agreement between James P.
Foley and Datakey, Inc. dated January 1,
1996**
10.19 Consulting Agreement between Gary R.
Holland and Datakey, Inc. dated November 1,
1995**
11 Earnings per share
13.1 Portion of Annual Report containing Financial
Statements for the year ended December 31,
1995
21.1 Subsidiaries of the Company Exhibit 21.1 to Form 10-KSB
for fiscal year ended December 31,
1994
23.1 Independent Auditors' consent
24.1 Power of Attorney for John H.
Underwood, Alan G. Shuler, Thomas R.
King, Terrence W. Glarner, Gary R.
Holland and Eugene W. Courtney (included
on the signature pages of this
Form 10-KSB)
</TABLE>
* Confidential treatment has been granted for certain portions of this exhibit.
** Designates a management contract or compensatory plan or arrangement.
17
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement made and entered into effective as of the 1st day
of January 1996, by and between Datakey, Inc., a Minnesota corporation (the
"Company" or "Datakey") and James P. Foley ("Executive").
RECITALS
James P. Foley became the Vice President of Engineering as of the date
hereof. The Company and the Executive are desirous that the Executive serves
the Company in this capacity under the following terms and conditions.
AGREEMENT
1. EMPLOYMENT
a. Datakey agrees to continue to employ Executive on a full-time basis as
the Vice President of Engineering of Datakey.
b. Executive agrees that he will, at all times, faithfully,
industriously, and, to the best of his abilities, experience and talents,
continue to perform all the duties and responsibilities that may be required of
him as an officer of Datakey.
2. TERM OF EMPLOYMENT
a. Subject to the terms and conditions hereof, Executive shall be
employed for a term ("Employment Term") commencing on January 1, 1996 and
terminating on December 31, 1996, unless extended as set forth in Subsection 2b
below.
b. This Agreement will be renewed automatically after December 31, 1996
for additional one-year periods unless either party gives the other party
written notice 30 days before December 31, 1996 or 30 days before the end of any
one-year period thereafter of his or its intention to terminate the Agreement.
3. BASE MONTHLY COMPENSATION
As compensation for his services to Datakey, Executive shall be paid a
monthly salary of $7,916.66, payable in accordance with Datakey's periodic
payment periods.
-1-
<PAGE>
4. BONUS
Executive shall be entitled to a bonus for his initial Employment Term in
the amount of $10,000, which amount shall be payable as of December 31, 1996.
Thereafter, bonuses will be paid pursuant to management incentive plans approved
by the Compensation Committee or at the discretion of the Compensation
Committee.
5. OTHER BENEFITS
a. VACATION. Executive will receive four weeks of vacation for every
twelve months of employment. Unused vacation may not be carried over from one
year to the next.
b. AUTOMOBILE ALLOWANCE. During the term of this Agreement, Datakey will
pay Executive $400 per month to be applied toward his automobile expenses.
c. MISCELLANEOUS. During the term of this Agreement, Executive will be
eligible to receive the other benefits described in the attached Exhibit A,
subject to such changes as Datakey may adopt from time to time for salaried
employees generally.
6. TERMINATION
a. Notwithstanding Section 2 above, the Employment Term or any extension
thereof shall terminate upon the happening of any of the following events:
(i) Mutual written agreement between the Board of Directors of
Datakey and Executive to terminate his employment;
(ii) Executive's death;
(iii) Executive's disability defined as physically or mentally
unable to perform as Vice President of Engineering for a period of six
consecutive months; or
(iv) For cause (as defined below) upon written notice from the Board
of Directors specifying the nature of the cause.
b. For purposes of this Agreement, "cause" shall include commission of
any felony, misdemeanor, any act of fraud or dishonesty in connection with the
affairs of Datakey.
7. PAYMENT UPON TERMINATION OF EMPLOYMENT FOR CAUSE OR VOLUNTARY RESIGNATION
If Executive is terminated for cause or voluntarily resigns, Executive
shall not be eligible to receive any severance benefits. The date of
termination under this Section 7 shall be on the day the notice of termination
for cause is given or 30 days from the date the notice of resignation is given.
Executive shall be entitled to no additional compensation past the date of a
notice of termination for cause or after 30 days from the notice of resignation.
-2-
<PAGE>
8. PAYMENT UPON TERMINATION OF EMPLOYMENT WITHOUT CAUSE
a. If during the term of this Agreement Executive is terminated without
cause, and without cause shall include death, disability or mutual agreement,
Executive shall not be entitled to receive his agreed compensation for the
balance of the term of this Agreement but shall instead receive a severance
payment equal to his base monthly compensation payable for six months in
accordance with Datakey's payment periods beginning on the 10th day of the first
month following the last month of his employment term.
b. Base compensation shall be deemed to be no less than $7,916.66 per
month.
c. The payments provided for under this Section 8 shall, in the event of
Executive's death, continue and shall be payable to his wife if she survives or,
if not, to his estate.
d. The Company will continue to provide medical and health coverage,
under its plans as they currently exist or may hereafter be amended, at Company
subsidized rates during the six-month severance pay period. Thereafter,
Executive and his covered dependents will be entitled to elect to continue
coverage under COBRA to the extent it is available. Coverage by the Company or
under COBRA will end on the earlier of Executive's obtaining new employment,
which gives him the ability to provide medical and health insurance coverage for
himself and his family through his new employer, or the failure to pay any
premium when due.
9. PAYMENT UPON TERMINATION OF AGREEMENT BY THE COMPANY ON DECEMBER 31, 1996
OR AT THE END OF ANY ONE-YEAR EXTENSION
a. If the Company decides to terminate the Employment Agreement on
December 31, 1996 or as of the end of any one-year extension, Executive shall
receive his base monthly compensation for six (6) months beginning on the 10th
of the first month following the last month of the Employment Term in accordance
with Datakey's payment periods.
b. The payments provided for under this Section 9 shall, in the event of
Executive's death, continue and shall be payable to his wife if she survives or,
if not, to his estate.
c. The Company will continue to provide medical and health coverage,
under its plans as they currently exist or may hereafter be amended, at Company
subsidized rates during the six-month severance pay period. Thereafter,
Executive and his covered dependents will be entitled to elect to continue
coverage under COBRA to the extent it is available. Coverage by the Company or
under COBRA will end on the earlier of Executive's obtaining new employment,
which gives him the ability to provide medical and health insurance coverage for
himself and his family through his new employer, or the failure to pay any
premium when due.
-3-
<PAGE>
10. TERMINATION OF EMPLOYMENT OR RESIGNATION WITHIN SIX MONTHS OF A CHANGE IN
CONTROL
a. If Employee's employment is terminated within six months of a Change
of Control, or if Employee resigns within six months of a Change of Control
because of a diminution of either position responsibilities or remuneration,
notwithstanding such termination or resignation, Employee shall receive his base
monthly compensation for a period of six months. The severance payments shall
be made in six monthly installments beginning on the 10th day of the first month
following Employee's termination or resignation in accordance with the Company's
payroll periods.
b. A Change in Control shall be deemed to have occurred if: (a) any
person or entity becomes the beneficial owner of thirty-five percent (35%) or
more of the Company's outstanding securities other than any institution,
individual, individuals acting in concert, or entity owning thirty-five percent
(35%) or more of the Company's outstanding securities as of the date of this
Agreement; (b) the consummation of a merger or consolidation of the Company into
or with any other corporation; (c) the consummation of a plan of complete
liquidation of the Company; or (d) the consummation of the sale of substantially
all of the Company's assets.
c. The payments provided for under this Section 10 shall, in the event of
Employee's death, continue and be payable to his wife if she survives or, if
not, to his estate.
11. NONDISCLOSURE
Except by written permission from Datakey, Executive shall never disclose
or use any trade secrets, sales projections, formulations, customer lists or
information, product specifications or information, credit information,
production know-how, research and development plans or other information not
generally known to the public ("Confidential Information") acquired or learned
by Executive during the course, and on account, of his employment, whether or
not developed by Executive, except as such disclosure or use may be required by
his duties to Datakey, and then only in strict accordance with his obligations
of service and loyalty thereto. Upon termination of employment, Executive
agrees to deliver to Datakey all Confidential Information.
12. INVENTIONS
Any invention, discovery, improvement, or idea, whether patentable or
copyrightable or not, and whether or not shown or described in writing or
reduced to practice ("Invention") shall be promptly and fully disclosed by
Executive to the Company, and the Company will hold in trust for its sole right
and benefit, any Invention that Executive, during the period of employment, and
for one year thereafter, make, conceive, or reduce to practice or cause to be
made, conceived, or reduced to practice, either alone or in conjunction with
others, that:
a. Relates to any subject matter pertaining to Executive's
employment with the Company;
-4-
<PAGE>
b. Relates to or is directly or indirectly connected with the
Company's business, products, projects, or Confidential Information; or
c. Involves the use of any time, material, or facility of the
Company's.
Executive hereby assigns to the Company all of his right, title, and interest in
and to all such Inventions and, upon the Company's request, shall execute,
verify, and deliver to the Company such documents including, without limitation,
assignments and applications for Letters Patent, and shall perform such other
acts, including, without limitation, appearing as a witness in any action
brought in connection with this Employment Agreement that is necessary to enable
the Company to obtain the sole right, title, and benefit to all such Inventions.
13. SPECIFIC PERFORMANCE
Executive acknowledges that a breach of this Employment Agreement would
cause Datakey irreparable injury and damage which could not be remedied or
adequately compensated by damages at law; therefore, Executive expressly agrees
that Datakey shall be entitled, in addition to any other remedies legally
available, to injunctive and/or other equitable relief to prevent a breach of
this Employment Agreement.
14. NONCOMPETITION
a. For a period of six months from and after the end of the Employment
Term or any extension thereof or after termination of employment, Executive will
not, directly or indirectly, alone or in any capacity with another legal entity,
(i) engage in any activity that competes in any respect with Datakey, (ii)
contact or in any way interfere or attempt to interfere with the relationship of
Datakey with any current or potential customers of Datakey, or (iii) employ or
attempt to employ any employee of Datakey (other than a former employee thereof
after such employee has terminated employment with the Datakey), and
b. Executive acknowledges that Datakey markets products throughout the
United States and that Datakey would be harmed if Executive conducted any of the
activities described in this Section 14 anywhere in the United States.
Therefore, Executive agrees that the covenants contained in this Section 14
shall apply to all portions of, and throughout, the United States.
c. Executive acknowledges that if he fails to fulfill his obligations
under this Section 14, the damages to Datakey would be very difficult to
determine. Therefore, in addition to any other rights or remedies available to
Datakey at law, in equity, or by statute, Executive hereby consents to the
specific enforcement of the provisions of this Section 14 by Datakey through an
injunction or restraining order issued by the appropriate court.
d. To the extent any provision of this Section 14 shall be invalid or
unenforceable, it shall be considered deleted herefrom and the remainder of such
provision and this Section 14 shall be unaffected and shall continue in full
force and effect. In furtherance to and not in limitation of the foregoing,
should the duration or geographical
-5-
<PAGE>
extent of, or business activities covered by, any provision of this Section 14
be in excess of that which is valid and enforceable under applicable law, then
such provision shall be construed to cover only that duration, extent or
activities which are validly and enforceably covered. Executive acknowledges
the uncertainty of the law in this respect and expressly stipulates that this
Section 14 be given the construction which renders its provisions valid and
enforceable to the maximum extent (not exceeding its expressed terms) possible
under applicable laws.
15. MISCELLANEOUS
a. Waiver by Datakey of a breach of any provision of this Agreement by
Executive shall not operate or be construed as a waiver of any subsequent breach
by Executive.
b. This Agreement shall be binding upon and inure to the benefit of
Datakey, its successors and assigns, and as to Executive, his heirs, personal
representatives, estate, legatees, and assigns.
c. This Agreement constitutes the entire agreement between the parties
hereto with respect to the subject matter hereof and supersedes all prior
agreements whether written or oral relating hereto.
d. This Agreement shall be governed by and construed under the laws of
the State of Minnesota.
IN WITNESS WHEREOF, the parties have hereto executed this Employment
Agreement effective as of the day and year first above written.
DATAKEY, INC.
By /s/ John H. Underwood
John H. Underwood, President
/s/ James P. Foley
James P. Foley, Executive
515679
-6-
<PAGE>
EXHIBIT A
TO
EMPLOYMENT AGREEMENT DATED JANUARY 1, 1996
EXECUTIVE BENEFITS
- -- Group health, dental, life and disability insurance, 401K plan, 125 plan
and other benefits as provided to all employees
- -- Supplemental life insurance in the amount of $200,000 paid 100% by the
Company
- -- Supplemental long-term disability insurance paying $4,000 per month paid
90% by the Company
- -- Auto allowance of $400 per month
- -- Four weeks of annual vacation, unused vacation cannot be carried over
- -- Sick leave as needed, up to 90 days at the discretion of the CEO
515679
<PAGE>
AGREEMENT
EFFECTIVE DATE: November 1, 1995
PARTIES:
Datakey, Inc.
407 West Travelers Trail
Burnsville, Minnesota 55337-2554 ("Datakey" or "Company")
Gary R. Holland
6312 Indian Hills Road
Edina, Minnesota 55439 ("Holland")
RECITALS:
A. Datakey is a public company engaged in the business of designing,
manufacturing and marketing portable-memory-based systems, subsystems and custom
designed components for security-driven markets;
B. Holland has unique experience, skill and expertise in the management of
public and private companies and in the development of business strategies; and
C. Datakey is desirous of appointing Holland to its Board of Directors as
its Chairman of the Board and having Holland provide certain consulting
services, and Holland is desirous of serving as Datakey's Chairman of the Board
and providing such consulting services to Datakey, subject to the terms and
conditions set forth herein.
AGREEMENT:
In consideration of the mutual covenants contained herein, and for other
good and valuable consideration, the receipt and sufficiency of which is hereby
acknowledged, the parties agree as follows:
1. DIRECTORSHIP. On the assumption that the terms and conditions of this
Agreement are acceptable to Holland and the Agreement has been signed by the
parties hereto, the Board of Directors will appoint Holland to serve on the
Board of Directors of Datakey as its Chairman of the Board and to serve on all
Board committees. The Company will include Holland on its list of director
nominees in Datakey's 1996 Proxy and Proxy Statement for election at the annual
shareholders' meeting expected to be held in May 1996. If elected by the
shareholders, Holland will serve as a director of the Company at least until
<PAGE>
the 1997 annual meeting. Thereafter, Holland's service on the Board will depend
on the annual submission by Datakey of his name to the shareholders of Datakey
as a director nominee and his election by the shareholders.
2. CONSULTING.
a. SERVICES. Holland shall use his best efforts to assist Datakey as
follows:
i. analyze its current business and business opportunities;
ii. develop a 1996 plan;
iii. analyze personnel needs;
iv. assess desirability of Datakey continuing to be a stand-
alone Company;
v. address strategic partnering issues; and
vi. as may be directed by the Board of Directors.
In performing such services, Consultant will be responsible to and
report to Datakey's Board of Directors.
b. TERM. Subject to the termination provisions of Section 10 of
this Agreement, Holland's consulting services shall commence as of November
1, 1995, and shall continue through October 31, 1996. The continuation of
its consulting services after October 31, 1996 is subject to the mutual
written agreement of both parties. If either party should desire to renew
this relationship, such party shall give the other party written notice of
such desire at least thirty (30) days prior to the end of the term of this
Agreement.
c. TIME. Holland shall provide his consulting services to Datakey
for a minimum of six (6) days per four (4) week period. The four-week
period shall begin on the effective date of this agreement and shall
continue for thirteen (13) equal four week periods, or until the Agreement
is terminated. All time which Holland spends on company matters as a
director will be accrued as a part of his consulting time commitment.
d. COMPANY POLICIES. Holland shall abide by all policies of Datakey
as such policies may be amended from time to time by Datakey.
e. USE OF DATAKEY'S NAME. Holland shall not use the name of Datakey
or any other similar name or any trademark, tradename or service mark of
Datakey which may in any way result in confusion or lead a third party to
believe that Datakey and Holland are not separate and distinct entities.
f. LAWS AND REGULATIONS. Holland shall conform to all applicable
laws and regulations and to the highest business ethics in performing his
obligations in accordance with the terms of this Agreement.
-2-
<PAGE>
3. CASH COMPENSATION.
a. AS A DIRECTOR. If Holland is receiving compensation as a
director pursuant to Section 3b below, he will receive no directors' fees.
If Holland's consulting services are discontinued and he continues to serve
as a director, he will receive the fees then being paid to the other
directors which is currently $1,000 for each directors' meeting attended,
$500 for each committee meeting attended, and an annual retainer of $2,500.
b. FOR CONSULTING SERVICES. Datakey will pay Holland $100,000 for
the term of the Agreement, payable in twelve monthly installments beginning
on December 1, 1995 and ending on December 1, 1996. The Company shall have
the right to withhold taxes from such payments if it believes it is legally
obligated to do so. The Company agrees to reimburse Holland for all
reasonable expenses incurred by Holland in performing his services
hereunder; provided that such expenses in excess of $500 in any given month
are preapproved by the Company, all expenses incurred will be properly
accounted for in accordance with the policies and procedures established by
the Company.
4. STOCK OPTIONS.
a. AS A DIRECTOR. Upon Holland's appointment to Datakey's Board of
Directors In November 1995, he will receive a non-qualified stock option
for 15,000 shares as evidenced by a stock option agreement in the form of
agreement attached hereto as Exhibit A. The Company has recently amended
its Non-Qualified Stock Option Plan providing for automatic option grants
to directors which is subject to approval by the shareholders at their 1996
annual meeting. If for any reason the Amendment is not approved and the
option is invalidated, the Company will grant to Holland a new option for
15,000 shares of the Company's Common Stock on the same terms, including an
exercise price. Beginning in 1997 at the annual shareholders' meeting,
Holland will receive additional non-qualified options for 3,000 shares, at
an exercise price equal to the fair market value on the date of grant, for
each year of service as a director.
b. FOR CONSULTING SERVICES. Upon the signing of this Agreement,
Holland will be granted an additional non-qualified stock option for 35,000
shares, at an exercise price equal to the closing price of Datakey's Common
Stock as reported in the Over-the-Counter Market on the Nasdaq National
Market System, to be evidenced by a stock option agreement in the form of
the agreement attached hereto as Exhibit B.
5. NONCOMPETITION. For so long as Holland is providing consulting
services or serving as a director of Datakey, Holland shall refrain from
directly or indirectly developing, selling, promoting or brokering any items
which are in competition with the products that Holland worked on pursuant to
the terms of this Agreement. Without limiting the generality of the foregoing
sentence, this provision shall be deemed to be breached if Holland acts as an
employee, agent or consultant of, independent contract, distributor or broker
for, or
-3-
<PAGE>
shareholder, director, officer or owner of any capital interest in, any person
or entity developing, manufacturing or selling such competitive items.
6. NONDISCLOSURE OF CONFIDENTIAL INFORMATION.
a. DEFINITION. For purposes of this Agreement "Confidential
Information" means any information or compilation of information, not
generally known, which is proprietary to Datakey and relates to Datakey's
existing or reasonably foreseeable business which is not readily disclosed
by inspection of Datakey's products, including, but not limited to, trade
secrets, Inventions, (as hereinafter defined) and information contained in
or relating to Datakey's product designs, tolerances, manufacturing
methods, processes, techniques, treatment or chemical composition of
material, plant layout, tooling, marketing plans or proposals, and customer
information. All information which Datakey identifies as being
"confidential" or "trade secret" shall be presumed to be Confidential
Information. Confidential Information shall also include any information
disclosed by a third party under contract with Datakey which contract
requires such disclosed information be kept confidential. Confidential
Information shall not include information that (i) is in or enters the
public domain other than through a breach of confidentiality owed to
Datakey, (ii) was known to consult prior to disclosure by Datakey as
demonstrated by Holland's written records or (iii) is disclosed to Holland
by a third party other than through a breach of confidentiality owed to
Datakey.
b. NONDISCLOSURE. During the term of this Agreement and at all times
thereafter, Holland shall hold in strictest of confidence and will never
disclose, furnish, transfer, communicate, make assessable to any person or
use in any way Confidential Information for Holland's own or another's
benefit or permit the same to be used in competition with Datakey, nor will
Holland accept any employment which would, by the nature of the position,
inherently involve the use or disclosure by Holland of Confidential
Information. The term "any person" as used above includes any individual
who does not have written authorization from Datakey to have access to
Confidential Information, including Datakey employees and other Datakey
consultants. Holland will refrain from such acts and omissions which would
reduce the value of the Confidential Information to Datakey.
7. INVENTIONS.
a. DEFINITION. For purposes of this Agreement "Invention" means any
invention, enhancement, alteration, modification, improvement, discovery,
new idea, formula, process, design, trade secret or other useful technical
information or know-how, whether or not shown or described in writing or
whether or not copyrightable or patentable, relating to the existing or
reasonably foreseeable business of Datakey.
b. DISCLOSURE AND ASSIGNMENT. Holland agrees to promptly disclose to
Datakey in writing complete information concerning all Inventions and
Confidential Information made, generated, discovered, developed, conceived,
perfected or first
-4-
<PAGE>
reduced to practice by Holland alone or in conjunction with others, during
the periods covered by this Agreement that:
i. Relate to any subject matter pertaining to projects assigned
to Holland hereunder;
ii. Relate to or is directly or indirectly connected with the
business, products, projects or Confidential Information of Datakey;
or
iii. Involve the use of any time, material or facility of
Datakey.
Holland hereby acknowledges that all said Inventions and Confidential
Information shall be "work made for hire" as defined in 17 U.S.C. Section
101 (1976), as amended, and as such, shall be the exclusive property of
Datakey. Holland hereby assigns to Datakey all of his/her right, title and
interest in such Inventions and Confidential Information.
c. LIMITATION OF SECTION 7.B. The provisions of Section 6.b. above
shall not apply to any Invention meeting all of the following conditions:
i. Such Invention was developed entirely on Holland's own time;
and
ii. Such Invention was made without the use of any of Datakey's
equipment, supplies, facility or trade secret information; and
iii. Such Invention does not relate (A) directly to the business
of Datakey or (B) to Datakey's actual or demonstrably anticipated
research and development; and
iv. Such Invention does not result from any work performed by
Holland for Datakey.
d. ASSISTANCE OF HOLLAND. Holland agrees, at Datakey's expense, to
give Datakey all assistance it reasonably requires to perfect, protect, and
use its rights to Inventions and Confidential Information. In particular,
but without limitation, Holland agrees to sign all documents, do all
things, and supply all information that Datakey may deem necessary or
desirable to (i) transfer or record the transfer of Holland's entire right,
title, and interest in Inventions and Confidential Information; and (ii)
enable Datakey to obtain patent, copyright, or trademark protection for
Inventions anywhere in the world.
e. CONTINUING OBLIGATION AFTER TERMINATION OF AGREEMENT. The
obligations of this Section 7 shall continue beyond the termination of this
Agreement with respect to Inventions conceived or made by Holland during
the term hereof and shall be binding upon Holland's assigns, executors,
administrators, and other legal representatives. In the event Holland is
called upon to render assistance to Datakey pursuant to Section 7.d. after
termination of this Agreement, Datakey shall pay Holland the compensation
-5-
<PAGE>
set forth in Section 3 above and shall call upon Holland for assistance at
such reasonable times so as not to interfere with Holland's employment or
business. For purposes of this Agreement, any Invention or discovery
relating to the business of Datakey upon which Holland files a patent
application within one (1) year after termination of this Agreement shall
be presumed to have been made during the term of this Agreement, subject to
proof to the contrary by good faith, written and duly corroborated records
establishing that such Invention or discovery was conceived and made by
Holland following termination of this Agreement.
f. RECORDS. Holland shall keep complete, accurate and authentic
accounts, notes, data and records of all Inventions in the manner and form
requested by Datakey. Such accounts, notes, data and records shall be the
property of Datakey, and upon its request Holland shall promptly surrender
the same to Datakey.
8. DOCUMENTS AND TANGIBLE PROPERTY. All tangible evidence of Confidential
Information or Inventions, including, without limitation, working models,
records, drawings, manuals, books, blank forms, documents, letters, memoranda,
notes, notebooks, reports, data, tables, calculations or copies thereof which
are conceived or generated by Holland or come into Holland's possession during
the term of this Agreement shall be and remain the exclusive property of
Datakey, and Holland agrees to return all such tangible evidence of Confidential
Information and Inventions to Datakey upon termination of this Agreement or at
such earlier time as Datakey may request.
9. INDEPENDENT CONTRACTOR. Holland acknowledges that in the performance
of his consulting services he is an independent contractor and is not and shall
not be deemed to be an employee, joint venturer, partner, franchisee or legal
representative of Datakey for any purpose whatsoever. Accordingly, Holland
shall be exclusively responsible for the manner in which he performs, and for
the profitability or lack thereof of, his activities under this Agreement.
Holland does not have, and shall not represent himself as having, any right or
authority to obligate or bind Datakey in any manner whatsoever.
10. TERMINATION. This Agreement to provide consulting services may be
terminated pursuant to any of the following provisions:
a. NOTICE. By either party, effective thirty (30) days after
delivery of written notice to the other party, with or without cause.
b. HOLLAND CEASES TO BE A DIRECTOR. At Datakey's option, upon
thirty (30) days written notice to Holland, if for any reason Holland
ceases to be a director of Datakey.
c. MUTUAL AGREEMENT. By mutual written agreement executed by both
parties.
d. DEFAULT. By either party, effective immediately upon delivery of
written notice to the other party, if the other party breaches any of its
obligations under this Agreement; provided that if such breach is curable,
such notice shall not be
-6-
<PAGE>
effective until the breaching party fails to correct such breach or default
within a period of thirty (30) days after delivery of such written notice.
If such breach is not curable, the Agreement shall terminate immediately
upon delivery of such notice of breach.
e. ADVERSE ACTIVITY. By Datakey effective immediately upon delivery
of written notice if (i) Holland is convicted of or enters a plea of guilty
or no contest to a charge of violating any law relating to Holland's
business, or (ii) Holland takes any action which impairs the goodwill
associated with Datakey's trademark, trade name or service mark, or makes
any unauthorized use or disclosure of any Confidential Information.
11. OBLIGATIONS UPON TERMINATION. In the event of the termination of
Holland as consultant to Datakey or his services as a director of Datakey, the
following provisions shall apply:
a. DOCUMENTS AND TANGIBLE PROPERTY. All documents containing any
Confidential Information or copies thereof which are conceived or generated
by Holland or which come into Holland's possession during the term of this
Agreement shall be returned to Datakey.
b. PAYMENT OF COMPENSATION. Datakey's sole obligation to Holland
upon expiration or proper termination of this Agreement shall be to pay
compensation determined in accordance with the provisions of Section 3
hereof for services rendered prior to the expiration or termination of this
Agreement. Holland hereby acknowledges that he has no right to and waives
any such implied rights to any reimbursement for lost profits or income or
any other loss, cost or expense resulting from expiration or termination of
this Agreement in accordance with its terms.
c. CONTINUING OBLIGATIONS. The obligations of Holland under
Sections 5, 6 and 7 herein shall survive the termination of this Agreement
and shall continue in full force and effect.
12. GENERAL PROVISIONS.
a. SEVERABILITY AND INTERPRETATION. In the event that a provision
of this Agreement is held invalid, the remaining provisions shall
nonetheless be enforced in accordance with their terms. Further, in the
event that any provision is held to be overbroad as written, such provision
shall be deemed amended to narrow its application to the extent necessary
to make the provision enforceable according to applicable law and shall be
enforced as amended.
b. NOTICES. Any notice required or permitted to be given under this
Agreement shall be deemed effective when received if delivered by hand,
telecopy, telex or telegram or three (3) days after depositing if placed in
the U.S. mails for delivery by registered or certified mail, return receipt
requested, postage prepaid and addressed to the appropriate party at the
address set forth on the first page of this
-7-
<PAGE>
Agreement. Such addresses may be changed by giving written notice to the
other party of such different address pursuant to the provisions of this
section.
c. NONASSIGNMENT. Holland shall not assign, transfer or sell all or
any part of his/her rights or obligations hereunder without the prior
written consent of Datakey. This Agreement shall be binding upon and inure
to the benefit of any successor or assignee of Datakey and of any permitted
successors and assigns of Holland as provided above.
d. CONTROLLING LAW AND ARBITRATION. This Agreement shall be deemed
to have been made in the State of Minnesota and shall be governed by and
construed in accordance with the laws of the State of Minnesota. All
disputes, controversies or differences arising out of or in connection with
this Agreement which cannot be settled by mutual agreement shall be finally
settled by binding arbitration pursuant to the Rules of Commercial
Arbitration of the American Arbitration Association then in effect. Any
arbitration hereunder shall be held in Minneapolis, Minnesota.
e. ENTIRE AGREEMENT. This Agreement, together with the exhibits
hereto, constitutes the entire Agreement between the parties and supersedes
any and all prior and contemporaneous oral or written understandings
between the parties relating to the subject matter hereof.
The parties have executed this Agreement in the manner appropriate to each
to be effective the day and year entered on the first page hereof.
/s/ Gary R. Holland
Gary R. Holland
DATAKEY, INC.
By: /s/ John H. Underwood
John H. Underwood
President and Chief Executive Officer
-8-
<PAGE>
EXHIBIT 11
DATAKEY, INC. AND SUBSIDIARY
COMPUTATION RE: EARNINGS PER SHARE
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Twelve Months Ended
December 31, December 31, December 31 December 31,
1995 1994 1995 1994
------ ------ ------ ------
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
EARNINGS
Net Income(loss) $51,861 $132,156 $175,626 ($173,020)
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
PRIMARY EARNINGS(LOSS) PER SHARE
Shares:
Weighted average number of common
shares outstanding 2,830,818 2,829,237 2,829,885 2,829,236
Assuming conversion of preferred stock 150,000
150,000 150,000 0
Assuming exercise of options and warrants
reduced by the number of shares which
could have been purchased with the
proceeds from exercise of such options
and warrants (treasury stock method)
using average market price 82,510 957 26,467 0
- ---------------------------------------------------------------------------------------------------------
Weighted average number of
common and common equivalent
shares outstanding 3,063,328 2,980,194 3,006,352 2,829,236
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
PRIMARY EARNINGS (LOSS) PER SHARE $0.02 $0.04 $0.06 ($0.06)
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
FULLY DILUTED EARNINGS(LOSS) PER SHARE
Shares:
Weighted average number of common 2,830,818 2,829,237 2,829,885 2,829,236
shares outstanding
Assuming conversion of preferred stock 150,000 150,000 150,000 0
Assuming exercise of options and warrants
reduced by the number of shares which
could have been purchased with the
proceeds from exercise of such options
and warrants (treasury stock method)
using the higher of the average market
price or the ending market price 89,939 957 65,289 0
- ---------------------------------------------------------------------------------------------------------
Weighted average number of
common and common equivalent
shares outstanding 3,070,757 2,980,194 3,045,174 2,829,236
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Fully Diluted Earnings(Loss) Per Share $0.02 $0.04 $0.06 ($0.06)
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 1995
<PAGE>
CONTENTS
- -------------------------------------------------------------------------
INDEPENDENT AUDITOR'S REPORT 1
- -------------------------------------------------------------------------
FINANCIAL STATEMENTS
Consolidated balance sheets 2 - 3
Consolidated statements of operations 4
Consolidated statements of stockholders' equity 5 - 6
Consolidated statements of cash flows 7 - 8
Notes to consolidated financial statements 9 - 14
- -------------------------------------------------------------------------
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Stockholders
Datakey, Inc.
We have audited the accompanying consolidated balance sheets of Datakey, Inc.
and subsidiary as of December 31, 1995 and 1994, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1995. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Datakey, Inc. and
subsidiary as of December 31, 1995 and 1994, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1995, in conformity with generally accepted accounting principles.
McGLADREY & PULLEN, LLP
Minneapolis, Minnesota
February 7, 1996
<PAGE>
<TABLE>
<CAPTION>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
ASSETS 1995 1994
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 713,230 $ 255,039
Investment in held-to-maturity securities (Note 2) 6,253,984 6,110,576
Trade receivables, less allowance for doubtful accounts
of $34,300 in 1995 and $53,700 in 1994 (Note 7) 1,055,075 1,190,893
Inventories (Note 4) 1,222,938 1,348,985
Deferred taxes (Note 3) 109,000 166,000
Prepaid expenses and other 52,177 26,242
Refundable income taxes 46,642 101,680
--------------------------------------
TOTAL CURRENT ASSETS 9,453,046 9,199,415
--------------------------------------
Other Assets
Licenses and patents, less amortization--1995 $118,702;
1994 $101,811 158,264 153,491
Non-compete agreement, less amortization--1995 $123,750;
1994 $41,250 41,250 123,750
--------------------------------------
199,514 277,241
--------------------------------------
Equipment and Leasehold Improvements, at cost
Production tooling 1,109,524 1,027,206
Equipment 2,358,938 2,211,216
Furniture and fixtures 211,822 211,822
Leasehold improvements 211,761 210,562
-------------------------------------
3,892,045 3,660,806
Less accumulated depreciation 2,366,660 1,936,935
-------------------------------------
1,525,385 1,723,871
-------------------------------------
$ 11,177,945 $ 11,200,527
-------------------------------------
-------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
2
<PAGE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS ' EQUITY 1995 1994
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current Liabilities
Accounts payable $ 509,683 $ 758,876
Accrued expenses:
Compensation 189,980 148,808
Other 108,692 93,918
Non-compete obligation - 82,500
-------------------------------------
TOTAL CURRENT LIABILITIES 808,355 1,084,102
-------------------------------------
Deferred Taxes (Note 3) 158,000 101,000
-------------------------------------
Commitments (Notes 5 and 8)
Stockholders' Equity (Notes 5 and 6)
Convertible preferred stock, voting, stated value $2.50 per
share; authorized 400,000 shares; issued and outstanding
150,000 shares in 1995 and 1994 375,000 375,000
Common stock, par value $0.05 per share; authorized
10,000,000 shares; issued and outstanding 2,835,236 shares
in 1995 and 2,829,570 shares in 1994 141,762 141,479
Additional paid-in capital 3,885,887 3,865,631
Retained earnings 5,808,941 5,633,315
-------------------------------------
10,211,590 10,015,425
-------------------------------------
$ 11,177,945 $ 11,200,527
-------------------------------------
-------------------------------------
</TABLE>
3
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Net sales (Note 7) $ 7,197,943 $ 5,814,636 $ 6,074,121
Other operating revenue 21,365 58,872 76,424
------------------------------------------------------
TOTAL REVENUE 7,219,308 5,873,508 6,150,545
------------------------------------------------------
Costs and expenses:
Cost of goods sold 4,821,516 4,111,131 3,749,894
Research and development 703,816 771,230 927,728
Marketing and sales 1,123,781 970,782 1,044,535
General and administrative 669,954 590,078 1,027,896
-----------------------------------------------------
TOTAL COSTS AND EXPENSES 7,319,067 6,443,221 6,750,053
-----------------------------------------------------
OPERATING LOSS (99,759) (569,713) (599,508)
Interest income 381,385 284,693 246,163
------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES 281,626 (285,020) (353,345)
Income tax expense (benefit) (Note 3) 106,000 (112,000) (163,000)
------------------------------------------------------
NET INCOME (LOSS) $ 175,626 $ (173,020) $ (190,345)
------------------------------------------------------
------------------------------------------------------
Net income (loss) per common share $ .06 $ .06 $ (.07)
------------------------------------------------------
------------------------------------------------------
Weighted average number of common shares and
common equivalent shares outstanding 3,006,352 2,829,236 2,772,883
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
<TABLE>
<CAPTION>
Convertible Preferred Stock
-------------------------------------
Shares Amount
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, December 31, 1992 195,500 $ 488,750
Issuance of common stock under stock options (Note 6) - -
Conversion of preferred stock (45,000) (112,500)
Net loss - -
-------------------------------------
Balance, December 31, 1993 150,500 376,250
Conversion of preferred stock (500) (1,250)
Net loss - -
-------------------------------------
Balance, December 31, 1994 150,000 375,000
Issuance of common stock under stock options (Note 6) - -
Net income - -
-------------------------------------
Balance, December 31, 1995 150,000 $375,000
-------------------------------------
-------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
Common Stock Additional
- --------------------------------------- Paid-In Retained
Shares Amount Capital Earnings Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
2,762,070 $ 138,104 $ 3,684,256 $ 5,996,680 $ 10,307,790
22,000 1,100 69,900 - 71,000
45,000 2,250 110,250 - -
- - - (190,345) (190,345)
--------- ----------- ------------- ------------- --------------
2,829,070 141,454 3,864,406 5,806,335 10,188,445
500 25 1,225 - -
- - - (173,020) (173,020)
--------- ----------- ------------- ------------- --------------
2,829,570 141,479 3,865,631 5,633,315 10,015,425
5,666 283 20,256 - 20,539
- - - 175,626 175,626
--------- ----------- ------------- ------------- --------------
2,835,236 141,762 $3,885,887 $5,808,941 $10,211,590
--------- ----------- ------------- ------------- --------------
--------- ----------- ------------- ------------- --------------
</TABLE>
6
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities
Net income (loss) $ 175,626 $ (173,020) $ (190,345)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation 461,378 402,394 293,701
Amortization 133,253 82,549 35,624
Change in accrued interest on investment
securities (44,399) (96,689) 69,961
Deferred taxes 114,000 18,500 (48,500)
Change in assets and liabilities:
Trade receivables 135,818 133,964 (558,864)
Inventories 126,047 (639,068) 87,423
Accounts payable (249,193) 63,488 400,074
Other 85,049 (107,972) (81,823)
-------------------------------------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES 937,579 (315,854) 7,251
-------------------------------------------
Cash Flows From Investing Activities
Purchase of equipment (262,892) (574,752) (785,199)
Purchase of held-to-maturity securities (6,073,735) (8,313,568) -
Proceeds from maturity of held-to-maturity
securities 5,974,726 6,806,795 -
Purchase of marketable debt securities - - (7,101,635)
Proceeds from maturity of marketable debt
securities - - 9,011,025
License and patent costs (55,526) (92,882) (38,218)
-------------------------------------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (417,427) (2,174,407) 1,085,973
-------------------------------------------
</TABLE>
(Continued)
7
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
<TABLE>
<CAPTION>
1995 1994 1993
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Financing Activities
Net proceeds from issuance of common stock 20,539 - 71,000
Payments on non-compete obligation (82,500) (82,500) -
-------------------------------------------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (61,961) (82,500) 71,000
-------------------------------------------
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 458,191 (2,572,761) 1,164,224
Cash and Cash Equivalents
Beginning 255,039 2,827,800 1,663,576
-------------------------------------------
Ending $ 713,230 $ 255,039 $ 2,827,800
-------------------------------------------
-------------------------------------------
Supplemental Disclosures of Cash Flow Information
Net cash refunds of income taxes $ 63,038 $ 136,603 $ 45,822
-------------------------------------------
-------------------------------------------
Supplementary Schedule of Noncash Investing and
Financing Activities
Obligation recorded under non-compete
agreement $ - $ 165,000 $ -
-------------------------------------------
-------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
8
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS: Datakey, Inc. designs, manufactures, and markets
portable-memory-based systems, subsystems, and custom-designed components for
security-driven markets. The Company's proprietary memory keys, cards, and
custom-shaped tokens serve as a convenient way to carry electronic information
and are packaged to survive in portable environments. Datakey products enhance
security and simplify equipment use for a wide range of applications by
automating critical identification, data collection, and control functions.
Sales are to customers in the United States and around the world. The Company's
practice is to grant credit to customers who meet certain financial criteria.
A summary of significant accounting policies follows:
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Datakey, Inc. and its wholly-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS: For purposes of reporting the statements of cash
flows, the Company includes all cash accounts and all highly liquid debt
instruments purchased with an original maturity of three months or less as cash
and cash equivalents on the accompanying consolidated balance sheets.
The Company maintains its cash in bank deposit accounts which, at times, may
exceed federally insured limits. The Company has not experienced any losses in
such accounts.
INVESTMENT IN DEBT SECURITIES: The Company has investments in debt securities
consisting of obligations of the U.S. government with maturities of 12 months or
less. Since the Company intends to hold the debt securities to their
maturities, the investment in debt securities has been classified as
held-to-maturity and is recorded at amortized cost.
FINANCIAL INSTRUMENTS: On December 31, 1995, the Company adopted Statement of
Financial Accounting Standards No. 107, DISCLOSURES ABOUT FAIR VALUE OF
FINANCIAL INSTRUMENTS, which requires all entities to disclose the fair value of
financial instruments. The following methods and assumptions were used by the
Company in estimating fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amount of cash equivalents
reported in the balance sheet approximates fair value because of the short
maturity of those instruments.
INVESTMENTS IN HELD-TO-MATURITY SECURITIES: The fair value of the
Company's investments in held-to- maturity securities is based on quoted
market prices (Note 2).
INVENTORIES: Inventories are stated at the lower of cost (first-in, first-out
method) or market.
9
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEPRECIATION: Depreciation of equipment and leasehold improvements is computed
on the straight-line and accelerated methods over the following estimated useful
lives:
<TABLE>
<CAPTION>
Years
- --------------------------------------------------------------------------------
<S> <C>
Production tooling 2-3
Equipment 5-7
Furniture and fixtures 7
Leasehold improvements Life of lease
</TABLE>
WARRANTY COSTS: The Company provides for estimated normal warranty costs at the
time of product sales to the customers and for other costs associated with
specific items at the time their existence and amounts are determinable.
INCOME TAXES: Deferred taxes are provided on a liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss or tax credit carryforwards, and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the amounts of assets and liabilities recorded for income
tax and financial reporting purposes. Deferred tax assets are reduced by a
valuation allowance when management determines that it is more likely than not
that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
LICENSES AND PATENTS: Licenses and patents are stated at cost and are being
amortized using the straight-line method over their economic useful lives which
has been estimated to be five years.
NON-COMPETE AGREEMENT: The Company's former president entered into a
non-compete agreement with the Company payable over a one-year period. The
agreement not to compete is for a period of two years and is being amortized
over that term using the straight-line method.
RESEARCH AND DEVELOPMENT: Research and development costs are charged to expense
as incurred.
NET INCOME (LOSS) PER COMMON SHARE: In 1995, net income per common share and
common equivalent share was based on the average number of common shares
outstanding during the year, assuming conversion of the preferred shares which
are common equivalent shares and the exercise of all stock options having
exercise prices less than the average market price of common stock using the
treasury stock method. In 1994 and 1993, the net loss per common share was
based on the weighted average number of common shares outstanding.
Net income per share in 1995 assuming full dilution was the same as primary net
income per share, as the difference between the two computations was not
material.
10
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
RECENTLY ISSUED ACCOUNTING STANDARD: In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION, which establishes new standards for
stock-based employee compensation plans. The Statement establishes a
fair-value-based method of accounting for stock-based compensation plans and
encourages, but does not require, entities to adopt that method in place of APB
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, for all arrangements
under which employees receive shares of stock or other equity instruments of the
employer or the employer incurs liabilities to employees in amounts based on the
price of its stock. Entities that elect to continue under Opinion No. 25 must
disclose pro forma net income (and earnings per share) for all years presented
as if Statement No. 123 had been adopted.
The Company does not intend to adopt Statement No. 123 in measuring expense,
however they must present the pro forma disclosures beginning in 1996, and those
pro forma amounts will likely reflect higher compensation expense than the
amounts shown in future statements of operations.
NOTE 2. INVESTMENT IN HELD-TO-MATURITY SECURITIES
The following is a summary of the Company's investment in held-to-maturity
securities as of December 31, 1995 and 1994:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995:
U.S. government securities $6,253,984 $8,713 $ 743 $6,261,954
1994:
U.S. government securities 6,110,576 504 28,646 6,082,434
</TABLE>
All securities are due within one year and all investment earnings represent
interest income on the above securities and previously held debt securities.
11
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. INCOME TAXES
The income tax expense (benefit), consists of the following:
<TABLE>
<CAPTION>
1995 1994 1993
- -------------------------------------------------------------------------------------
Currently payable (refundable):
<S> <C> <C> <C>
Federal $ (9,000) $(131,500) $(115,500)
State 1,000 1,000 1,000
Deferred 114,000 18,500 (48,500)
-----------------------------------------
$106,000 $(112,000) $(163,000)
-----------------------------------------
-----------------------------------------
</TABLE>
The income tax expense (benefit) is different from that which would be computed
by applying the U.S. federal income tax rate (35 percent) to pretax income
(loss) as follows:
<TABLE>
<CAPTION>
1995 1994 1993
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed "expected" federal tax expense
(benefit) at statutory rates $ 99,000 $(100,000) $(124,000)
Effect of graduated tax rates (3,000) 3,000 4,000
State income taxes, net of federal benefit 1,000 1,000 1000
Nontaxable municipal bond interest income - (11,000) (23,000)
Other 9,000 (5,000) (21,000)
----------------------------------------
Actual tax expense (benefit) $106,000 $(112,000) $(163,000)
----------------------------------------
----------------------------------------
</TABLE>
Net deferred tax (liabilities) assets consist of the following components as of
December 1995 and 1994:
<TABLE>
<CAPTION>
1995 1994
- -------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liability:
Depreciation $158,000 $101,000
------------------------
Deferred tax assets:
Allowance for doubtful accounts 12,000 21,000
Inventory 59,000 106,000
Warranty reserve 13,000 20,000
Vacation 13,000 19,000
Other 12,000 -
------------------------
109,000 166,000
------------------------
$(49,000) $ 65,000
------------------------
------------------------
</TABLE>
No valuation allowance is required for the deferred tax assets as the recorded
amounts are considered to be fully realizable.
12
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4. INVENTORIES
Inventories consist of the following components as of December 31, 1995 and
1994:
<TABLE>
<CAPTION>
1995 1994
- --------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 822,035 $ 935,157
Work in process 127,567 169,831
Finished goods 273,336 243,997
-------------------------
$1,222,938 $1,348,985
-------------------------
-------------------------
</TABLE>
NOTE 5. PREFERRED STOCK
The preferred shares are convertible at the rate of one share of common stock
for each share of preferred stock subject to certain anti-dilution adjustments.
Conversion is mandatory in the event of certain future public offerings of
corporate stock. The holders of the preferred stock have certain piggyback and
demand registration rights and also have a liquidation preference of $2.50 per
share and share in dividends paid on common stock.
NOTE 6. STOCK OPTIONS
The Company has reserved 550,000 common shares for issuance under qualified and
nonqualified stock options for its key employees and directors. The Company has
also reserved 50,000 common shares for issuance under nonqualified options to
various distributors, dealers, and consultants. Option prices are the fair
market value of the stock at the time the option was granted. Options become
exercisable as determined at the date of grant by a committee of the Board of
Directors. Options expire ten years after the date of grant unless an earlier
expiration date is set at the time of grant. Other pertinent information
related to the plans is as follows:
<TABLE>
<CAPTION>
Number of Shares
-----------------------------------------
1995 1994 1993
-----------------------------------------
<S> <C> <C> <C>
Under option, beginning of year 179,000 304,000 351,000
Granted 312,000 20,000 -
Terminated and canceled (33,000) (145,000) (25,000)
Exercised (5,666) - (22,000)
-----------------------------------------
Under option, end of year 452,334 179,000 304,000
-----------------------------------------
-----------------------------------------
Exercisable, end of year 193,000 72,500 87,750
</TABLE>
<TABLE>
<CAPTION>
Price Ranges
-----------------------------------------
1995 1994 1993
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Granted during the year $3.50-3.81 $ 3.63 $ -
Exercised during the year 3.63 - 3.00-3.50
Under option, end of year 3.13-5.75 3.13-7.25 3.00-7.25
</TABLE>
Stock options for 45,000 shares were granted to non-employee directors during
1995. These options are subject to shareholder approval in 1996 of an amendment
to the stock option plan
13
<PAGE>
DATAKEY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7. MAJOR CUSTOMERS AND INTERNATIONAL SALES
MAJOR CUSTOMERS: Net sales for the years ended December 31, 1995, 1994, and
1993, include sales to the following major customers.
<TABLE>
<CAPTION>
Amount of Net Sales Trade Receivables Balance
---------------------------------------- --------------------------
1995 1994 1993 1995 1994
- ---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. government agencies $ 993,000 $1,146,000 $3,108,000 $ 192,000 $ 223,000
Customer A 2,158,000 781,000 702,000 94,000 152,000
Customer B 563,000 627,000 142,000 - 301,000
Customer C 530,000 603,000 524,000 98,000 54,000
-----------------------------------------------------------------------
$4,244,000 $3,157,000 $4,476,000 $ 384,000 $ 730,000
-----------------------------------------------------------------------
-----------------------------------------------------------------------
</TABLE>
INTERNATIONAL SALES: Export sales to international customers for the years
ended December 31, 1995, 1994, and 1993, were $1,907,000, $1,716,000, and
$1,125,000, respectively.
NOTE 8. COMMITMENT
The Company leases its office and warehouse facilities under a noncancelable
operating lease which expires June 1997. Total rent expense for each of the
years ended December 31, 1995, 1994, and 1993, was $97,000.
Minimum annual cash commitments under this lease are as follows:
<TABLE>
<CAPTION>
Year ending:
<S> <C>
1996 $114,000
1997 59,000
</TABLE>
14
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement on
Forms S-8 No. 33-14144, No. 33-47068, No. 33-67280 and No. 33-80894 of our
report dated February 7, 1996, with respect to the financial statements of
DATAKEY, INC., which appear in Item 7 of the annual report on Form 10-KSB for
the year ended December 31, 1995.
McGLADREY & PULLEN, LLP
Minneapolis, Minnesota
March 27, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<EXCHANGE-RATE> 1
<CASH> 713,230
<SECURITIES> 6,253,984
<RECEIVABLES> 1,089,375
<ALLOWANCES> 34,300
<INVENTORY> 1,222,938
<CURRENT-ASSETS> 9,453,046
<PP&E> 3,892,045
<DEPRECIATION> 2,366,660
<TOTAL-ASSETS> 11,177,945
<CURRENT-LIABILITIES> 808,355
<BONDS> 0
0
375,000
<COMMON> 141,762
<OTHER-SE> 9,694,828
<TOTAL-LIABILITY-AND-EQUITY> 11,177,945
<SALES> 7,197,943
<TOTAL-REVENUES> 7,219,308
<CGS> 4,821,516
<TOTAL-COSTS> 4,821,516
<OTHER-EXPENSES> 2,497,551
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 281,626
<INCOME-TAX> 106,000
<INCOME-CONTINUING> 175,626
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 175,626
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
